MODULE 1

Costing and Pricing

Session Topic: Introduction to managerial and cost accounting

Learning Objectives:

The following specific learning objectives are expected to be realized at the end of the session;

1. Distinguish the difference between cost accounting and management accounting

2. Define cost accounting
3. Discuss the functions of cost accounting
4. Define direct costs and indirect costs
5. Define fixed costs, variable costs and semi-variable costs
6. Define management accounting?
7. Discuss the importance of management accounting in business

Key Points

Cost Accounting Management Accounting Direct Costs

Indirect Costs Fixed Costs Variable Costs

Core Content

____________________________________________________________________

Introduction

Module 1 covers the definition of cost accounting and management accounting, the functions of cost
accounting, the definition of direct costs, indirect costs, fixed costs, variable costs and semi-variable costs and the
importance of management accounting in business.

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In-text Activities

 Definition of cost accounting and management accounting.

 Cost accounting revolves around cost computation, cost control and cost reduction.
 Management accounting helps management make effective decisions about business.

Cost Accounting vs Management Accounting

There are many differences between cost accounting vs management accounting. Let’s glance at these distinctions:

Difference Cost Accounting Management Accounting

Cost accounting revolves around Management accounting helps

Inherent Meaning cost computation, cost control and management make effective
cost reduction. decisions about business.

Cost accounting prevents a Management accounting offers a big

Application business from incurring cost picture of how management should
beyond budget. strategize.

Scope Scope is much narrow Scope is much broader

Measuring grid Quantitative Both quantitative and qualitative

Cost accounting is one of the many

Management accounting itself is
Sub-set sub-sets of management
pretty vast.
accounting.

Basis of decision Historic information is basis of Historic and predictive information are
making decision making basis of decision making

Statutory audit of cost accounting

Statutory Audit of management accounting has
is a requirement in big business
requirement no statutory requirement.
houses.

Management accounting is
Cost accounting isn't dependent on
dependent on both cost and financial
Dependence management accounting to be
accounting for successful
successfully implemented.
implementation.

Management, shareholder and

Used for Only for management
vendors

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 What is Cost Accounting?

 Cost accounting comes down to two words – “cost” and “accounting”.

 First, let’s understand what “cost” is. Then we will look at “accounting”.

What is “cost”?

Cost is an expense incurred to a particular unit. In another way, the cost is what the business sacrifices in order to
produce one unit of product.

What is “accounting”?

Accounting is the art and science of recording, classifying, summarizing, and analyzing inputs to make a sense of
the information related to financial, management, or cost.

What is “cost accounting”?

Cost accounting is the art and science of recording, classifying, summarizing, and analyzing costs to help
management make prudent business decisions.

Functions of Cost Accounting

There are basically three functions of cost accounting –

 Cost control: The first function of cost accounting is to control the cost within the budgetary constraints
management has set for a particular product or service. This is important since management allocates limited
resources to particular projects or production processes.

 Cost computation: This is the main function of cost accounting and this is the source of all other functions of cost
accounting. In the section below, we will see how we can calculate the cost of sales per unit for a particular
product.

 Cost reduction: Cost computation helps the company reduce costs on projects and processes. Reduction in
costs means more profits since the margin will naturally increase.

Direct Costs & Indirect Costs

Direct costs are directly involved in producing goods. That means direct costs can be directly identified as being used
in the production of goods. For example, we can talk about direct material and direct labor that is used in producing
goods. These costs we can identify as direct costs.

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Indirect costs, on the other hand, are costs that can’t be identified easily. The reason these costs can’t be identified
separately because these costs assist in functioning multiple activities. For example, the renting business pays for
running a production operation would be called indirect costs since we can’t identify how much portion of the rent is
used for the production of goods, how much is used for preparing the raw material, how much is used to install the
simulation systems that can train the workers.

Understanding these two types of costs is important since we would be using these costs in the computation of the
cost of sales per unit for a particular product.

Fixed Costs, Variable Costs, & Semi-variable Costs

Fixed costs are costs that don’t change with the increase or decrease of production units. That means these costs
remain similar within a broad range of the spectrum. Plus, the per-unit fixed cost changes as the production increases
or decreases. For example, rent is a fixed cost. Even if the production increases or decreases, the business needs to
pay the same rent month in and month out.

Variable cost is the exact opposite of fixed cost. Variable cost changes as per the increase or decrease of production
units. But even if the total variable cost changes, per unit cost per unit, remain same irrespective of changes in
production units. For example, the cost of raw material is a variable cost. The total cost of raw material changes if the
production increases or decreases. But the per-unit cost of raw material remains the same even if the production
increases or decreases.

In semi-variable costs, both components are present. Semi-variable costs are a combination of fixed costs and variable
costs. Let’s say that you pay $1000 per month as fixed salary to all your workers and the workers who produce more
than 50 units of toys every month, they get an additional $5 for every additional unit produced. This sort of wages will
be called semi-variable wages.

What is Management Accounting?

Management accounting is the process of collecting, analyzing, and understanding the financial statements, statistical,
and qualitative information to make sense of how the business is going and what to do in the near future.

Management accounting helps to make short term decisions and also helps strategize for future big events. The idea
behind management accounting is to prepare periodical reports which can educate and inform the managers of the
company to make effective decisions.

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Even if management accounting is much different than financial accounting and cost accounting (cost accounting is
one of the sub-sets of management accounting), it gathers information from both of these accounting in producing
periodical reports for management.

What can we expect to find in those periodical reports?

The exact motto of these reports is to help management get all the information at their fingertips and use the
information to make effective decisions for the business.

Since there is no statutory requirement, these reports are articulated as per the need of the management.

Here are the characteristics of these reports –

 Quantitative and qualitative data points: Financial accounting and cost accounting solely revolves around
quantitative data. But only quantitative information isn’t able to portray the whole picture of the business. Rather
we should also look at qualitative information to make sense of what’s happening within the business. For
example, the absenteeism rate doesn’t depend on any quantitative information; rather it’s purely psychological.
Management accounting looks at all aspects of the business – both quantitative and qualitative data points to
create reports.

 Predictive information: If you look at financial accounting and cost accounting, you will see that these whole two
accounting systems are based on historical information. But in the case of management accounting, the focus is
both on historical and predictive information. Since historical information only solves part of the problem,
estimated information helps management see the big picture and makes financial statements forward-looking.
That’s why in management accounting reports, predictive information is one of the biggest circle-in areas.

 Used for the internal purpose: These reports contain very sensitive information about the business and
management. That’s why it is only provided to the management to make effective use of these reports and
strategize based on the information provided in these reports.

Importance of Management Accounting in Business

Since we know that management accounting periodical reports serve a great purpose in making effective decisions for
management, we need to know the importance of management accounting in business. Here are the top-most factors
–

 Forecast the future: As mentioned earlier, the sole focus of management accounting is not on the past, but
toward the future. Management accounting propels management to ask – “What company should do in the near
future – should it buy more plants? Or should it acquire a few small companies which are experts in producing the
raw materials for the company?” Management accounting helps to answer these valid questions and assists to
start approaching the decision.

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 Forecast cash-flow: Without cash-flow business can’t move molehills, forget about the mountains. So
understanding and predicting how much cash-flow the company would be able to generate in the near future is
critical. Management accounting helps with budgeting, trend charts to estimate the future cash-flow for business.

 Return on investment: One of the main functions of management accounting is to see how much return it could
produce on the investments it has made earlier. Looking at the past gives management an idea about where they
went wrong and what to correct in the next investments.

 Understanding performance variances: Since management accounting is more about predictive analysis,
naturally there will be variances. Variances are the differences between estimated costs/profits and actual
costs/profits. The purpose of management accounting is always to create positive variances and try to learn from
the negative variances.

 Create/outsource decision: This is an important question for every business these days – whether to create raw
materials/a part of the product or outsource it to a third party. Management accounting helps to see the costs and
profits of both of these options and choose the best one among the two.

SUMMARY:

Both cost accounting vs management accounting help management makes effective decisions. But their scope and
tools are completely different. As management accounting depends a lot on cost accounting to prepare reports, cost
accounting happens to be a sub-set of management accounting. But if we look at the usage, estimation process, data
points used, and utility, cost accounting has a much narrower scope than management accounting.

At the same time, to understand management accounting, it is imperative that you understand cost accounting well.
That’s why it is important to understand the contrast between cost accounting and management accounting.

References

See the references listed in the syllabus of the subject.

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 Name: Section:
Instructor: Date:

ACTIVITY 1-PRELIM

PART I. ESSAY

1. Describe management accounting and cost accounting. (10 points)

2. Is cost accounting or management accounting more useful to an operations manager? Why?
(10 points)
3. Briefly describe how managers make use of management accounting information. (10 points)

PART II. PROBLEM

A. Identification of Variable, Fixed, and Semivariable Costs. Place a check mark in the
appropriate column to indicate whether the following costs are variable, fixed, or semivariable.
(1 point each)

Item Variable Fixed Semivariable

1.Small tools
2.Patent amortization
3.Health and accident insurance
4.Heat, light, and power
5.Straight-line depreciation
6.Maintenance of buildings and
grounds
7.Royalties
8.Materials handling

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9.Property and liability insurance
10.Maintenance of factory equipment

B. Butler Hospital wants to estimate the cost for each patient stay. It is a general health care
facility offering only basic services and not specialized services such as organ transplants. (2
points each)

Required:
a. Classify each of the following costs as either direct or indirect with respect to each
patient.
b. Classify each of the following costs as either fixed or variable with respect to hospital
costs per day.

Direct Indirect Fixed Variable

1. Electronic monitoring ______ ______ ______ ______

2. Meals for patients ______ ______ ______ ______
3. Nurses' salaries ______ ______ ______ ______
4. Parking maintenance ______ ______ ______ ______
5. Security ______ ______ ______ ______

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