CHAPTER 1

MANAGERIAL ACCOUNTING AND THE BUSINESS ENVIRONMENT

COST ACCOUNTING

The term Cost Accounting is sometimes used in place of management accounting.

It includes defining costs and valuating inventories to help the mangers run the business.

MANAGEMENT ACCOUNTING

One of the core functions of businesses.

Relates to the provision of making of appropriate information, including cost information for decisionmaking, planning, control, and performance evaluation.
Management accounting helps manage businesses, it is critical that management accounting
information is prepared, provided, and used on a timely basis.
It is important for management accounting information to be relevant. Such relevant information needs
to be obtained efficiently and effectively.
Requires Forecasting

MANAGEMENT AND COST ACCOUNTING

Are intertwined
Are sometimes interchangeable and their functions are to help companies make better decisions.

Cost Benefit evaluation is a key concept in management accounting.

The main objective of decision making is to obtain relevant and materially accurate information that can lead
to correct and unbiased decisions.
STRATEGY

A game plan that enables a company to attract customers by distinguishing itself from competitors.
The focal point of the companys strategy should be its target customers. A company can only succeed if
it creates a reason for customers to choose it over its competitor.

Customer Value Propositions

Essence of the strategy

3 Broad Categories:
1. CUSTOMER INTIMACY You should choose us because we understand and respond to your
individual needs better than our competitors.
Example: Starbucks and Ritz Carlton
2. OPERATIONAL EXCELLENCE You should choose us because we can deliver products and
services faster, more conveniently, and at a lower price than our competitors.
Example: Daiso, Southwest Airlines, Wal-Mart, and the Vanguard Group
3. PRODUCT LEADERSHIP You should choose us because we offer higher quality prodcuts
than our competitors.
Example: Louis Vuitton, BMW, Cisco Systems, and W.L. Gore (GORE-TEX fabrics)

ORGANIZATIONAL STRUCTURE
Decentralization is the delegation of decision making authority throughout an organization by giving
managers the authority to make decisions relating to their area of responsibility. Some organizationa are more
decentralized than others.
THE FUNCTIONAL VIEW OF ORGANIZATIONS

Organization Chart

Organizational structure

Show how responsibility is divided among managers and to show formal lines of reporting and
communication (Chain of Command)
Line Position is directly involved in achieving the basic objectives of the organization.
Staff Position in only indirectly involved in achieving those basic objectives. Staff positions provide
assistance to the line positions or other parts of the organization, but they do not have direct authority over line
positions.
Chief Financial Officer (CFO)

a member of the top management team, also occupies a staff position as he is not directly involved in
the core business.

Responsible for providing timely and relevant data to support the main objectives of the company, and is
assisted by a team of accountants who spend most of their time analyzing the business.

who is in-charge of the Accounts (Finance) Department

*Relevant data to support planning and control activities and for preparing financial statements.

PROCESS MANAGEMENT
A Business Process is a series of steps that are followed in order to carry out some tasks in a business.
A Value Chain consists of the major business functions that add value to a companys products and services.
The customers needs are most effectively met by coordinating the business processes that span these
functions.
Lean Production
Toyota pioneered this process that has since gained popularity and benefitted many Asian companies.
1. RAW MATERIALS material that are used to make a product.
2. WORK IN PROCESS inventories consist of units of product that are only partially complete and
will require further work before they are ready for sale to a customer.
3. FINISHED GOODS - inventories consist of units of product that have been completed but have not
yet been sold to customers.
The push process in traditional manufacturing starts by accumulating large amounts of raw material
inventories from suppliers so that operations can proceed smoothly even in unanticipated disruptions occur.
Next, enough materials are released to workstations to keep everyone busy. When a workstation completes its
tasks, the partially completed goods (ex. WIP) are pushed forward to the next workstation regardless of
whether that workstation is ready to receive them. The result is that partially completed goods stack up,
waiting for next workstation to become available. They may or may not be completed in days, weeks, or even
months. Additionally, when the units are completed, customers may or may not want them. If finished goods
are produced faster than the market will absorb, the result is bloated finished goods inventory. *Results in
large inventories.
The Lean Thinking Model
Is a five step management approach that organizes resources such as people and machines around
the flow of business processes and that pulls units through these processes in response to customer
orders.
The result is lower inventories, less defects, less wasted effort, and quicker customer response times.
Used to improve the business processes that link companies together.
Steps:
1. Identify the value to customers in specific products and services.
2. Identify the business process that delivers this value to customers.
3. Organize work arrangements around the flow of the business process.

This is often accomplished by creating a manufacturing cell. The cellular approach takes
employees and equipment from departments that were previously separated from one
another and places them side-by-side in a workspace called a cell. The equipment in the cell
is aligned in a sequential manner that follows the steps of the business process. Each

employee is trained to perform all the steps within his or her manufacturing cell.
4. Create a pull system where production is not initiated until a customer has ordered a product.
Inventories are reduced at a minimum by purchasing raw materials and producing units only

as needed by the customer demand.

JUST-IN-TIME PRODUCTION (a production and inventory control system in which materials

are purchased and units are produced only as needed to meet actual customer demand)
The change from push to pull production is more profound than it may appear. Producing
only in response to a customer order means that workers will be idle whenever demand falls

below the companys production capacity.

5. Continuously pursue perfection in the business process.
The companys suppliers are responsible for the quality of incoming parts and materials.
Production workers are directly responsible for spotting defective units.
Supply Chain Management is commonly used to refer to the coordination of business processes across
companies to better serve end consumers.

The Theory of Constraints (TOC)

A Constraint is anything that prevents you from getting more of what you want.
The Theory of Constraints (TOC) is based on the insight that effectively managing the constraint is a
key to success.
The constraint, or bottleneck, in the system is determined by the step that has the smallest capacity.

Six Sigma

is a process improvement method that relies on customer feedback and fact based data gathering and
analysis techniques to drive process improvement.

The term Six Sigma refers to a profess that generates no more than 3.4 defects per million
opportunities.

Associated with the term Zero Defects

Most Common framework used to guide Six Sigma process improvement efforts is known as DMAIC.
(Define, Measure, Analyze, Improve, and Control)
Stage
DEFINE:

Goals
Establish the scope and purpose of the project.
Diagram the flow of the current process.
Establish the customers requirements for the process.
MEASURE: Gather baseline performance data concerning the existing process.
Narrow the scope of the project to the most important problems.
ANALYZE: Identify the root causes of the problems that were identified during the measure stage.
*Often reveals that the process includes many activities
that do not add value to the product or service.
*Activities that customers are not willing to pay for because they add no value are known
as Non-value-added activities and such activities should be eliminated wherever
possible.
IMPROVE: Developed, evaluated, and implement potential solutions to the problems *
to eliminate non-value-added activities and any other problems uncovered in the Analyze
stage

CONTROL: ensure that problems remain fixed

seek to improve the new methods over time
THE IMPORTANCE OF ETHICS IN BUSINESS
(IMA) Institute of management of accountants of the United States has adopted an ethical code called the
Statement of Ethical Professional Practice that describes in some detail the ethical responsibilities of
management accountants.
Chartered Institute of Management Accountants (CIMA) in the UK has issued its Codes of Ethics for
Professional Accountants based on the Handbook of the Ethics for Professional Accountants published by
the International Federation of Accountants (IFAC) in April 2010.
Code of Conduct for Management Accountants
The IMAs Statement of Ethical Professional Practice consists of two parts:
1.
Provides general guidelines for ETHICAL BEHAVIOR
Maintain a high level of professional COMPETENCE
Treat sensitive matters with CONFIDENTIALITY
Maintain personal INTEGRITY
Disclose information in a credible fashion (CREDIBILITY)
2.
Specifies what should be done if an individual finds evidence of ethical misconduct.
The ethical standards provide sound, practical advice for management accountants and managers.

CORPORATE GOVERNANCE
Is the system by which a company is directed and controlled. If properly implemented, the corporate
governance system should provide incentives for the board of directors and top management to pursue
objectives that are in the interests of the companys owners and it should provide for effective monitoring of
performance.
ENTERPRISE RISK MANAGEMENT
Is a process used by a company to proactively identify and manage those risks.
CORPORATE SOCIAL RESPONSIBILITY AND SUSTAINABILITY REPORTING
Corporate Social Responsibility (CSR) is a concept whereby organizations consider the needs of all
stakeholders when making decisions.
To serve other stakeholders such as customers, employees, suppliers, communities, and environmental and
human rights advocates whose interest are tied to the companys performance.

CHAPTER 2
MANAGERIAL ACCOUNTING AND COST CONCEPTS

THE WORK OF MANAGEMENT AND THE NEED FOR MANAGERIAL ACCOUNTING INFORMATION

Planning
Involves establishing a basic strategy, selecting a course of action, and specifying how the action will be
implemented.
Identify alternatives and then to select from among the alternatives the one that best fits the
organizations strategy and objectives.
One of the basic objectives of a company is to earn profits for the owners of the company by employing
the appropriate strategies at the right time and in the right market or a country.
The plans of management are often expressed formally in budgets, and the term budgeting is generally
used to describe this part of the planning process.
The budgets are usually prepared under the direction of the CFO, who is in-charge of the Accounts
(Finance) Department.
Budgets are prepared annually and represent the managements plans in specific, quantitative terms.
Directing and Motivating
Involve mobilizing people to carry out plans and run routine operations.
Managers assign tasks to employees, arbitrate disputes, answer questions, solve on-the-spot problems,
and make many small decisions that affect customers and employees.
Directing is that part of the managers job that deals with the routine and the here and now.
Controlling
Involves ensuring that the plan is actually carried out and is appropriately modified as circumstances
change.
Feedback, which signals whether operations are on track, is the key to effective control. Provided by
detailed reports. One of these reports, which compares budgeted to actual results, is called the
Performance Report.
Performance reports suggest where operations are not proceeding as planned and where some parts of
the organization may require additional attention.

The Planning and Control Cycle

Involves the smooth flow of management activities from planning through directing and motivating,
controlling and then back to planning again.
Involves decision making
COMPARISON OF FINANCIAL AND MANAGERIAL ACCOUNTING
Financial Accounting
Financial report or statements
Concerned with providing information to stockholders, creditors and others who are OUTSIDE the
organization
Managerial Accounting
Concerned with providing information to managers that is, the people INSIDE an organization who
direct and control its operations.

Financial
1. User
2. Time Focus
3.Verifiability versus

External persons who make

financial decision
Historical perspective (summarizes
past financial transactions)
Emphasis on verifiability (verify,

Managerial
Managers who plan for and control an
organization (Internal users)
Future emphasis (changing economic
conditions, customer needs and desires)
Emphasis on relevance for planning and

Relevance

proof of statement reports)

4. Precision versus
Timelines
5. Subject

Emphasis on precision

control (relevance of information for decision

making)
Emphasis on timeliness

Primary focus on the whole

organization
Must follow GAAP and prescribed
formats
Mandatory for external reports

Focuses on SEGMENTS of an organization

(parts)
Need not to follow GAAP or any prescribed
formats
Not mandatory

6. GAAP
7. Requirements

Segments: parts of a company, maybe product line, sales territories, divisions, departments or any other
categorization that management finds useful.

GENERAL COST CLASSIFICATIONS

MANUFACTURING COSTS
Direct Materials
*RAW MATERIALS
The materials that go into the final product are called RAW MATERIALS. Raw materials refer to
the any materials that are used in the final product; and the finished product of one company can
become raw materials of another company.
May include both direct and indirect
Materials that become an integral part of the finished product and whose costs can be CONVENIENTLY
TRACED to the finished product.
Direct Labor
Consists of labor costs that can be easily (PHYSICALLY AND CONVENIENTLY) traced to individuals
units of product.
Touch Labor
Manufacturing Overhead
Includes all manufacturing costs except direct materials and direct labor
INDIRECT MATERIALS: small items of material such as glue and nails that may be an integral part of a
finished product, but those costs cannot be easily or conveniently traced to it.
INDIRECT LABOR: labor costs that cannot be easily physically traced to particular products, or that can
be traced only at great cost and inconvenience
Maintenance and repairs on production equipment; and heat and light, property taxes, depreciation, and
insurance on manufacturing facilities.
A.k.a. indirect manufacturing costs, factory overhead, and factory burden

NONMANUFACTURING COSTS
Also often called selling, general, and administrative (SG&A) costs or just selling and administrative costs.
Selling Costs
Include costs that are incurred to secure customer orders and get the finished product to the customer.
Order-getting and order-filling costs
Advertising, shipping, sales travel, sales commissions, sales salaries, and costs of finished goods
warehouses

Administrative Costs
Include all costs associated with the general management of an organization rather than with
manufacturing or selling
Executive compensation, general accounting, secretarial, public relations, and similar costs involved in
the overall, general administration of the organization as a whole.
PRODUCT COSTS VERSUS PERIOD COSTS
Matching principle is based on the accrual concept that costs incurred to generate a particular revenue should
be recognized as expenses in the same period that the revenue is recognized.
This means that if a cost is incurred to acquire or make something that will eventually be sold, then the cost
should be recognized as an expense only when the sale takes place that is, when the benefits occur.
Product Costs
Include all costs involved in acquiring or making the product
(manufactured goods) these costs consist of direct materials, direct labor, and manufacturing overhead.
attach to units of product as the goods are purchased or manufactured and they remain attached as
the goods go into inventory awaiting sale.
Initially assigned to an inventory account on the balance sheet
When goods are sold, the costs released from inventory as expenses (COSTS OF GOODS SOLD) and
matched against sales revenue
A.k.a Inventorial Costs
Treated as expenses in the period in which the related products are sold. This means that a product
cost such as direct materials or direct labor might be incurred during one period but nor recorded as an
expense until the following period when the completed product is sold.
Period Costs
All costs that are not product costs
Sales commissions and the rental costs of administrative offices
Not included as part of either purchased or manufactured goods;
instead period costs are expensed on the income statement in the period in which they are incurred
using the usual rules of accrual accounting
Prime Cost and Conversion Costs
Prime Cost
Sum of direct materials cost and direct labor cost
DIRECT MATERIALS COSTS + DIRECT LABOR COSTS
Conversion Cost
Sum of direct labor cost and manufacturing overhead cost
DIRECT LABOR COST + MANUFACTURING OVERHEAD COST
Term conversion cost is used to describe direct labor and manufacturing overhead because
these costs are incurred to convert materials into the finished product
COST CLASSIFICATIONS ON FINANCIAL STATEMENTS
The Statement of Financial Position (Balance Sheet)
A merchandising company has only one class of inventory goods purchased from suppliers for resale
to customers.
Manufacturing Companies have 3 classes of inventories: Raw Materials, Work in Process and Finished
Goods
INVENTORY ACCOUNTS
Beginning Balance
Ending Balance
Raw Materials
$ 60,000
$ 50,000
Work In Process
90,000
60,000
Finished Goods
125,000
175,000
Total Inventory Accounts
$ 275,000
$ 285,000

The Income Statement

Basic Equation for Inventory Accounts:
Beginning Balance + Additions to Inventory = Ending Balance + Withdrawals from inventory
Total Amount of Inventory
Cost of Goods Sold in a Merchandising Company
Beginning
merchandise
inventory

purchases

Ending
merchandise
inventory

Cost of Goods Sold

OR
Cost of
Goods Sold

Beginning
merchandise
inventory

purchase
s

Ending merchandise
inventory

Cost of Goods Sold in a Manufacturing Company

Beginning
finished
goods
inventory

Cost of goods
manufactured

Ending finished
goods inventory

Cost of Goods Sold

Beginning
finished goods
inventory

Cost of goods
manufactured

Ending finished goods

inventory

OR
Cost of
Goods Sold

Schedule of Cost of Goods Manufactured

Manufacturing Cost
Direct Materials
Beg raw materials inventory
Add: Purchases of raw materials
Raw materials available for use
Less: Ending raw materials inventory
Raw materials used in the production
Direct Labor
Manufacturing Overhead

$ 60,000
400,000
460,000
(50,000)

Schedule of Cost of Goods Manufactured:

Total Manufacturing Cost
Add: Beginning Work in Process
Less: Ending work in process inventory
Cost of goods manufactured

$ 820,000
90,000
910,000
60,000
$ 850,000

$410,000
60,000
350,000

PRODUCT COST FLOWS

Cost
Raw Materials
Purchases
Product
Costs

Direct labor
Manufacturing
Overhead

Statement of Financial
Position
Raw Materials Inventory
materials used
Direct
in production

Work in process inventory

Inventorial Costs
Product costs are
Goods Completed (Cost

of Goods Manufactured)
Finished goods
Inventory

Period
Selling and
Costs Administrative

Income Statement

Goods
Sold

Cost of Goods Sold

Selling and
Administrative
Expenses

often called inventoriable costs

Reason is that these costs go directly into inventory accounts as they are incurred rather than go into
expense accounts
COST CLASSIFICATIONS FOR PREDICTING COST BEHAVIOR
Cost Behavior
Refers to how a cost reacts to changes in the level of activity. As the level of activity level rises and
falls, a particular cost may rise and fall as well or it may remain constant.
For planning purposes, a manager must be able to anticipate which of these will happen; and if a
cost can be expected to change, the manager must be able to estimate how much it will change.
Categorized into Variable and Fixed
Variable Cost
A cost that varies, in total, in direct proportion to changes in the level of activity
The activity can be expressed in many ways, such as units produced, units sold, miles driven, beds
occupied, lines of print, hours worked, and so forth.
Example: direct materials (during a period may vary, in total, in direct proportion to the number of
units produced)
Constant if expressed in a per unit basis
Fixed Cost
A cost that remains constant, in total, regardless of changes in the level of activity
Not affected by changes in activity
As the activity level rises and falls, total fixed costs remain constant unless influenced by some
outside force such as price change
Example: rent
We say a cost is fixed, we mean it is fixed in a relevant range

 The Relevant Range is the range of activity within which the assumptions about variable and fixed
costs are valid.
COST CLASSIFICATIONS FOR ASSIGNING COSTS TO COST OBJECTS
Costs are assigned to cost objects for a variety of purposes including pricing, preparing profitability studies,
and controlling spending.
Cost Object
is anything for which cost data are desired including products, customers, jobs, and organizational
subunits
classified either: direct or indirect
Direct Cost
a cost that can be easily and conveniently traced to a specific cost object.
Direct materials and direct labor
Indirect Cost
A cost that cannot be easily and conveniently traced to a specified cost object.
To be traced to a cost object such as a particular product, the cost must be caused by the cost object.
A type of indirect cost: Common Cost Is a cost that is incurred to support a number of cost objects
but cannot be traced to them individually
COST CLASSIFICATIONS FOR DECISION MAKING
Differential Cost and Revenue
Differential cost a difference in cost between any two alternatives
Differential Revenue a difference in revenues between any two alternatives
Differential Cost
A.k.a. incremental cost
Although technically an incremental cost should refer to an increase in cost from one alternative to
another; decreases in costs should be referred to as decremental cost
Differential cost is a broader term, it encompasses both cost increases (incremental) and decreases
(decremental)
*Economists marginal cost. Marginal cost and marginal revenue. And the cost involved in producing
one more unit of product is called MARGINAL COST.
Can be either fixed or variable
Opportunity Cost
Is the potential benefit that is given up when one alternative is selected over another.
Sunk Cost
A cost that has already been incurred and that cannot be changed by any decision made now or in
the future.
Since it cant be changed, they are not differential costs
Can and should be ignored

COST OF GOODS MANUFACTURED

Refers to the cost of goods brought to completion during the accounting period; it does not matter if work on
these started in the past or in the current accounting period.
The manufacturing costs of Work in Process in the current period are held back as the cost of the
ending Work in Process. Similarly the beginning Work in Process inventory also becomes a part of the
cost of goods manufactured in the period.

Beginning
inventory

Purchased
(added) in the
period

Total Available

Supply

Consumed
(withdrawal) in
the period

Ending Inventory

Demand

Beginning raw materials inventory

Add: Raw materials purchased in the period
Cost of total materials purchased
Less: Ending raw materials inventory
*Raw materials consumed in the period (cost of materials used in the period)
Then
Raw materials consumed in the period
Add: Labor Cost
Add: Manufacturing (production) overhead
Cost of converting materials in the work in process and finished goods = manufacturing cost (production cost)
This manufacturing cost covers expenses involved in converting raw materials into work in process and
finished goods.
SCHEDULE OF COST OF GOODS MANUFACTURED
Direct Materials
Raw materials inventory, beg
Purchases of raw materials
Materials Available for use
Less: Raw materials inventory,
end
Materials used in production
Direct Labor
Manufacturing overhead applied to
work in process
Total manufacturing costs
Add: Work in Process, beg.
Deduct: Work in process, ending
Cost of Goods Manufactured

$ 30,000
200,000
230,000
(45,000)
$ 185,000
230,000
390,000
805,000
21,000
826,000
(56,000)
$ 770,000

SCHEDULE OF COST OF GOODS SOLD

Finished goods inventory, beginning
Add: Cost of Goods Manufactured
Goods available for sale
Deduct: Finished goods inventory, ending
Cost of Goods Sold
Optional

Unadjusted cost of goods sold

Deduct: overapplied overhead
Adjusted cost of goods sold

$ 2000
265,000
285,000
(35,000)
$ 250,000