INTRODUCTION TO

MANAGEMENT ACCOUNTING

Shehani Sanchila Kodithuwakku

Department of Industrial Management
Faculty of Business
University of Moratuwa
 LEARNING OUTCOMES

• Analyze the nature, scope and utility of cost accounting.

• Examine how cost accounting arises out of the need to
make business decisions.
• Identify the difference between cost, management and
financial accounting.
• To familiarize with costing terminology.
 WHAT IS MANAGEMENT ACCOUNTING ?

• Management accounting is a process providing accounting and

financial information to managers within organizations, to
facilitate the managers in their decision making and management
control functions.
• Management accounting is only used by the internal team of the
organization.
• Objective of management accounting is to use the statistical data
and take a better and accurate decision, controlling the
enterprise, business activities and development.
 FINANCIAL ACCOUNTING VS.
MANAGEMENT

• Financial Accounting focuses on preparing financial

information for the use of external decision makers.
• Management Accounting focuses on the requirements of
Managers within the organization & the information they require
making decisions.
 FINANCIAL ACCOUNTING VS.
MANAGEMENT

Financial Accounting Management

Accounting

Principal Objectives Stewardship or business for Seek to improve economy,

the benefit of shareholders efficiency and effectiveness
of operations

Time horizon Past Not only look at the past,

but the present and the
future which affects the
operation of the company
Report recipients External/ Outsiders namely Internal parties like
Shareholders and Directors and Managers
Government(tax)
 FINANCIAL ACCOUNTING VS.
MANAGEMENT CONTD.

Outputs Summary (usually annual) Detailed monthly and

statement of profit and annual management
loss and other accounts showing results
comprehensive income , by product and function
statement of financial ad hoc reports
position and statement of
cash flow
Regulating framework Accounting standards, None prescribed
Accounting concepts plus
statutory requirement by
the companies Act
 COST ACCOUNTING

• Cost refers to the value of resources sacrificed to achieve a specific

objective, such as manufacturing, acquiring a good or providing a
service or it means the amount of expenditure incurred on, or
attributable to a given thing. Usually, cost is measured in monetary
terms.
• Cost Accounting is a systematic set of procedures for recording
and reporting measurements of the cost of manufacturing goods and
performing services in the aggregate and in detail.
 MANAGEMENT ACCOUNTING
ACTIVITIES

1) Explaining production & non - production costs & how they are reported in the
financial statements.
2) Computing the costs of providing a service or manufacturing a product.
3) Determining the behavior of costs & expenses as activity levels change.
4) Analyzing cost-volume profit relationships within a Company.
5) Assisting management in profit planning & budgeting.
6) Providing a basis for controlling costs & expenses by comparing actual results
with planned objectives & standard costs.
7) Accumulating & presenting relevant data for management decision making.
 COST TERMS

• Cost Unit
• Cost center
• Relevant cost
• Irrelevant cost
• Opportunity cost
• Standard cost
• Sunk cost
 COST UNIT

• Unit of quantity of product, service or time in relation to

which costs may be ascertained or expressed.
 COST CENTER

“A location, person or item of equipment (or group

of these) for which costs may be ascertained and
used for the purpose of cost control.”
- The Chartered Institute of Management Accountants -
 RELEVANT COST

• A managerial accounting term that is used to describe

costs that are specific to management's decisions.
• The concept of relevant costs eliminates unnecessary data
that could complicate the decision-making process.
 EXAMPLE – RELEVANT COST

• A company wants to add a new unit that requires • Material A:

different Raw materials. • With zero inventories, they will buy all 50 units at
Rs.10.
The cost per • Hence, relevant costs = 50 units x Rs.10= Rs. 500
Material A: Nil units required
unit is Rs.10 per
inventory 50
unit • Material C:
• Rs.30 per unit is not relevant since the current
Material Current cost price is Rs.23.
C: Inventory 90 units required per unit Rs.23
units at Rs.30 100 fully used in • Therefore, Relevant cost of Material C =
per unit production
100 units x $23=$2,300
 IRRELEVANT COST

• A managerial accounting term that represents a cost, either positive or

negative, that does not relate to a situation requiring management's
decision.
• Sunk Cost – Sunk costs are the costs for which the company has
already spent, and for that, there is no future recovery, and Company
will not benefit from that cost.
• Committed Cost – Committed costs are the costs that are non-
erasable from the books of accounts.
• Notional / Non-Cash Costs – Notional / Non - Cash costs can be coined
as the costs that are not directly related to a cash outflow, and the
company need not have to incur any expense to bear these costs.
 EXAMPLES - IRRELEVANT COST

1. Rent paid for the Company’s premises – Relevant cost

2. Money spent on the purchase of new equipment - Irrelevant cost
3. Advertising/Marketing campaign expenses - Irrelevant cost
4. Insurance paid by the Company for its employees or the company’s fixed assets - Irrelevant cost
5. Different taxes paid by the Company - Irrelevant cost
6. Salaries of top-level management who rarely participate in business decision making - Irrelevant cost
7. Interest on owner’s capital which the Proprietor brings to the business but never claims back the interest
on his funds - Irrelevant cost
8. The rent which can be receivable upon using own business premises - Relevant cost
9. Depreciation on equipment – Irrelevant cost
10.Legal expenses are borne by the Company, which hardly generates revenue – Irrelevant cost
 OPPORTUNITY COST

• The cost of an alternative that must be forgone in order to pursue a

certain action. Put another way, the benefits you could have received
by taking an alternative action.
• Mr. Kamal makes Rs.400 an hour as an attorney and is considering
paying someone Rs.1000 to paint his house. If he decides to do it
himself, it will take four hours. His opportunity cost for doing it himself
is the lost wages for four hours, or Rs.1600.
 STANDARD COSTS

• The standard cost is a production or operating cost that is

carefully predetermined.
• It is a target cost that should be achieved.
 SUNK COST

• A cost that has already been incurred and thus cannot be

recovered.
• A sunk cost differs from other, future costs that a business may
face, such as inventory costs or R&D expenses, because it has
already happened.
• Sunk costs are independent of any event that may occur in the
future.
 CLASSIFICATION OF COSTS

1) Function wise classification (Purpose)

2) Classification on the basis of elements of cost (Nature)
3) Behavior wise Classification
 (1) FUNCTION WISE CLASSIFICATION

➢Direct cost
o Direct material cost
o Direct labour cost
o Direct other cost
➢Indirect cost
o Production overheads
o Non - production overheads
• Administrative expenses
• Selling and distribution expenses
• Finance and Other expenses
 DIRECT COST VS. INDIRECT COST

• Direct cost refers to the cost that can be

specifically and exclusively identified with a
particular cost object.
• Indirect cost can’t be specifically and exclusively
identified with the cost object.
 PRODUCTION OVERHEAD COST

• Manufacturing costs that cannot be traced directly to specific units produced.

Example:

Indirect Labour Indirect Materials & other

Wages paid to employees

Materials used to support
who are not directly
the production process.
involved in production
Ex: lubricants and cleaning
work.
supplies used in the
Ex: maintenance workers,
automobile assembly plant.
janitors and security guards
 (2) CLASSIFICATION ON THE BASIS OF
ELEMENTS OF COST

• Material Cost
• Labor Cost
• Other cost
 MATERIAL COST

• Those materials that become an integral part of the product and

that can be conveniently traced directly to it.
Rs.
Invoice price xxxx
Freight chargers xxxx
Excise duty xxxx
Non - refundable VAT xxxx
Non - returnable Containers xxxx
(-) Discount xxxx
Cost of Material xxxx
 PRACTICE QUESTION 01

The following quotation received from Mr. Naleen in respect of a

material item;
Lot price,
2000 units Rs. 5.00 each
4000 units Rs. 4.75 each
6000 units Rs. 4.00 each
Trade discount 25% and Cash discount 5% ( if settled within 10 days)
Freight charges per order Rs. 2,000
Containers charged Rs. 10 each One container is required for every
100 units.
Calculate the material cost for 6000 units.
 LABOR COST

• Those labor costs that can be easily traced to individual units of

product.

OTHER COST

• Those labor costs that can be easily traced to individual units of

product.
 BEHAVIOR WISE CLASSIFICATION

• Variable costs
• Fixed costs
• Semi-variable costs (Step cost)
 VARIABLE COST

• Cost that varies with number of units produced.

• Variable costs increase and decrease in direct proportion to the level of business
activity. So, if your sales increase by 10%, so too will the variable costs associated
with the sales.
Examples of variable costs include:
o stock purchases
o incentive payments
o sales commissions
o power consumption.
 FIXED COST

• Fixed costs remain unchanged despite the level of business activity.

• They are incurred regardless of whether the business produces or/and sells
anything or not. When used to calculate production costs, fixed costs include:
o depreciation
o insurance
o leasing
o loan repayments
o rent
o managerial salaries
 SEMI -VARIABLE COST

• Semi-variable costs are influenced by the level of business activity but, not
in direct proportion to that activity.
• Semi-variable cost is an expense which contains both a fixed-cost
component and a variable-cost component.
• For example: Equipment maintenance has a fixed component (regular
preventative maintenance) and repair expenses which increase
proportionally as production increases.
Examples,
✓Electricity expenses
✓Telephone expenses
SEMI – VARIABLE COST BEHAVIOUR
 VARIABLE AND FIXED COST BEHAVIOUR

Cost As a total As an average (per

unit)
Variable cost Total variable cost Variable cost per unit
changes with the remains the same
activity level changes. over wide ranges of
activity.
Fixed cost Total fixed cost Fixed cost per unit
remains the same goes down as activity
even when the level goes up.
activity level changes.
 TOTAL PRODUCTION COST

• The summation of the prime cost and production overhead is termed as

Total production cost and it can be depicted as follows;
THANK YOU