LECTURE – TWO MANAGEMENT ACCOUNTING

MANAGEMENT ACCOUNTING LECTURE – TWO

CONTENTS

MANAGERS COST CONCEPT                1: MANUFACTURING COSTS. 2: NON-MANUFACTURING COSTS: 3: PRODUCT VERSUS PERIOD COST. 4: FIXED COST AND VARIABLE COST

 

MANAGERS COST CONCEPT:

1. MANUFACTURING Costs.

Manufacturing consists of activities and processes that convert raw materials into finished goods. Contrast this type of operation with merchandising, which sells merchandise in the form in which it is purchased. Manufacturing costs are typically classified as below:

1.      DIRECT MATERIAL

2.      DIRECT LABOR

3.      MANUFACTURING OVERHEAD 

1. DIRECT MATERIALS:

To obtain the materials that will be converted into the finished product, the manufacturer purchases raw materials.

Raw materials are the basic materials and parts used in the manufacturing process.

For example, auto manufacturers such as General motors, Ford, plastics, and tires as raw materials in making cars.

Raw materials that can be physically and directly associated with the finished product during the manufacturing process are called direct materials.

Examples include flour in the baking of bread, syrup in the bottling of soft drinks, and steel in the making of automobiles.

Direct materials for Dell computer include plastic, glass hard drives, and processing chips.

But some raw materials cannot be easily associated with the finished product. There are considered indirect materials.

(A) Indirect materials.

1.      Do not physically become part of the finished product, such as lubricants and polishing compounds. or

2.      Cannot be traced because their physical association with the finished products is too small in terms of cost, such as cotter pins and lock washers. Indirect materials are accounted for as part of manufacturing overhead.

(B) DIRECT LABOR.

The term direct labor is reserved for those labor costs that can be easily (i.e. physically and conveniently) raced to individual units of product. Direct labor is sometimes called touch labor, since direct labor workers typically touch the product while it is being made. The labor costs of assembly line workers, for example, would be direct labor costs, as would the labor costs of carpenters, bricklayers, and machine operators.

Labor costs that cannot be physically traced to the creation of products, or that can be traced only at great cost and inconvenience, are termed as indirect labor and treated as part of manufacturing overhead, along with indirect materials.

C)  MANUFACTURING OVERHEAD:

Manufacturing overhead, the third element of manufacturing cost, includes all costs of manufacturing except direct materials and direct labor. Manufacturing overhead includes items such as indirect materials, indirect labor, maintenance and repairs on production equipment; and heat and light, property taxes, depreciation, and insurance on manufacturing facilities.

Various names are used for manufacturing overhead, such as indirect manufacturing cost, factory overhead, and factory burden. All of these terms are synonymous with manufacturing overhead.

Manufacturing cost combined with direct labor is called conversion cost. This term stems from the facts that direct labor costs and overhead costs are incurred in the conversion of materials into finished products. Direct labor combined with direct materials is called prime cost.

2. NON-MANUFACTURING COSTS:

Generally non-manufacturing costs are sub classified into two categories:

1. Marketing or selling costs

2. Administrative costs

1. Marketing or selling costs include all costs necessary to secure customer order and get the finished product or service into the hands of the customer. These costs are often called order –getting or order filling cost. Examples are advertising, shipping, sales travel etc.

2. Administrative costs include all executive, organizational, and clerical costs associated with the general management of an organization rather than with manufacturing, marketing or selling. Examples of administrative costs are executive compensation, general accounting, secretarial, and public relations etc.

3 PRODUCT vERSUS Period cost.

Each of the manufacturing cost components (direct materials, direct labor, and manufacturing overhead) are product costs. As the term suggests, product costs are necessary and integral part of producing the finished product.

Product costs are recorded as inventory when incurred. Under the matching principle, these costs do not become expenses until the finished goods inventory is sold. The expense is cost of goods sold.

Period costs are those costs that are matched with the revenue of a specific time period rather than included as part of the cost of a salable product. These are no manufacturing costs.

 Period costs include selling and administrative expenses. They are deducted from revenues in the period in which they are incurred. The foregoing relationships and cost terms are summarized in as below:

All cost two types:

A.    Product cost --Manufacturing cost

B.     Period cost _ Non manufacturing cost

A. Product cost

1.      Direct Material

2.      Direct labor

3.      Manufacturing overhead

B. Period cost

1.      Selling expenses

2.      Administrative expenses

 In a sense production cost = (Product cost +    Period cost)

4. Fixed Cost and Variable Cost.

Comparison between the two with respect to a few criteria may, however, be summed up as follows:

Particulars	FIXED COSTS	VARIABLE COSTS
1.      Type of Costs	v  Fixed costs tend to remain constant irrespective of the volume of out- put or activity v  Because these costs generally accrue with the passage of time, they are known as ‘period costs’ or ‘time costs’. v  Fixed costs are ‘costs of being in the business’	v  Variable costs lend to vary directly with output or activity. v  Since these costs tend to fluctuate in proportion to changes in output or activity, they may be called ‘activity costs’ v  Variable costs are costs of doing the business’
2.      Relationship to Activity.	-Fixed costs result from the capacity to produce and they are not a result of the performance of that activity. -They are not generally influenced by output. -So, apart from knowing the incidence of costs per unit, does not, make any sense.	-Variable costs vary in proportion to activity rather than to the passage of time.  -So, expressing variable cost in relation to time does not make any sense.
3.      Relevant Activity Range.	-Fixed costs tend to remain constant only within a given range of output or activity.  -There are a few, if any, costs that would remain constant over the wide range of output or activity, say, from zero to full capacity.	The pattern of variable costs also remains constant within a normal or relevant range of operations beyond that these costs may well change.

4.      Relevant Period.	Other things remaining constant, a change in period may lead to change in fixed costs structure (e.g. due to annual increment. Salary bills in two periods will not be identical)	All other factors given constant, variable costs cannot be affected due to change in period alone.
5.      Controllability.	-All fixed costs are controllable over the life- span of an enterprise. Only few items are subject to short- run management control. -Many items of fixed costs are dependent entirely on specific management decisions. -Therefore, they may be regulated by changing management decisions.	-Variable costs are generally subject to short- term management control. In some cases, variable costs may also be affected by the discretionary policy decisions of management. For example, a decision to use a less expensive raw materials than that currently used (without impairing quality of product) will reduce the amount of variable cost (although the cost is still variable but at a different rate).

A

Summary of cost terms:

 

B

 

REVIEW:

2.1.      Management function

1.      Planning,

2.      Organizing,

3.      Staffing,

4.       Leading, 

5.      Controlling

2.2.      Managerial Cost concepts

v  Material

v  Labor and

v  Overhead

2.3.      Manufacturing Costs

4.      Direct Material

5.      Direct labor

6.      Manufacturing overhead 

2.4.      Product vERSUS Period cost

A .Product Cost- Manufacturing Cost

B. Period Cost _ -Non Manufacturing Cost.

2.5.      Fixed Cost and Variable Cost

Fixed costs tend to remain constant irrespective of the volume of out Variable costs lend to vary directly with output or activity. Since these costs tend to fluctuate in proportion to changes in output or activity,

 CONCLUSION:  Managers needs to consider various types of cost for production of goods and services to ensure productivity.

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