Featured Mind map
Cost & Management Accounting: Exam Guide & Core Concepts
Cost and Management Accounting provides internal financial data for decision-making, planning, and control, unlike financial accounting which focuses on external reporting. Key areas include classifying costs by behavior and function, calculating product costs (material, labor, overhead), and using tools like CVP analysis and budgetary control to optimize performance and evaluate investments.
Key Takeaways
Management accounting supports internal decision-making, planning, and operational control.
Costs are classified by function, element, and behavior (fixed, variable, mixed).
Only relevant costs and opportunity costs should be considered for decisions.
Absorption costing allocates all manufacturing overheads to the cost of products.
Standard costing compares predetermined costs with actual results to analyze variances.
What is the core purpose of Management Accounting?
Management accounting involves the process of identifying, measuring, analyzing, and communicating financial information specifically for internal users like managers and directors. Its core purpose is to support effective decision-making, facilitate strategic planning, and ensure operational control within the organization. Unlike financial accounting, management accounting focuses on improving efficiency and effectiveness using past, present, and future data.
- Definition: Process of identification, measurement, analysis, preparation, interpretation, and communication of information.
- Core Purpose: Supports decision-making, planning, and control functions.
- Difference from Financial Accounting: Focuses on internal users and is not governed by prescribed standards.
- Cost Accounting Definition: System for recording, classifying, allocating, and reporting manufacturing and service costs.
Which cost concepts are most relevant for management decision-making?
Management decisions rely heavily on relevant costs, which are specific costs that will change based on the choice made, and opportunity costs, representing the benefit forgone by choosing one alternative over another. Conversely, sunk costs—past costs already incurred and unrecoverable—and irrelevant costs must be ignored when evaluating future choices, as they do not impact the decision outcome.
- Cost Unit: A unit of quantity (product, service, or time) for which cost is determined.
- Cost Centre: A location, person, or equipment where costs are collected and controlled.
- Standard Cost: A predetermined target cost used for budgeting and performance evaluation.
- Quick Tip: Only relevant and opportunity costs are considered in decision-making.
How are costs categorized for effective cost management?
Costs are primarily classified in three ways: by function (direct vs. indirect), by element (material, labor, other costs), and by behavior (fixed, variable, or semi-variable). Understanding cost behavior is crucial, as variable costs change in total with activity level, while fixed costs remain constant within a relevant range, impacting profitability analysis and pricing strategies.
- Main Ways to Classify Costs: Function (purpose), Elements (nature), and Behavior (response to activity changes).
- Function-wise Classification: Direct Cost (easily traceable) and Indirect Cost (not directly traceable, e.g., overheads).
- Element-wise Classification: Material Cost, Labour Cost, and Other Costs (utilities, depreciation).
- Behavior-wise Classification: Variable Cost, Fixed Cost, and Semi-variable (Mixed) Cost.
What are the key functions and organizational structures in Material Costing?
Material costing focuses on managing the purchase function, storing materials efficiently, and valuing material issues. The purchase function involves obtaining materials of the right quality, quantity, time, and price. Organizations choose between centralized buying, which offers better control and consistent policy, or decentralized buying, which allows for quicker handling of local issues and reduced transportation costs.
- Main Functions: Managing purchase function, storing of materials, and valuing material issues.
- Managing the Purchase Function: Obtaining materials of the right quality, quantity, time, and price, from the right source.
- Organizing the Purchase Function: Centralized Buying (better control) versus Decentralized Buying (less transport cost).
- Stock Levels Maintained: Re-order level, Maximum stock level, Minimum stock level (safety/buffer stock), and Average stock level.
How is labour cost classified and tracked within an organization?
Labour costs are classified as either direct (traceable to a product or job) or indirect (part of overheads, like supervisor salaries). Accurate tracking is achieved through time-keeping methods, which can be manual (attendance registers) or mechanical (time records), and time-booking documents like daily time sheets or job cards. Remuneration methods include time rates, piece rates, or combination schemes, influenced by job evaluation to ensure fair wages.
- Labour Cost Classification: Direct labour cost versus Indirect labour cost (part of overheads).
- Methods of Time-Keeping: Manual methods (Attendance register, Disc method) and Mechanical methods (Figure machines, Dial time records).
- Time-Booking Documents: Daily time sheets, weekly time sheets, job tickets / job cards.
- Methods of Remuneration: Time rates, Piece rates, Combination, and Premium / bonus schemes.
What are the stages involved in charging overheads to production?
Overhead costing deals with the total of all indirect costs, including indirect materials, labor, and expenses. Charging these costs to products involves three stages: allocation, where full costs are assigned directly to a cost center; apportionment, where costs are shared among several cost centers on a fair basis (e.g., rent based on floor area); and finally, absorption, where costs are charged from the cost centers to the final cost units or products.
- Overhead Definition: Total of all indirect costs (indirect materials + indirect labour + indirect expenses).
- Stages of Charging Overheads: Allocation, Apportionment, and Absorption.
- Cost Centre Types: Production cost centres, Service cost centres, and Process cost centres.
- Re-apportionment: Service department costs must be transferred to production departments using methods like Direct, Step-down, or Reciprocal.
How does Absorption Costing determine the full cost of a product?
Absorption costing is a method used to share overheads fairly among different products, ensuring that each unit bears a share of the total indirect costs. This process requires calculating the Overhead Absorption Rate (OAR) by dividing total overheads by a total activity base, such as machine hours or labor hours. Management must monitor for under- or over-absorbed overhead, which occurs when actual overhead differs from the amount absorbed.
- Definition: Method of sharing overheads between different products on a fair basis.
- 3 Stages of Absorption Costing: Allocation, Apportionment, and Absorption.
- Overhead Absorption Rate (OAR): Total Overheads divided by Total Activity Base.
- Under/Over Absorbed Overhead: Occurs when actual overhead does not equal absorbed overhead, often due to differences in budgeted activity levels.
What steps and objectives guide the process of setting a product price?
Pricing is the only element in the marketing mix that generates revenue, and it communicates value and positioning. The process involves selecting a pricing objective (like maximizing profit or market share), determining demand (considering elasticity), estimating costs, and analyzing competitors. The basic formula is Price = Cost + Profit (Markup). Target costing reverses this, setting the cost based on the desired selling price and profit margin.
- Importance of Price: Only element in marketing mix that brings in revenue.
- Basic Pricing Formula: Price equals Cost plus Profit (Markup).
- Main Pricing Objectives: Survival, Maximize current profit, Maximize market share, Market skimming.
- Main Pricing Methods: Cost-plus pricing, Target return pricing, Value-based pricing, and Penetration pricing.
How do Marginal Costing and CVP Analysis support internal decision-making?
Marginal costing is an internal decision-making tool where only variable costs are charged to cost units, treating fixed costs as period costs. This contrasts with absorption costing, which includes all manufacturing costs. Marginal costing facilitates Cost-Volume-Profit (CVP) analysis, which uses the contribution margin (Sales minus Variable Costs) to calculate the Break-Even Point (BEP), the level where total revenue equals total cost.
- Marginal Costing: Only variable (direct) costs charged to cost units; fixed costs treated as period costs.
- Contribution: Difference between Sales and Variable Costs.
- Break-Even Point (BEP): Point where Total Revenue equals Total Cost (No profit, no loss).
- P/V Ratio: Indicates how much contribution is earned per rupee of sales.
Why is a Budgetary Control System essential for organizational planning?
Budgetary control is a system that uses detailed quantitative plans to manage resource acquisition and use. Its main purposes are planning, coordinating activities, allocating resources, and evaluating performance. The system involves setting budgets, measuring actual performance, comparing results to analyze variances, and taking corrective action. The Master Budget combines all operational and financial budgets, providing a comprehensive plan for the organization.
- Budgeting Definition: Detailed plan, expressed in quantitative terms, for resource acquisition/use.
- Main Purposes: Planning, coordinating, resource allocation, performance evaluation, and control.
- Steps in Budgetary Control: Establish budgets, measure actual performance, analyze variances, and take corrective action.
- Cash Budget Key Notes: Includes only actual cash receipts and payments, excluding depreciation and credit transactions.
How does Standard Costing help control production costs?
Standard costing is a control technique that compares predetermined estimated costs (standards) with actual results to identify variances. Standards can be Ideal (perfect efficiency), Attainable (realistic but challenging), or Basic (long-term benchmark). Variance analysis breaks down the total profit variance into components like Material Price and Usage variances, and Labour Rate and Efficiency variances, allowing management to pinpoint operational inefficiencies.
- Standard Cost: Predetermined estimated cost per unit under normal conditions.
- Types of Standards: Ideal Standard, Attainable Standard, and Basic Standard.
- Production Cost Variances: Direct Material (Price, Usage), Direct Labour (Rate, Efficiency), and Overhead Variances.
- Limitation: Standards may quickly become outdated or cause behavioral issues if used punitively.
What methods are used to determine the financial viability of a project?
Project appraisal assesses proposed investments before committing resources to determine if they are financially viable and worthwhile. Key issues considered include environmental factors, resource inputs, and risk. Appraisal methods include non-discounting techniques like Payback Period (PBP) and Accounting Rate of Return (ARR), and discounting methods like Net Present Value (NPV) and Internal Rate of Return (IRR), which incorporate the time value of money.
- Definition: Assessing/evaluating proposed investment before committing resources.
- Key Issues: Environmental factors, options, inputs, value for money, and risk & uncertainty.
- Non-Discounting Methods: Payback Period (time to recover investment) and Accounting Rate of Return (ARR).
- Discounting Methods: Net Present Value (NPV) and Internal Rate of Return (IRR).
Frequently Asked Questions
What is the difference between allocation and apportionment in overhead costing?
Allocation assigns the whole cost directly to a single cost center. Apportionment involves sharing a cost among several cost centers based on a fair measure, such as floor area for rent expenses. Both are initial steps before absorption.
What is the Economic Order Quantity (EOQ) formula used for?
EOQ determines the most economical quantity to order each time. It minimizes the total of ordering costs and carrying costs. The formula is EOQ = sqrt(2 * D * Co / Ch), where D is annual demand and Co is cost per order.
How does Marginal Costing differ from Absorption Costing regarding fixed costs?
Marginal costing treats fixed manufacturing overheads as period costs, expensing them immediately. Absorption costing includes fixed manufacturing overheads in the product cost, capitalizing them until the product is sold, which is required for external reporting.
What is the decision rule for accepting a project using Net Present Value (NPV)?
The Net Present Value (NPV) method calculates the difference between the present value of cash inflows and the initial investment. The decision rule is straightforward: accept the project if the calculated NPV is greater than zero.
What are the main components of a standard labour cost variance analysis?
Standard labour cost variances are typically broken down into the Labour Rate Variance (comparing actual rate paid versus standard rate) and the Labour Efficiency Variance (comparing actual hours worked versus standard hours allowed to produce output).
Related Mind Maps
View AllNo Related Mind Maps Found
We couldn't find any related mind maps at the moment. Check back later or explore our other content.
Explore Mind Maps
