602 Management Accounting

602 The accounting management
1．The Role Of Management Accounting
So you want to be a management accountant.
What would this involve?
How would this differ from the work performed by other types of accountants?
Would your role involve management functions as well as accounting functions?
What skills and qualities would you be expected to have?
In this first topic we answer these questions.
Learn ing ou tco mes
Once you‟ve completed this topic you should be able to:
Identify the d iffe rences and similarities be tween manage me nt a ccounting and
financia l a ccounting
Outline what the p lanning and contro l p ro cess is
Exp la in the ro le o f the mana ge ment a ccountant in the p lanning and co ntro l p rocess Management Accounting And Financial Accounting
Finan cial a ccoun ting
Financial accounting is about recording and reporting financial information to external users such as investors, creditors, banks and the government. Typical tasks for financial accountants include:
Recording journals
Carrying out reconciliations
Maintaining the fixed asset register
Preparing tax returns
Preparing and auditing financial statements
Manag eme nt ac coun ting
Management accounting is about providing financial and non-financial information to internal users - to the managers of an organisation - to help the organisation achieve its goals. Typical tasks for management accountants include:
Preparing budgets and forecasts
Costing and pricing products and services
Designing, implementing and maintaining management information systems
Preparing daily, weekly or monthly management reports
Carrying out ad hoc investigations for management
Differences Between Management And Financial Accounting
Key differences include:
Management accounting is for internal users while financial accounting is for external users
Financial accounting uses historical data. Management accounting uses historical data and future-focused data
Financial accounting uses data from the general ledger accounting system. Management accounting uses many sources of data
Management accounting is unregulated while financial accounting is highly regulated, being subject to the rules of the Financial Reporting Act and the Income Tax Act
Financial accounting reports usually cover the whole organisation while management accounting reports are normally for individual sections of the organisation
Management accounting information is timelier than financial accounting information; shareholders may wait three months to get an annual report but department managers usually expect their reports within a few days of period end
Go to the job website www.s e e . Carry out a s earch for jobs under the “Classification” of Accounting.
Enter the keyword “management” to bring up management accounting jobs and then “financial” to bring up financial accounting jobs. Choosing two management accountant job advertisements and two financial
accountant job advertisements write down a summary of:
i) the differences between the management accounting and financial accounting jobs
ii) the similarities between the management accounting and financial accounting jobs
Are the s kills and qualities that employers are looking for from management accountants those that you
would expect?
Similarities Between Management And Financial Accounting Include: Both use data from the general ledger accounting system
In New Zealand both are generally me mbers of the Institute of Chartered Accountants of New Zealand (ICANZ) and are bound by the same ethical and professional standards
Many of the core skills required are the same for both e.g. good communication and information
technology skills
Many accountants perform both financial accounting and management accounting tasks. New Zealand businesses are often too small to justify multiple accountants and employ one accountant who performs both roles. Chartered accounting firms also increasingly offer management accounting services for their clients, not just financial reporting and compliance services.
The Planning And Control Process
You may have started this paper with a goal in mind such as “to get an A grade”. To achieve this you plan to spend a certain number of hours a week studying. L et‟s pretend that you get 60% in your first assignment, disappointing as you need to average 75% to get that A grade. You try to identify why you didn‟t do as well as hoped. Perhaps you didn‟t do enough research or you left writing the assignment until the last moment.
You might now decide to increase the amount of time you spend on study or to change the way you study. Or you might revise your target from an A to a B grade. You‟d then see how you went in the next assessment compared to your plan.
This scenario represents the planning and control process, the same process that is carried out in businesses across New Zealand. The key stages of this process are:
Planning: Identifying what your goals are, the steps you intend to take to achieve them and how you‟ll measure your progress towards them
Measuring: Collecting data on actual performance
Variance reporting: Reporting the actual results compared to the plan
Investigating variances: Finding out the underlying reasons for significant variances from the plan
Corrective action: Taking steps to improve performance or to adjust the plan
The Management Accountant’s Role
The role of the management accountant in the planning and control process varies depending on the organisation‟s resources and management philosophy. Typical tasks include:
You will explore the management accountant‟s role in planning and control in more depth in Topics 9 (Budgeting) and 10 (Standard Costing).
Go to htt p://www.a cce l-te /cont rol_sy ste ms/h_cont rol_01.htm l and read the Management
Planning Process article. Consider:
How management accountants might be involved in establishing standards?
What forms of response can the “corrective action” s tage involve?
What could the “behavioural aspects of the (control) process” involve?
What skills do management accountants need to perform well in their planning and control role?
2. Choosing Costs
Different Ways To Classify Cost
What do es it co st you to s tud y this pape r?
Did you answer “the amount of the enrolment fee”? Or did you also include the cost of your textbook? What about a share of your hom e internet and computer costs if you study from home? How about a share of your home rent and power bill? What about the extra wages that you could be earning if you weren‟t studying this paper?
Cost is not a set, easily calculated amount. You can see from considering the cost of studying this paper that what som ething “costs” depends on what types of cost we cho ose to include.
Common cost classifications
Direct And Indirect Costs
Whether a cost is direct or indirect depends on the cost object–the thing we‟re relating the cost to. If the cost object is a Big Mac burger then the beef patty in it would be a direct cost but the cost of cleaning the McDonalds outlet you buy it from would be an indirect cost. If the cost object is your local McDonalds outlet then the cleaning cost would be a direct cost but the salary of McDonalds‟ New Zealand‟s CEO would be an indirect cost. If the cost object was McDonald‟s New Zealand then the CEO‟s salary would be a direct cost.
Traceability
Whether a cost can be easily traced to a cost object or not determines whether it is a direct or indirect cost. Would photocopying be a direct or an indirect cost of a research organisation‟s individual projects?
Direct if an individual project code was entered in the photocopier each time photocopying was done
Indirect if no code or if one general code was entered each time photocopying was done
Fitting Cost To Purpose
The fabric a clothing manufacturer makes a garment from depends on what the garment will be used for. Lightweight, quick-drying fabric for a swimsuit, thick and weatherproof fabric for alpine clothing, soft fabric for underwear etc. Accountants follow the same principle when choosing which costs to include when costing a product or service – their choice depends on what the cost is to be used for.
Illustration
Fisher and Paykel Appliances – see ww – make home appliances – ovens, washing machines, dishwashers, fridges etc.
The cost of a dishwasher depends on the decision managers will make with this information:
Information: Costs vs. Benefits
As a student you specialise in information gathering. Every day you make information-gathering decisions. Is it worth reading a particular article? Should you spend the next hour researching in the library or on the internet? Will reading chapter five of the text really help you in the test?
What factors do you consider when deciding what information you’ll seek and how you’ll get it?
Management accountants face the same situation as you each day as they support management decision-making. What level of detail is needed? Where would be the best place to get the information? How much time and cost should they spend getting it?
To decide what information to gather we need to assess the value of the information and the cost of collecting it.
Costs of collecting information
Time spent designing, setting up and maintaining an information system
Time spent collecting, reporting and interpreting data
Information technology costs – the set-up and running costs of computer terminals, scanners, servers and networks used to collect, store and report data
Information overload: So much data is collected and reported that managers may be unable to absorb what is significant
Behavioural costs: Staff may resist providing new data and even deliberately feed in incorrect data
Benefits of information
Improved decision-making due to more accurate and complete information
Competitive advantage over rivals working with less accurate information
Balancing costs and benefits
Before committing to any significant information-gathering project we need to weigh up both the likely benefits of the information and the cost of collecting it. This is difficult because:
Behaviour costs are almost impossible to value yet may be significant
It is difficult to quantify the benefits of information in monetary terms
We should still identify the costs and benefits. Where these can‟t easily be quantified in monetary terms we should still rate their relative importance taking account of:
Competitive strategy e.g. information on delivery times is critical to a pizza firm using prompt delivery as
a key selling point but not to one using low prices as its key selling point
Information-problem warning signs e.g. unexpectedly losing tenders may indicate inaccurate cost
information, production hold-ups due to unexpected component shortages may indicate inaccurate
production data
3. Cost Flows
The cost of a product or service represents the value of the resources used to make it. These resources don‟t simultaneously come together –they‟re added to the product or service over a period of time. Tracking this flow of resources is an important managementaccounting task and the focus of this topic.
Learn ing ou tco mes
Once you‟ve completed this topic you should be able to:
Outline the flow of costs in manufacturing firms
Outline the flow of costs in service firms
Demonstrate an understanding of the value chain
Manufacturing Cost Flows
Traditional manufacturing cost tracking
Traditional cost accounting has focused on production cost flows with no tracking of upstream and
downstream costs to products. These production costs are made up of:
Direct materials: the physical components that go into the product
Direct labour: the wages of those making the product
Production overhead: the machinery, power and other factory resources that labour needs to convert direct material into finished product
Re cording cost flows
Accounting entries record the addition of resources and the flow of product through the business. Once recorded using manual journalstoday entries are likely to be computerised. Entries would include:
Purchase raw materials:Debit Raw materials inventory Credit Accounts payable
Issue raw materials to work in process (WIP):Debit WIP inventory Credit Raw materials inventory
Record direct labour costs:Debit WIP inventory Credit Wages expense
Allocate manufacturing overhead:Debit WIP inventory Credit Manufacturing overhead expense
Individual overhead expenses such as power and factory rent would first be recorded individually and then transferred to manufacturing overhead expense
Transfer finished product to inventory:Debit Finished goods inventory Credit WIP inventory
Record cost of product sold:Debit Cost of goods sold Credit Finished goods inventory
Service Firm Cost Flows
Differences from manufacturing cost flows:
Service outputs are intangible
Unlike products, services are not inventoriable
Services tend to be heterogenous - varying from client to client. Manufactured products tend to be
homogenous e.g. one can of Watties tomato sauce is the same as the next
Direct material is a separate component for manufacturers but is usually included within overheads for service firms
Service firms don‟t distinguish between production and non-production overhead
Se rvice costing challenges:
The true cost of the service varies greatly from customer to customer but is often unknown; the one-off nature of servicesmeans that the effort to calculate an accurate cost may not be justified
Close tracking of the work carried out by specific employees is critical to accura te costing but may be resisted by employees
Overheads are a significant cost for service firms but most don‟t track how different services actually use overhead resources
The Value Chain
Michael Porter introduced the concept of the value chain in his 1985 book Competitive Advantage: Creating and Sustaining Superior Performance. The value chain views business as a sequence of activities that convert inputs into outputs valued by customers. The value chain model applies to:
Whole industries e.g. from a farmer raising lambs through to a supermarket selling sheep meat
Individual businesses
Breaking down a business into its key activities helps managers to assess which activities are competitive strengths and which are weaknesses. The activities are grouped into:
Primary activities: activities directly involved in creating and delivering a product/service
Support activities: activities not directly involved in production but that assist effectiveness or efficiency Primary activities
Inbound logistics: receiving and storing materials
Operations: the manufacture of products and services
Outbound logistics: getting goods and services to buyers
Marketing and sales: informing customers about goods and services
Service: after-sale support of the goods/services
Support activities
Procurement: sourcing and negotiating resource supply
Human resource management: recruiting, developing and rewarding employees
Technology development: managing information processing and protection
Infrastructure: various support functions including finance, planning, quality control and senior
management
The words in red font are a lis t of activities for Mowit Ltd, a lawnmower manufacturer. Click and drag each activity into the appropriate place in value chain diagram:
Summary
The cost of a product or service is not static. It grows as more resources are added to convert raw material into finished product or to provide the complete service. Identifying and tracking these cost flows is a key function of management accounting.
Having completed this topic you should be able to:
Identify the three categories of production costs for a manufacturer: direct material, direct labour and production overhead
Understand how accountants record the flow of manufacturing costs from direct material through to cost of goods sold
Understand that service cost flows lack the tangible, inventoriable and homogenous nature of
manufacturing cost flows
View costs as stages in a value chain that converts inputs into value-added outputs
4. Allocating Overhead
Tracking overhead costs to products and services presents a major challenge for management accountants. In this topic you will learn why this is and explore options for dealing with this challenge.
Learn ing ou tco mes
Once you‟ve completed this topic you should be able to:
Use cost drivers to apply overhead
Distinguish between actual costing and normal costing
Explain the importance of choosing appropriate cost drivers to apply overhead
Overhead Costs
Next time that you buy a flat white at your local coffee bar ask yourself what it cost to make. The direct material cost of coffee beans and milk? Plus the wages of the barista? But it takes more than coffee beans, milk and a barista for you to be drinking that cup in that coffee bar – the othe r things needed are what we call “overhead”. These would include:
Rent
Power
Espresso machine and grinder
Furniture
Fridge, cash register and EFTPOS machine
Crockery
Music and magazines
Staff to clear and clean cups
Allocating overheads: single product
If the business only sells one product how difficult is it to allocate overhead? Let‟s pretend a coffee bar sells only cups of coffee and:
Overheads total $6,000 a month
The business sells 5,000 cups of coffee a month
then the overhead cost per cup = $6,000/5,000 cups
= $1.20 per cup
Simple - if a business sells only one product!
Allocating overheads: multiple products
Few businesses sell only one product. The coffee bar would not just sell cups of coffee but also cups of tea, slices and cakes, soft drinks and light meals. Should a can of Coke have the same overhead allocated to it as a cup of coffee? Should a meal?
If a product uses more overhead resources then more overhead cost should be allocated. Allocating the same amount to each item sold is not generally fair. Instead of allocating overhead based on output – units produced or sold – most businesses allocate it based on units of input such as direct labour hours.
Example
The coffee bar sells only cups of coffee and light meals. Each month on average it:
Has $7,500 in overheads
Sells 5,000 cups of coffee
Sells 1,000 light meals
Takes 6 minutes (0.1 hours) to make a cup of coffee
Takes 15 minutes (0.25 hours) to make a light meal
DLHrs = 5,000 cups x 0.1 + 1,000 meals x 0.25 = 500 + 250 = 750
Overhead rate = overhead cost/DLHrs = $7,500/750 = $10.00 per DLHr So:
cup o f co ffee o verhead = $10 x 0.10 DLHr = $1.00 pe r cup
light mea l ove rhead = $10 x 0.25 DLHr = $2.50 per mea l
Service Firms And Overhead Costs
Like manufacturers, service firms have overhead costs to allocate to their …products‟. They want to know the cost of their different servicesin order to:
Work out appropriate rates to charge clients
Identify how efficiently you deliver particular services
Overheads and charge out rate
Let‟s say you‟re going into business on your own as a dentist, accountant, painter, mechanic, wedding planner or gardener. How much should you charge your clients? Enough to cover your overhea d costs and your desired income. Let‟s assum e:
You want to earn $45,000 p.a.
Your overhead costs total $25,000 p.a.
First work out your expected chargeable hours for the year.
Remember to:
Allow time off for public holidays and annual leave
Allow for non-chargeable time spent on planning, marketing, training and administration
If you expect to work 46 weeks at 30 chargeable hours per week then total chargeable hours are 1,380
As you need $70,000 ($45,000 + $25,000) from your 1,380 hours your charge-out rate needs to be: $70,000/1,380 = $50.73 per hour i.e. roughly $50 per hour
Overheads and service efficiency
Allocating overhead based on direct labour hours fairly measures cost if overheads are used in proportion to the time spent performing the service. Yet many overheads don‟t fit this. Dental equipm ent may be used for a 10 minute filling but not for a 15 minute check-up. A dentist may spend ten minutes on one client and one hour on the next but the receptionist‟s effort checking in the client is un changed.
Most service providers will need to develop a more sophisticated way to allocate overhead in order to fairly assess how efficiently they‟re performing their different services. This is explored in Topic 8 – Activity based costing.
Actual And Normal Costing
Actual costing and normal costing are alternative ways of allocating overhead costs to products or services.
Actual costing
The overhead rate used to allocate costs is the period‟s actual overhead costs divided by the actual units of cost driver.
Example:
Sportex makes a range of sports products and allocates overhead using direct labour hours. In July overheads totalled $10,940 and 2,415 hours were worked. 500 of these hours were spent making golf carts.
The overhead rate = $10,940/2,415 = $4.53 per DLHr
500 x $4.53 = $2,265 in overheads is allocated to the golf carts.
Normal costing
The overhead rate used to allocate costs is the expected overhead costs divided by the expected units of cost driver. This rate is then multiplied by the actual units of cost driver that a particular product uses to allocate the overhead. Example:
Sportex makes a range of sports products and allocates overhead using direct labour hours. The year‟s overhead is budgeted to total $115,000. Direct labour hours are expected to total 25,000. In July 500 hours are spent making golf carts.
The overhead rate = $115,000/25,000 = $4.60 per DLHr.
500 x $4.60 = $2,300 in overheads is allocated to the golf carts.
Because normal costing uses a pre-determined rate cost information is available to managers far sooner than with actual costing. Most businesses use normal costing.
Under and over-applied overhead
While timely, normal costing will never be 100% accurate. The actual overheads for a period will differ from the total overhead applied to products.
Example:
In July Sportex worked 2,120 hours making products.
2,120 DLHrs x $4.60 overhead rate = $9,752 overhead applied.
If actual production overhead for July totalled $9,890 then overhead has been under-applied by $138. If the actual overhead was only $9,600 then overhead would have been over-applied by $152.
Manufacturing Overhead
Dr Cr
apply to WIP 9,752
rent 2,000
indirect materials 540
salary 2,600
power 1,560
depreciation 3,190
Under-applied - to
COGS138
9,890 9,890
Most businesses expense under/over-applied overhead to cost of goods sold. If the amount is significant and not all of the period‟s production has been sold then it may instead be apportioned between cost of goods sold,
finished inventory and work-in-process.
Choosing Cost Drivers
Cost drivers
A cost driver is a factor that causes overhead costs. Examples:
Kilowatt hours used is a cost driver of electricity cost
Machine hours used is a cost driver of machinery cost
Square metres occupied is a cost driver of building cost
The term “cost driver” is often used when referring to the basis on which overhead cost is allocated but not all allocation bases are true cost drivers.
Example: a polytechnic uses student numbers as the …cost driver‟ to allocate advertising costs to courses. Yet each course‟s advertisement may c ost the same regardless of the number of students each has.
Think of a business you work in or visit regularly. Consider what its overhead cos t drivers would be. Choosing a cost driver
Choosing the right cost driver to allocate overhead is critical to accurate product costs
Using the wrong cost driver can result in bad decision-making. Example: 80% of ManuTech‟s production overhead is machine-related – depreciation, power etc. It allocates overhead using direct labour hours.
Products that use a lot of machinery but littlelabour get allocated a low cost despite using much of the overhead resources. Management think these products are far less costly than they really are and
under-price them
Choose a cost driver that is closely correlated to the consumption of most overhead resources
Using one plant-wide/department-wide cost driver will mean some inaccurate cost allocation e.g. ManuTech would be best to use machine hours to allocate overhead if 80% of costs are machine related. But the other 20% of costs will be unfairly allocated. In Topic 8 – Activity-based costing –we look at multiple cost drivers
Summary
Allocating overhead to products and services is not easy. You need to understand the options available and be able to recognise the most appropriate option in a given situation.
Having completed this topic you should be able to:
Distinguish between normal costing - using a pre-determined overhead rate - and actual costing - using an actual overhead rate
Recognise that under-applied and over-applied overhead result from using a pre-determined rate
Allocate overhead to products/services using a specific cost driver
Understand that choosing a cost driver that fairly reflects how products consume overhead is critical to accurate product costsand management decision-making
5. Service Department Costs
Most large businesses are made up of:
Operating departments: Departments that make products or services
Service departments: Departments that give support to operating departments rather than making the product/service themselves
Service department costs are allocated to operating departments in order to calculate the full cost of
products/services.
Learn ing ou tco mes
Once you‟ve completed this topic you should be able to:
Allocate service department costs to production departments using the direct method
Allocate service department costs to production departments using the sequential method
Allocate service department costs to production departments using the reciprocal method
Explain when a particular service department cost allocation method is appropriate
The Direct Method
Case stu dy
Alumex Ltd, an aluminium foundry has two operating departments – Smelting and Moulding – and two service departments – Human Resources (HR) and Information Technology (IT).
Annual costs are budgeted to be $100,000 for HR and $200,000 for IT
HR cost is allocated based on number of employees (50 in total)
IT cost is allocated based on IT technician hours worked (6,000 hours in total)
A breakdown of HR and IT use is shown in figure 1 (see right hand side of page)
Using the direct method
The direct method ignores services provided by one service department to another service departm ent. It allocates all service departmentcosts directly to operating departm ents.
Alumex example:
HR cost is allocated: 20/45 x $100,000 = $44,444 to Smelting 25/45 x $100,000 = $55,556 to Moulding Note that the 5 employees in IT are ignored
IT cost is allocated: 3,000/4,800 x $200,000 = $125,000 to Smelting 1,800/4,800 x $100,000 = $75,000 to Moulding Note that the 1,200 hours used by HR are ignored
The Sequential Method
The sequential or step-down method takes into account the services provided from one service department to another but any other interdepartmental services are ignored.
Select the service department whose services will be allocated to all other departments (including service departments). Select the department: i) that serves the most other service departments ii) – if there is a tie in i) – that has the highest cost
Allocate that dep artment‟s cost to ALL other user departments
Add the direct costs of the second service department together with its cost allocated from the first
department
Allocate the second service department‟s costs out to all other departments except the first service
department - ignore that department‟s share of the allocation base
Case study example
Let‟s use the sequential method to allocate the service departm ent costs of Alumex:
Both IT and HR serve the same number of service departments (one) so we start with the department with the biggest cost, IT
IT‟s $200,000 is allocated to all other departments
HR‟s $100,000 direct cost plus its $40,000 share of IT is then allocated to just Smelting and Moulding in proportion to their use of HR。