3: Cost Classification I Flashcards
Types of Accounting
Financial Accounting
Management Accounting
What is Financial Accounting?
Accounting deal with the external reporting requirements of the organisation
Is required by law
Prepare statutory Accounts / Financial Statements
Example; balance sheet, income statement, cash flow statement based on specific standards and formats (IFRS / GAAP)
It has time dimension – report frequency, retrospective (12 months period)
It covers the entire organisation
It is for both Internal Stakeholders (Management) and External Stakeholders (Shareholders, lenders, tax authorities etc.)
It may require independent external review (Statutory Audit)
What is Management Accounting?
The process of collecting, classifying, processing, analysing and reporting info to managers to allow them to take efficient and effective management decisions - Kaplan and Atkinson 1989
Deals with collecting and processing data to facilitate internal decision-making
There is no legal requirement to use management accounting
There is no specific formats or standards required
For Internal stakeholders only - provides decision-relevant info to people within an organisation, mainly management
Does not require independent external audit (but can be reviewed internally)
Forward looking - Looks to the future (eg. Revenue/costs for the next 12m period)
The purpose of Management Accounting
An increased understanding of costs should be created
Allocating costs between goods sold and inventories for profit reporting
Providing cost and other info to help managers make better decisions
The info must be relevant to a particular decision, accurate, and prompt
Providing cost info for planning, controlling, performance measurement and continuous improvement
Making sure organisations see the benefits of management accounting via a reduction in costs
Cost is the key element
What is Cost?
Cost, in accounting sense, is the monetary value of resources consumed to produce a product or provide a service
It does not include profit markup
In a business sense, cost can also be the expenditure to acquire another business or project
In management accounting, the term cost has many different uses
But the uses depend on purpose
What is Cost Accounting?
Is the process of collecting, analysing, summarising and evaluating various decision options using cost information
Cost information can be used by managers for their own organisation (planning and control, decision-making)
This information can also be used for financial accounting (e.g. for stock valuations)
Cost control is a major concern for managers
Managers want to control the organisational activities so that the organisational objectives are realised in an efficient manner
To control cost - need info about costs and revenue
From this they need management accounting and management accountants
Categorisation of Costs
General Categorisation
Manufacturing cost
Non-manufacturing cost
Categorisation from the decision-making perspective
Relevant cost
Irrelevant cost
Categorisation based on cost behaviour
Fixed cost
Variable cost
Mixed cost
What are Manufacturing Costs?
Costs incurred to produce a product
Manufacturing Cost Equation
= Direct Material (DM) + Direct Labour (DL) + Manufacturing Overhead (MOH)
What are Manufacturing Costs?
Costs incurred to produce a product
Manufacturing Cost Equation
= Direct Material (DM) + Direct Labour (DL) + Manufacturing Overhead (MOH)
What are Direct Costs?
CAN be specifically and exclusively identified (traced) to a given cost object & is related to a particular cost object
Example; The mango Juice T3H produces
For each juice, the company needs to use mango»_space; mango goes directly to juice»_space; so, direct cost
What are Indirect Costs?
Indirect costs CANNOT be specifically and exclusively identified (traced) to a given cost object & are allocated to the cost object using cost allocation method
Example; T3H again
The cost of the tape that T3H uses in the production process of juice
It is not possible to assign the cost of tape to any particular unit of juice directly
Hence, this is an indirect cost»_space; included in the MOH
These costs are assigned to cost objects through cost allocation
What is Cost Allocation?
Process of identifying, accumulating and assigning costs to cost objects/centres that involve the use of surrogate, rather than direct measure (allocation base)
Example; Department Programs
Distinction between direct and indirect costs depend on what is the cost object
What is a Cost Object?
Any activity for which a separate measurement of cost is required
Example; cost of making a product or providing a service
The product or service is the usual cost of object
It can be an item within the company
It is a possible that each phase of a product development is a cost object (e.g, product development phase)
Profitability of a product is considered
It can also be external to a company (e.g, a supplier or customer)
Customer/Supplier profitability analysis might be considered
What is a Direct Material?
The costs of the raw materials that are an integral part of the finished product and can be physically and conveniently traced into the final product.
Final product of one company can be raw materials for another company
Example; Water and sugar that are added to mangoes
What is an Indirect Material?
The materials in the final product other than the direct materials
These are relatively insignificant parts of the final product, and it is not worthy to trace their costs individually
Example; Glue in a chair or Tape used in the production of juice
Thus, grouped under indirect material category
