AC4100

MANAGEMENT ACCOUNTING:
PLANNING AND CONTROL

SECTION A: DR MARGARET HEALY

RECAP OF COST TERMS
AND CONCEPTS; COST
ASSIGNMENT
LEARNING OUTCOMES

• Explain why it is necessary to understand the meaning of

different cost terms
• Describe the purposes for which costing information required

READ: Textbook, chapter 2.

GENERAL COST CLASSIFICATIONS

• Manufacturing Costs vs. Non-manufacturing Costs

• Product Costs vs. Period Costs

NB: Determine the Cost Object First!

Cost object: any item or entity for which a separate

measurement of costs is desired
MANUFACTURING COSTS
NON-MANUFACTURING COSTS

Generally non-manufacturing costs are sub-classified into two

categories:

1. Marketing or selling costs: costs to get the finished product

or service to the customer
2. Administrative costs: executive, organizational or clerical
costs
PRODUCT & PERIOD COSTS

• Product costs include all the costs that are involved in

acquiring or making a product.

• Period costs are all the costs that are not included in
product costs. All selling and administrative expenses are
considered to be period costs.
PRODUCT & PERIOD COSTS
COST CLASSIFICATIONS FOR PREDICTING COST
BEHAVIOUR

A variable cost is a
cost that varies, in
total, in direct
proportion to
changes in the level
of activity.
COST CLASSIFICATIONS FOR PREDICTING COST
BEHAVIOUR

A fixed cost is a
cost that remains
constant, in total,
regardless of
changes in the
level of activity.
SUMMARY OF VARIABLE AND FIXED COST
BEHAVIOUR
COST CLASSIFICATIONS FOR PREDICTING COST
BEHAVIOUR

A semi-fixed cost (step

cost) is a cost that
remains fixed within
specified activity levels
for a given amount of
time but will eventually
increase or decrease by
a constant amount at
critical activity levels.
COST CLASSIFICATIONS FOR PREDICTING COST
BEHAVIOUR

A semi variable
cost (mixed
cost) is a cost
that contains
both a fixed and
a variable
component.
OTHER COST DEFINITIONS

• Sunk Costs: The costs of resources already acquired and

unaffected by the choice between the various alternatives.
Sunk costs are irrelevant for decision-making.

• Opportunity Costs: A cost that measures the opportunity

that is lost or sacrificed when the choice of one course of
action requires that an alternative course of action be given
up.

• Relevant costs (revenues): Relevant costs and revenues

are those future costs and revenues that will be changed by
a decision.
OTHER COST DEFINITIONS
• Marginal and incremental costs (revenues):
• Incremental costs and revenues are the additional
costs/revenues from the production or sale of a group of
additional units.
• Marginal cost/revenue represents the additional
cost/revenue of one additional unit of output.

• Avoidable and unavoidable costs (revenues):

• Avoidable costs are those costs that can be saved by not
adopting a given alternative
• Unavoidable costs cannot be saved.
Avoidable/unavoidable costs are alternative terms
sometimes used to describe relevant/irrelevant costs.
COST ASSIGNMENT
LEARNING OUTCOMES

• Describe the purposes of cost allocation and criteria to guide

cost allocation decisions
• Assign indirect costs to cost objects
• Apply methods of allocating support department costs to
production departments

READ: Textbook, chapter 3 (including the appendix)

COST ALLOCATION
Cost allocation: The process of assigning costs when the quantity of
resources consumed by a particular cost object cannot be directly
measured
PURPOSES OF COST ALLOCATION
CRITERIA FOR COST ALLOCATION DECISIONS

• Cause-and-effect (preferred method)

• Benefits received
• Fairness (equity)
• Ability to bear
COST SYSTEMS DESIGN
ASSIGNING INDIRECT COSTS TO COST OBJECTS

Using Plant-wide (blanket) overhead rates

Example
Total overheads = €900,000
Direct labour (hours) = 60,000
Overhead rate = €15 per hour
ASSIGNING INDIRECT COSTS TO COST OBJECTS

Assume that the company has 3 separate departments and

costs and hours are analysed as follows:
ASSIGNING INDIRECT COSTS TO COST OBJECTS

Product X spends 1 hour in each department and Product Y

spends 5 hours in each department

Product X Product Y
Blanket rate: 3 hrs * 15 = €45 15 hrs * 15 =
€225
Departmental 1 hr * 10 = 10 5 hr * 10 = 50
Rates 1 hr * 30 = 30 5 hr * 30 = 150
1 hr * 5 = 5 5 hr * 5 = 25
Total: €45 Total: €225
ASSIGNING INDIRECT COSTS TO COST OBJECTS

Product Z requires 20 hours (all in department C)

Separate departmental rates should be used since Product Z

only consumes overheads in department C.
ASSIGNING INDIRECT COSTS TO COST OBJECTS
Two stage allocation process, using departmental overhead rates
ASSIGNING INDIRECT COSTS TO COST OBJECTS
SURVEYS OF PRACTICE
COST ASSIGNMENT
ALLOCATING SUPPORT DEPARTMENT
OVERHEADS
LEARNING OUTCOMES

• Apply methods of allocating support department costs to

production departments

READ: Textbook, chapter 3 (including the appendix)

SUPPORT DEPARTMENTS AND OPERATING
DEPARTMENTS

• Supporting (service) department: provides the services

that assist other internal departments in the company

• Operating (production) department: directly adds value

to a product or
METHODS OF ALLOCATING SUPPORT COSTS
TO PRODUCTION DEPARTMENTS

1. Direct allocation method

2. Step-down (specified order of closing) method

3. Reciprocal (repeated distribution) method

DATA USED IN WORKED EXAMPLE
DIRECT METHOD
• Allocates support Support Departments Production Departments

costs only to
operating
departments. Information Systems

Manufacturing

• Direct method does

not allocate
support-department
costs to other
support Packaging

departments. Accounting
DIRECT ALLOCATION METHOD [EXAMPLE]
DIRECT ALLOCATION METHOD EXAMPLE
STEP-DOWN METHOD
• Also called the sequential
allocation method
• Allocates support-
department costs to other
support departments and
to operating departments
in a sequential manner
• Partially recognizes the
mutual services provided
among all support
departments
STEP-DOWN ALLOCATION METHOD EXAMPLE
STEP-DOWN ALLOCATION METHOD EXAMPLE
RECIPROCAL METHOD [REPEATED DISTRIBUTION]

• Fully recognizes the Support Departments Production Departments

mutual services provided

among all support
Information Systems
departments
Manufacturing

• Reciprocal method fully

incorporates
interdepartmental
relationships into the
Packaging
support-department cost
allocation. Accounting
RECIPROCAL ALLOCATION METHOD EXAMPLE
RECIPROCAL ALLOCATION METHOD (LINEAR
EQUATIONS) ILLUSTRATED
CHOOSING BETWEEN METHODS

Machining Assembly Total

Direct 7,653,000 6,098,850 13,752,150

Step 8,300,800 5,451,350 13,752,150

Reciprocal 8,187,025 5,565,125 13,752,150

CHOOSING BETWEEN METHODS

• Reciprocal is the most precise.

• Direct and step-down are simple to compute and
understand.
• Direct method is widely used.