MANAGEMENT ACCOUNTING Introduction to Management Accounting Chapter - PowerPoint PPT Presentation

MANAGEMENT ACCOUNTING Introduction to Management Accounting Chapter 1 Prepared and delivered by: Dhanushka Abeysekara Sithari Herath

Learning Outcomes • LO1: Demonstrate an understanding of management accounting systems. • LO2: Apply a range of management accounting techniques. • LO3: Explain the use of planning tools used in management accounting. • LO4: Compare ways in which organisations could use management accounting to respond financial problems.

Assessment Method • LO1 / LO3/ LO4 Closed Book Exam • LO2 Closed Book Exam

Assessment Criteria

What are the differences between Financial Accounting & Management Accounting? Financial Accounting (FA) Management Accounting (MA) Mainly for external users Mainly for internal users Users Usually prepared for a year Usually prepared monthly or quarterly Frequency Rules, laws, concepts, standards apply No regulations Regulations Standard formats are compulsory Only traditional formats Formats Mainly past information Past and forecasted information Focus External audit is compulsory for some Not normally audited Audit entities Accounting Management Accounting MA FA Cost Accounting

What is meant by cost? We can explain cost in two angles 1. Cost as a noun Eg: cost of a pen £1, cost of a table £40 2. Cost as a verb Eg: in the above example finding out the cost of a pen or table can be referred to as “cost the item”.

Terminologies related to cost Cost unit Eg: 1000 red bricks, a pen, a packet of milk powder, 1 kg of sugar Composite cost unit Eg: per room per hour (hotel), passenger mile (bus fair) Cost centre Eg: the stores department, packing machine, quality control function, research and development function. Cost object Eg: Any of the above

Cost Behaviour Mainly the following behaviour patterns can be found 1. Fixed cost 2. Variable cost 3. Semi-variable cost

Fixed cost Total Fixed cost Example 1 For a period the rent was £500. Draw a graph to show the rent cost changes with the no of units produced Total Fixed Cost No. of units Cost (£) 600 Cost £ 0 500 500 1 500 400 300 2 500 200 3 500 100 4 500 0 0 1 2 3 4 5 6 5 500 No of units

How to graph cost per unit? No. of Total Fixed Fixed Fixed Cost per Unit units Cost (£) Cost/Unit (£) 600.00 Cost £ 1 500 500.00 500.00 2 500 250.00 400.00 300.00 3 500 166.67 200.00 4 500 125.00 100.00 5 500 100.00 0.00 6 500 83.33 0 2 4 6 8 No of units

Fixed cost Stepped Fixed cost Example 2 If the company wants to increase the production capacity beyond 5000 units, it has to increase the storage capacity as well. For this, it has to rent out another warehouse for £250. Draw a graph to show the rent cost changes with the no of units produced No. of units Cost (£) Total Fixed Cost 0 500 800 Cost £ 500 500 700 1,000 500 600 3,500 500 500 4,000 500 400 5,000 500 300 200 5,001 750 100 5,500 750 0 6,000 750 0 2000 4000 6000 8000 10000 12000 7,000 750 No of units 10,000 750

Fixed cost Fixed cost per unit Example 3 For a company the rent cost is £50. Draw a graph which shows the fixed cost per unit using a production of 1 to 5 units. Fixed Cost per Unit No. of Total Fixed Cost per 60.00 Cost £ units Cost (£) unit (£) 50.00 1 50 50.00 40.00 2 50 25.00 30.00 20.00 3 50 16.67 10.00 4 50 12.50 0.00 0 1 2 3 4 5 6 5 50 10.00 No of units

Variable cost Total variable cost Example 4 To produce one unit of product X , it costs £5 for the materials. Draw a graph to show changes in total variable cost (material cost) with the activity level (no of units of X) Total Total Variable Cost No. of Variable Variable Cost 30 Cost £ units cost/unit (£) (£) 25 0 5 0 20 1 5 5 15 10 2 5 10 5 3 5 15 0 4 5 20 0 1 2 3 4 5 6 No of units 5 5 25

Variable cost Variable cost per unit Example 5 Draw a graph to show how the variable cost per unit changes with the activity level. (For the same example above Variable Cost per Unit No. of Variable units cost/unit (£) 6 Cost £ 0 5 5 1 5 4 2 5 3 3 5 2 4 5 1 5 5 0 0 1 2 3 4 5 6 No of units

Semi-variable cost Example 6 In a company telephone charges comprises of £100 fixed cost as well as per unit charge of £2. However first 100 units are free of charge. Draw a graph to show how the above cost changes with the activity level. No of Fixed Units more Variable Cost Total Variable Total Cost (£) Units than 100 Cost (£) per Unit (£) cost (£) (FC+TVC) 0 100 0 0 0 100 50 100 0 0 0 100 75 0 100 0 0 100 100 100 0 0 0 100 101 100 1 2 2 102 130 30 100 2 60 160 150 50 100 2 100 200 200 100 100 2 200 300

Semi-variable cost Semi Variable Cost No of Total Cost (£) 350 Units (FC+TVC) Cost £ 300 0 100 250 50 100 200 75 100 150 100 100 100 101 102 50 130 160 0 150 200 0 50 100 150 200 250 No of units 200 300

Semi-variable cost Example 7 If the company wants to increase the production capacity beyond 5000 units, it has to increase the storage capacity as well. For this, it has to rent out another warehouse for £250. Draw a graph to show the rent cost changes with the no of units produced Variable Total Total Cost Units more Fixed Cost Cost per Variable (£) No of Units than 100 (£) Unit (£) cost (£) (FC+TVC) 0 0 100 0 0 100 50 0 100 0 0 100 75 0 100 0 0 100 100 0 100 0 0 100 120 20 100 2 40 140 500 400 100 2 800 900 3,500 3,400 100 2 6,800 6,900 5,000 4,900 100 2 9,800 9,900 5,500 5,400 350 2 10,800 11,150 7,000 6,900 350 2 13,800 14,150 10,000 9,900 350 2 19,800 20,150

Semi-variable cost Total Cost (£) Semi Variable Cost No of Units (FC+TVC) 25000 0 100 Cost £ 50 100 20000 75 100 15000 100 100 120 140 10000 500 900 3,500 6,900 5000 5,000 9,900 5,500 11,150 0 7,000 14,150 0 2000 4000 6000 8000 10000 12000 No of units 10,000 20,150

Analysing semi-variable cost Example 8 For a company January telephone bill was £600 for 100 units. In February it was £750 for 150 units. Calculate the fixed cost and variable cost per unit. Month Units Cost (£) Jan 100 600 Feb 150 750 Step 1: Calculate the change in units and change in cost Change in Units 50 Change in Cost (£) 150 Step 2: Calculate the Variable cost per unit (VC/Unit) VC/Unit = 𝐷ℎ𝑏𝑜𝑕𝑓 𝑗𝑜 𝐷𝑝𝑡𝑢 𝐷ℎ𝑏𝑜𝑕𝑓 𝑗𝑜 𝑉𝑜𝑗𝑢𝑡 VC/Unit = 150/50 £3

Step 3: Calculate the total variable cost at any activity level of your choice At activity level 100: TVC = VC per Unit × Activity level or Number of Units 3 × 100 £300 Step 4: Calculate the total Fixed Cost using the same activity level At activity level 100: TFC = Total Cost - Total Variable Cost 600 - 300 £300 Step 5: Double check the answer by calculating total cost of the other activity level Total cost at the activity level of 150 TC = TVC+TFC (3×150)+300 £750

Example 9 For a company January electricity bill was £900 for 40 units. In February it was £1,000 for 50 units. Calculate the fixed cost and variable cost per unit. Month Units Cost (£) Jan 40 900 Feb 50 1000 VC Per Unit = (1000-900)/(50-40) £10 TVC @ 40 Units= 10×40 £400 TFC = 900-400 £500 Example 10 For a company January telephone bill was £1,200 for 200 units. In February it was £1,050 for 150 units. Calculate the fixed cost and variable cost per unit. Answer : Variable cost per unit = £3 Fixed Cost = £600

Classification of costs According to their According to their According to their Nature Purpose Function

Classification of costs according to their Nature Here costs can be classified into Materials, Labour and Expenses Materials include the cost of obtaining the materials and receiving them within the organisation Eg: Raw materials; components; cleaning materials; machine spare parts; machine oil. Labour those costs incurred in the form of wages and salaries, together with related employment costs Eg: wages, Salaries, Commission, Bonuses etc. Expenses are external costs such as rent, business rates, electricity, gas, postages, telephones and similar items.

Classification of costs according to their Purpose Here costs can be classified into Direct costs and Indirect costs Direct costs These are costs can be directly identified with a unit of product or service produced Indirect costs These are costs can not be directly identified with a unit of product or service produced

Cost of materials that can be clearly identified with Material a unit of product or service produced Cost classification by purpose Direct Cost of labour that can be clearly identified with a Labour unit of product or service produced Other costs that can be clearly identified with a Expenses unit of product or service produced Cost of materials that can not be clearly identified Material with a unit of product or service produced Indirect Labour Cost of labour that can not be clearly identified with a unit of product or service produced Expenses Other costs that can not be clearly identified with a unit of product or service produced