Strategic Cost Management – Module 1

 Management Accounting Overview

 Cost Control and Concepts
 Review of Cost Accounting
 Absorption and Variable Costing
Management Accounting Overview
● Accounting is an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and
events which are, at least, of a financial character, and interpreting the results thereof (AICPA)
● Management Accounting - a branch of accounting that provides information to management
● Management’s goal is to maximize the shareholders wealth
● Objectives of Management Accounting
○ Providing information for management decision making
○ Assisting managers in directing and controlling operational activities
○ Motivating managers and employees towards organization goals
○ Measuring the performances
○ Assessing the organization’s competitive position
● Role of Management Accounting- to assist management in performing its functions effectively.
○ Modification of Data
○ Analysis and Interpretation of Data
○ Facilitating Management Control
○ Use of Qualitative information
○ Satisfaction of informational needs of different levels of management
● Scope of Management Accounting
○ Financial Accounting
○ Cost Accounting
○ Budgeting and Forecasting
○ Cost Control Procedures
○ Reporting
○ Methods and Procedures
○ Taxation
○ Internal Financial Control
○ Interpretation
○ Evaluating the performance of management
Financial Accounting VS Management Accounting

Financial Accounting Management Accounting

External Users (investors, creditors, government

Users agencies, customers, suppliers, etc.) Internal Users (Management)

Purpose General Purpose Specific Purpose

Output Financial Statements Special reports to be used for planning,

monitoring and controlling

Types of data used Primarily financial Financial and Nonfinancial

Time Orientation Historical/Past/Passive Future Oriented/Active

Guiding Principles GAAP/Reliability/Precision User’s requirement/Relevance/ Timeliness

Unifying Concepts Accounting Equation (A=L+E) Management’s Decision Making

Content Pertains to the business as a whole Pertains to individual subunits of the business

Format Highly aggregated (Condensed) Very detailed

Frequency Annually/Quarterly/As required by the regulators As frequently as needed by the management

Cost Control and Concepts

● Cost- the sacrifices made in order to achieve the objectives
TYPES OF COSTS
● As to Financial Statement Presentation
○ Cost of Sales
■ Merchandising - inventoriable costs are purchase price and other directly attributable costs
■ Manufacturing
● Direct Materials- inventoriable costs are purchase price and other directly attributable costs
● Direct Labor - costs includes salary and other benefits given to direct laborers
● Manufacturing Overhead
○ Indirect Materials
○ Indirect Labor
○ Other manufacturing overhead
○ Operating Expenses (Cost to Sell)
■ Selling Expenses- costs from the time the product is being offered for sale up to time the product is delivered
including post-sale services
■ General and Administrative Expenses- cost of general administration and management of the company
○ Financing Costs
● As to Purpose
○ Product Cost (Inventoriable) - are matched with units of products and are recognized as an expense on the income
statement only when the units are sold. Until that time, product costs are considered to be assets and are recognized
on the balance sheet as inventory
○ Period Cost (Non inventoriable)- are expensed on the income statement in the period in which they are incurred
● As to Traceability
○ Direct Costs - physically and easily traceable to the cost object under consideration and material in costs
○ Indirect Costs - is a cost that cannot be conveniently traced to the cost object
■ Cost allocation- the process of incorporating indirect costs to the cost object
● As to Behavior
○ Variable Cost - changes in total, in direct proportion to changes in the level of activity (fixed per unit)
■ Pure or real- directly proportionate to the level of activity based
■ Step- increase in small-steps
○ Fixed Cost - total cost does not change with changes in the volume of activity (varies per unit)
■ Discretionary- the result of a management decision to spend a particular amount of money for some
purpose
■ Committed- cannot be significantly reduced even for short period of time without making fundamental
changes
○ Mixed Cost
■ Contains both variable and fixed cost elements
■ Expressed in terms of a cost function: y=a+bx
■ Must be analyzed and segregated into its variable and fixed component
Note: Cost behavior is applicable within the relevant range. Relevant Range is the level of activity wherein the classification
to changes is valid. (High-Low Method, Scatter graph, and Least Square Regression Analysis)
● As to Controllability
○ Controllable- costs that can be influenced by a decision
○ Non controllable- costs that are influenced by another party’s decision
● As to role in Decision Making
○ Differential Costs- costs that differs between alternatives
○ Opportunity Costs- benefits that are foregone by choosing another alternative
 ○ Sunk Costs- costs that are already incurred and paid for and cannot be returned
● As to Quality
○ Cost of achieving good quality
■ Prevention costs- costs incurred before any defect has occurred
■ Appraisal costs- costs of measuring, testing and analyzing whether a defect has occurred
○ Cost of poor quality
■ Internal failure costs- defects detected inside the company’s premises include scrap, rework, process
failure, downtime, and price reductions
■ External failure costs- defects were detected outside or by a customer include complaints, returns, warranty
claims, liability and lost sales
Mixed Costs
● Y= a + bx
○ Y = Total/ mixed cost
○ a = fixed cost
○ b = variable cost per unit
○ x = volume
● High low Method
○ Look for the variable cost per unit
■ b = (Y2 - Y1) / (X2 - X1)
■ Y2= highest Total/mixed cost
■ Y1= lowest Total/mixed cost
■ X2= highest volume
■ X1= lowest volume
○ Use variable cost per unit to compute for fixed cost (you can use the highest or the lowest)
■ a= Y2 - (b x X2)
■ a= Y1 - (b x X1)
● Least Square Regression Analysis/ Algebraic Method

● N= no. of periods

Review of Cost Accounting

Absorption and Variable Costing

Type of Product Costing Method
● Throughput Costing
○ Assigns only the unit-level spending for direct costs as the cost of products or services
○ A unit-level cost is incurred every time that a unit of product is manufactured
● Variable Costing
○ Product cost is comprised solely of variable manufacturing costs
○ Fixed manufacturing overhead is viewed as cost of being ready to produce, not an actual production cost since it will
remain constant no matter how many units are produced. Hence, expense immediately.
○ Also called as Direct or Marginal Costing
○ Direct materials, direct labor and variable overhead
● Absorption Costing
○ All costs related to the manufacture of a good are product costs
○ Direct material, direct labor, variable and fixed overhead

Variable Costing Absorption Costing

Advantages ● It can be used in constructing the contribution ● Results in the preparation of a traditional income
format approach income statement to highlight statement
the cost behavior structure of the entity ● Is considered GAAP and is generally acceptable
● Fit nicely with CVP analysis for tax reporting
● Net income closely tied to changes in sales level- ● Considers all cost when setting the price (cost
not production levels which makes it easier to plus pricing method)
predict the level of operating income
● Fixed costs are not accounted for as an
inventoriable cost (no need for allocation)
● Companies can also break down each department
or product line under VC, which provides a more
thorough analysis of a company’s business
operation

Disadvantages ● Does not conform to generally accepted ● Does not consider excess capacity since fixed
accounting principles costs are already allocated to the different units
● Costs are required to be separated into fixed and ● Distort the result of decisions made to
variable discontinue a business segment
● Expensing fixed production costs as a period
expense lowers net income for each accounting
period
● Too much emphasis may be given to variable
costs at the expense of disregarding fixed costs

Summary of Product Cost

Variable Costing

Absorption Costing
Effect of Product Costs in Net Income
● Since absorption costing will always have a higher inventory value (due to the fixed overhead)- the effect in net income of
changes in production and sales level will be highlighted using the variable costing
● When production is greater than sales- will result to a higher ending inventory which will decrease total cost of sales that will
result in an increase in operating income. Hence, absorption costing net income will be higher than variable costing net income
● When production is less than sales- will result to a lower ending inventory which will increase total cost of sales that will result in
a decrease in operating income. Hence, absorption costing net income will be lower than variable costing net income
● When production is equal to sales - this would mean that all costs incurred will be expense in the same period, hence net income
will be equal
● Summary
○ P>S= NIA>NIV
○ P<S=NIA<NIV
○ P=S = NIA=NIV
Reconciling Absorption and Variable Costing Net income
● Beginning Inventory= Fixed Cost that will be released will increase cost of sales, decrease net income so NIA < NIV
● Ending Inventory= Fixed cost that will be deferred will decrease cost of sales, increase net income so NIA > NIV