CHAPTER 1: STRATEGIC COST MANAGEMENT AND

MANAGEMENT ACCOUNTING Strategic Cost Management

Application of cost management techniques which aims to
Management reduce costs while strengthening the strategic position of a
The process of achieving organizational objectives. business.

Involves: It would be beneficial to increase costs that support the

1. Planning strategic position of the business. It is not good to cut costs in
- One of the two important functions of strategically important areas, as it reduces customer
management. satisfaction and experience.
- Setting goals and developing strategies and
tactics to achieve them. 3 ways to institute cost management techniques
2. Organizing 1. Develop systems that would streamline the
3. Leading transactions between corporate support department
4. Controlling and the operating units.
- One of the two important functions of 2. Establish transfer pricing systems to coordinate the
management buyer-supplier interactions between decentralized
- Determining whether goals are being met, organizational operating units.
and if not, what can be done. 3. Utilize pseudo profit centers to create profit
- Performance evaluation is a must. maximizing behavior in what were formerly cost
centers.
Decision Making
Selecting one alternative from a set of choices The Relationship of Management Accounting with
Financial and Cost Accounting as provider of information
Making the best choice depends on:
1. Manager’s goals 3 functions of Accounting Information:
2. Expected results from each alternative 1. To provide information to external parties such as
3. Information available when decision is made stockholders, creditors and various regulatory bodies
for investment and credit purposes
Decisions made are highly information dependent 2. To estimate the cost of products produced or services
rendered
Management Accounting 3. To provide information useful for making decisions
The process of identifying, measuring, accumulating, and controlling operations
analyzing, preparing, interpreting, and communicating
information Financial Accounting
The field of Accounting that develops information for external
Information provided to internal users decision-makers such as stockholders, suppliers, banks, and
government regulatory agencies.
Not governed by GAAP; manager must define which data are
relevant for a particular purpose and which are not. Primary Financial Accounting reports:
Balance sheet, Statement of Income, Statement of Cash Flows
Indispensable part of the system that provides information to
managers - the people whose decisions and actions determines GAAP is provided for strict adherence of financial accounting
the success or failure of the organization. reports.

Objectives of Management Accounting Cost Accounting

1. Providing managers with information for decision Field of Accounting that creates an overlap between financial
making and planning accounting and management accounting.
2. Assisting managers in directing and controlling
operations Integrates Financial Accounting by:
3. Motivating managers toward achieving organization’s Providing product costing information for financial statements
goals
4. Measuring performance of managers and sub-units Integrated Management Accounting by:
within the organization. Providing some of the quantitative, cost-based information
managers need to perform their functions.
external accumulates the
information Financial
Functions of Cost Accounting: Information
1. Focuses primarily on the determination of the cost of
making products or performing services Nature of Reports often Reports focus on
2. Determines the cost of products or services by direct Reports and focus on subunits the company in its
measurement, arbitrary assignment, and systematic or Procedures within the entirety. Reports
organization. are based almost
rational allocation of such costs. Reports are based exclusively on
3. An Integral part of the broader field of Management on a combination historical
Accounting and its overlap causes the Financial and of historical data, transactions or
Management Accounting systems to be more estimates and data.
integrated to form a complete informational network. projection of
future events.
Accounting System
One part of the organization’s Management Information The Need for Accounting Information
System
Information comes from various sources:
Cost Accounting System Economics, finance, marketing, research, production,
One part of the organization’s Overall Accounting System personnel, and accounting.

Accounting System
Management Accounting Financial Accounting
A Formal mechanism for gathering, organizing, and
Preparation of information Preparation of published communicating information about an organization’s activities.
for Planning, directing, financial statements and
controlling organization’s other financial reports Managers need information to make decisions about:
operations, and decision- ➢ Acquiring and financing production capacity
making
➢ Determining which products to produce and market
➢ Pricing products, jobs or services
Internal Users External Users ➢ Determining the best method of distributing goods
and services to the target market
Managers at all levels in the Stockholders, financial ➢ Locating the best property for production facilities
organization analysts, lenders, unions, ➢ Financing the costs of production and operations
consumer groups,
government agencies Managers should provide both:
● Quantitative information
Cost-benefit analysis Allows managers to know the number of impact of
Analytical process of comparing the relative costs and benefits every alternative choice.
that result from a specific course of action, which the
managers should apply. ● Qualitative information
Furnishes the facts that help eliminate some of the
inherent uncertainties related to such alternative
choices.
Basis Management Financial
Accounting Accounting
Managers are information users, while Accountants are
Users of Internal External information providers.
information

Regulations to Not required and GAAP

Follow unregulated
Management functions or process:
Sources of Data Organization’s Data are drawn ➢ Planning
basic Accounting exclusively from Process of translating the goals and objectives of an
System plus the organization’s organization and developing a strategy for achieving
various other basic Accounting those goals in a systematic manner.
sources, such as System, which
 ➢ Controlling The Changing Role of a Traditional Accountant’s Function
Process of setting performance standards, measuring to a Financial Manager’s Function
performance, periodically comparing actual
performance with standards, and taking corrective Competition among firms: Information system and Financial
measures or actions when operations do not conform management
with what is expected.
Good financial management will help any business provide:
➢ Performance evaluation ● Better products or services to its customers
Process of determining the degree of success in ● Pay higher wages and salaries to its workers and
accomplishing the plan. It is done to determine if the employees, and even managers
actual results materially differ with what was set by ● Greater returns to the investors who put up capital
the firm. needed to form the company and then operate the
firm
Tries to equate both:
● Effectiveness Traditional Accountant’s function is to provide information
A measure of how well an organization’s about the firm’s financial activities for decision making.
goals and objectives are achieved. Compares Management accountants became users of this information
actual output results to desired results. and introduced many changes towards better management
decisions. Changes include:
● Efficiency ➢ A Shift toward addressing the needs of service
A measure of the degree to which tasks were companies and improving practices to better serve
performed to produce the best yield at lower and meet the needs of managers
cost from the resources available. ➢ Improved practices which include a focus on
managing the value chain through techniques such as
➢ Decision making JIT system and ERP (Enterprise Resource Planning)
Process of choosing among the possible solutions ➢ The use of the balanced scorecard in order to attain a
available to a given problem situation. more comprehensive view of the company’s
operations.
Organizational Structure
Refers to how authority as well as responsibility for making Financial Management Responsibilities
decisions is distributed in the organization.
Primary task of financial manager:
Line of going down - line of authority Plan for the acquisition and use of funds so as to maximize the
Line of going up - line of responsibility value of the firm, that is, he or she makes decisions about
alternative sources and uses of funds.
Most common officers involved in the financial information:
● Chief Executive Officer (CEO) ➢ Forecasting and planning
● Chief Financial Officer (CFO) Financial managers must interact with other
● The Treasurer executives as they jointly look ahead and formulate
● The Comptroller or Controller plans, which will shape the firm’s future position.
● The Chief Accountant
➢ Capital investment and financing decisions
CFO reports to the President or CEO Financial manager must raise the capital needed to
support growth.
Treasurer
Has direct responsibility for managing the firm’s cash and Financial officer must help determine the optimal rate
marketable securities, for planning its capital structure, for of sales growth, and decide on the specific
selling stock and bonds to raise capital, and for overseeing the investments to be made as well as on the types of
corporate pension fund. funds to be used to finance these investments
(internal vs. external funds; long term vs. short term
Controller debt)
Responsible for the activities of the accounting and tax
departments. ➢ Controlling and coordinating
Financial manager must interact with other
 executives so that the firm could operate as The organizational chart of the company shows the corporate
efficiently as possible. governance.

Basic Duties of Controller Ethical Conduct (CCIO)

● Planning, controlling, designing, installing and 1. Competence
maintaining the cost accounting system ● Maintain an appropriate level of
● Predicting future costs professional competence by ongoing
● Coordinating the development of the budget development of their knowledge and skills.
● Accumulating and analyzing actual costs ● Perform their professional duties in
● Preparing and analysing performance reports accordance with laws, regulations, and
● Preparing reports for external users technical standards.
● Providing information for special decisions ● Prepare complete and clear reports and
● Consulting with management as to cost information recommendations after appropriate analyses
● Internal auditing of relevant and reliable information.
● Tax administration
● Protection of assets 2. Confidentiality
● Economic appraisal ● Refrain from disclosing confidential
information acquired in the course of their
Basic Duties of Treasurer work, except when authorized, unless
● Financial planning or fund management legally obliged to do so
● Obtaining funds to finance the acquisition of fixed ● Inform subordinates as appropriate
assets regarding the confidentiality of information
● Evaluating the acquisition of fixed assets acquired in the course of their work and
● Short term finance sourcing or managing working monitor their activities to assure the
capital needed maintenance of that confidentiality.
● Banking and custody ● Refrain from using or appearing to use
● Managing the pension fund confidential information acquired in the
● Managing foreign exchange transactions course of their work for unethical or illegal
● Credits and collection advantage either personally or through third
● Distribution of corporate earnings to owners parties.

Major responsibilities of financial management involves 3. Integrity

decision such as: ● Avoid actual or apparent conflicts of interest
1. Which investments the firm should make and advise all appropriate parties of any
2. How their projects should be financed potential conflict.
3. How managers of the firm can most effectively ● Refrain from engaging in any activity that
protect and manage its existing resources would prejudice their ability to carry out
their duties ethically
Professional Ethics for Management Accountants ● Refuse any gift, favor, or hospitality that
would influence or would appear to
Maximizing shareholders’ wealth should be achieved subject influence their actions.
to ethical constraints. ● Refrain from either actively or passively
subverting the attainment of the
In the United States, Sarbanes-Oxley Act of 2002 has been organization’s legitimate and ethical
passed to reduce the apparent conflicts of interest that exist in objectives.
many corporate structures. ● Recognize and communicate professional
limitations or other constraints that would
Companies developed guidelines for good corporate preclude responsible judgement or
governance. successful performance of an activity.
● Communicate unfavorable as well as
Corporate Governance favorable information and professional
A system of organizational control that is used to define and judgments or opinions.
establish lines of responsibility and accountability among ● Refrain from engaging in or supporting any
major participants in the corporation. activity that would discredit the profession.
 Type of strategy that focuses on action plans for managing a
4. Objectivity particular functional area within a business in a way that
● Communicate information fairly and supports the business-level strategy
objectively
● Disclose fully all relevant information that Goal commitment
could reasonably be expected to influence an One’s attachment to, or determination to reach
intended user’s understanding of the reports,
comments, and recommendations presented. Operating plans
Contain the details necessary to implement and maintain an
Resolution of Ethical Conflict organization’s strategies

When faced with significant ethical issues, management Strategic goals

accountants should follow the established policies of the Broadly defined targets or future end results set by top
organization. If these policies do not resolve ethical conflict, management
management accountants should consider the ff:
Strategic management
● Discuss such problems with the immediate superior Process through which managers formulate and implement
except when the superior is involved. If satisfactory strategies geared toward optimizing strategic goal
resolution cannot be achieved when the problem is achievement, with given available environmental and internal
initially presented, submit to the next higher conditions
managerial level.
● If the immediate superior is the CEO, or equivalent, Grand strategy
the acceptable reviewing authority may be a group Master strategy that provides the basic strategic direction at
(audit committee, BOD, board of trustees). the corporate level
● Clarify relevant concepts by confidential discussions
with an objective advisor to obtain an understanding Strategy formulation
of possible courses of action. Process of identifying the missions and strategic goals,
● If the ethical conflict still exists after exhausting all conducting competitive analysis, and developing specific
levels of internal review, the management accountant strategies. Foundation level of organization planning.
may have no other recourse on significant matters
than to resign and submit an informative Strategy implementation
memorandum. Process of carrying out strategic plans and maintaining control
over how those plans are carried out
Terms in management process:
Total Quality Management (TQM)
Administrative Management Aimed at continually improving product and service quality so
An approach that focuses on principles that can be used by as to achieve high levels of customer satisfaction and build
managers to coordinate the internal activities of organization strong customer loyalty.

Management Accounting Information System

Functional authority
Authority of staff departments over others in matters directly Definitions of Management Information System:
related to their respective functions ➢ A business system that provides past, present and
projected information about a company and its
Functional managers environment (David M. Kroenke and Kathleen A.
Managers who have responsibility for a specific specialized Nolan)
area and supervise mainly individuals with expertise and ➢ A formal method of making available to management
training in that area the accurate and timely information necessary to
facilitate the decision-making process and enable the
Functional structure organization’s planning, control and operational
Structure in which positions are grouped according to their functions to be carried out effectively (James A F.
main functional or specialized area Stoner)
➢ System that monitors and retrieves data from the
Functional-level strategy environment, captures data from transactions and
 operation within the firm, filters, organizes and
selects data and presented them as information to Management Control System (MCS)
managers, and provides the means for managers to Guides the organizations in designing and implementing
generate information as desired (Robert G. Maudrick) strategies such that the organizational goals and objectives are
achieved.
Designing a Management Accounting System
4 primary components:
Each firm requires a management accounting system that is 1. A detector or sensor
tailored to its circumstances, such as: organizational form, Identifies what is actually happening in the process of
structure and culture. being controlled

➢ The firm’s legal nature must be reflected in its 2. An assessor

organizational form (proprietorship, partnership, or Device for determining the significance of what is
corporation) happening
➢ The firm’s organizational structure refers to how
authority and responsibility for decision making are 3. An effector
distributed (centralized or decentralized form) Device that alters behavior if the assessor indicates
➢ The firm’s organizational culture refers to the the need for doing so. “Feedback”
underlying set of assumptions about an entity and the
goals, processes, practices and values that are shared 4. A communication network
by its members Transmits information between the detector and the
assessor and between the assessor and the effector
Systems should be evaluated to determine the answers to the
following questions: Cost Management System (CMS)
1. What is being gathered and in what form? Consists of a set of formal methods developed for planning
2. What outputs are being generated and in what form? and controlling an organization’s cost-generating activities
3. How to current systems interact with one another and relative to its goals and objectives.
how effective are those interactions?
4. Is the current chart of accounts appropriate for the CMS helps managers:
management accounting information desired? ➢ Identify the cost of resources consumed in
5. What significant information issues are not presently performing significant activities of the firm - the
being addressed by the information system and could accounting models and practices
those issues be integrated into the current system? ➢ Determine the efficiency and effectiveness of the
activities performed - performance measurement
Proper incentives and reporting systems must be incorporated ➢ Identify and evaluate new activities that can improve
into the system for managers to make appropriate decisions. the future performance of new firm - investment
management, and
➢ Accomplish the first three functions stated above in
System must be composed of three primary elements: an environment characterized by changing
1. Motivational elements technology - adapting the firm in the changes of
Includes performance measures, reward structure, technologies
support of organizational mission and competitive
strategy Essential characteristics and qualities of information

2. Informational elements We describe information in terms of:

Includes all necessary information related to 1. Accuracy and Verifiability
budgeting, cost control, value added and non-value The degree to which information is free from error
added activities, and assessment of core
competencies and analysis of make-or-outsource 2. Completeness
decisions Refers to the degree to which it is free from
omissions
3. Reporting elements
Includes the preparation of financial statements for Benefit-cost analysis is a good example of the
both financial and management accounting purpose importance of considering the completeness of
 information in the decision-making process. Orderly, efficient scheme for providing accurate financial
information and controls
Referred to as sufficient information
Classified into:
3. Relevance 1. Operating results
Refers to the appropriateness of the information as Accounting information enables both internal and
input for a particular decision to be made external users evaluate organizational performance

4. Timeliness 2. Setting priorities

Refers to the time sensitivity of information. Accounting information, by way of accounting
Sensitivity refers to the effect of decision that should reports, enables the management to focus on
have been mad if the information was given on time operating problems, imperfections, inefficiencies, and
or not given on time. opportunities.

Components of Information Systems (Computer Based 3. Problem solving

System) Commonly related with non-recurring decisions or
situations that require special accounting analyses or
Systems reports.
A group of components that interfere with and complement
one another to achieve one or more predefined goals. Uses of Accounting System
➢ Routine reporting to management, primarily for
Information system is normally referred to as computer-based planning and controlling current operations
system that provides: ➢ Special reporting to management, primarily for long-
a. Data processing (DP) capabilities of a department or range planning and short-term but non-recurring
perhaps an entire company, and decisions
b. Information - as people need to make better, more ➢ Routine reporting on financial and operating results,
informed decision is inevitable primarily for external parties

Major components of a system: (ITOF) Components of an Accounting System (FEPP)

1. Inputs 1. Forms
Various human, material, financial, equipment and Documents on which data is recorded(O.R., sales
informational resources put together required to invoices, checks)
produce goods and services

2. Equipment
2. Transformation processes Devices and machines (computers, cash registers,
Organization’s managerial and technological abilities vaults, filing cabinets)
that are applied to convert inputs into outputs
3. Procedures
3. Outputs Series of operations or steps that must be performed
Products, services, information or any other to complete a task (sales form)
outcomes produced by the organization
4. People
4. Feedback An accounting system can only function efficiently
Information about the results and organizational and effectively if the people who are involved in it
status relative to the environment perform their duties carefully and accurately

Purpose of Accounting Information and Need for General Guidelines in Setting Good Accounting System
Accounting Systems Design
➢ Flexibility
Ultimate use: help someone make decisions System must be adaptable to meet changing
circumstances and demands
Accounting System
 ➢ Reliability
System must be strong and can stand up to misuse, 6. Job rotations and forced leaves and bonds
both deliberate and accidental Key employees handling custodianship functions
should be forced to take some vacation leaves and be
➢ Simplicity rotated occasionally and if possible to place bonds.
System must be simple and easy to understand
7. Periodic review of the system
➢ Helpfulness Periodic review of all phases of the system by
It is also about the usefulness of the system to those internal or external auditors are necessary.
who have to work with it.
8. Physical safeguards
➢ Economy Safe boxes, locks and other safety measures must be
It is always related to the idea of cost-benefit installed, and limited access to authorized personnel
analysis. An accounting system may be too good but will minimize asset and record losses.
too costly for an organization
9. Routine and spot checks
➢ Control Mechanisms Routine but unscheduled checks must be done to
Accounting system must contain controls to ensure: prevent commission of fraud at any time.
● Accuracy
Records are checked at various stages of the 10. Cost feasibility
accounting cycle Benefits should outweigh costs

● Honesty Sources of Accounting Data

Effective controls are needed to prevent
temptation of mishandling, theft and other Common transaction systems in a typical firm are:
possible commission of fraud and ➢ Order (Sales or service) Entry System
irregularities Sales orders from customers are processed and filed,
and customers are billed for their purchases.
● Efficiency and speed
More than one person can work on related ➢ Cash Receipts System
records at the same time. Refers to the Cash receipts from customers are recorded, and cash
theory of “check and balance”. is deposited intact.

➢ Purchases System
Elements of Good Internal Control Items for sale or for production use are ordered,
1. Reliable personnel received and recorded.
Personnel should be given duties appropriate to their
interests, experience and capabilities. ➢ Production Planning and Control System
In manufacturing firms, production schedules are set;
2. Separation of duties purchases are made; materials, labor and equipment
Recording and custodianship of assets should not be are scheduled; and production output is monitored.
handled by one person. No one person must be in
total control of any activity. ➢ Cash Disbursement System
All payments for purchases and any other are made
3. Supervision and recorded.
Each supervisor oversees and appraises the
performance of his subordinates. ➢ Personnel System
All personnel events are recorded, including hiring,
4. Responsibility giving benefits, evaluation and payroll activities.
Must be clearly laid out to trace who should be
praised or punished. ➢ General Accounting System
Data from all other transaction systems are brought
5. Document control together, and most management reports and financial
Immediate, complete and tamper-proof recording statements are generated.
 Matched against revenues in the time period in which
Elements of a Computerized Accounting System it is incurred. These are the normal operating
expenses of the firm.
Input Data → Process → Output Information
Product and period costs are useful in income statement using
Data variable costing method.
Customer’s name, details of items needed by customer, terms
of sale Costs classified in relation to management controlling
functions, particularly in managing cost.
Processing
Invoice prepared and approved, recording and billing Classifying costs as direct or indirect would be meaningless,
prepared. TOTAL sales summarized unless the firm first identifies some organizational segment to
which these costs are to be related. The segment could be a
Information product line, a functional department, a division, a branch, or
Sales reports generated. Daily, weekly or monthly by product some other sub-unit.
line or by territory whatever is applicable
A. As to Traceability
CHAPTER 2: COST CONCEPTS, CLASSIFICATIONS ● Direct cost
AND COST BEHAVIOR Can be traced to a particular plant or
department.
“Cost is sacrifice”
● Indirect cost
Sacrifice - something of value for an expected benefit greater Not directly traceable to a particular
than its cost. department or sub-unit.
Cost classified as to direct or indirect is useful to:
Cost classified by the functional areas of the organization to
which the costs relate Cost Management System
- Aims to trace as many costs as possible directly to
● Manufacturing cost the activities to which costs are incurred.
Incurred in the production. Composed of direct - Sometimes called “Activity Accounting”.
material, direct labor and manufacturing overhead. - Vital to the objective of eliminating “non-value
added costs,'' which are costs that can be eliminated
● Nonmanufacturing cost without deterioration of service quality, performance
Incurred in administering the operation of the or perceived value. Achieved by AB Costing.
business and commercializing the product or service.
Called operating expenses. B. As to Controllability
● Controllable cost
Service - consumed as it is produced Manager can significantly or heavily
Manufactured product - can be stored in inventory influence the level of incurrence of such
cost.
Cost classified as to timing of charges to revenue in an
accounting period ● Uncontrollable cost
Manager cannot significantly influence its
● Product cost incurrence. Costs allocated to his department
Cost assigned to goods or services until sold. Also by the higher authority.
known as inventoriable cost.
Viewed as “attaching” to units of product as the Cost classified in relation to decision making
goods are purchased or manufactured and they
remain to be the cost of goods in inventory awaiting ● Opportunity cost
sale. Benefit sacrificed/foregone in choosing one
When sold, expensed (COGS) and matched against alternative over another.
sales revenue.
● Differential cost/Incremental cost/Decremental cost
● Period cost Amount by which cost differs under two alternative
 actions.
Inversely proportional to the changes in activity/cost
● Relevant cost driver
Cost incurred in one alternative, but will not be
incurred in another. ● Mixed or semi-variable cost
Management assumes that mixed cost has been
● Marginal cost segregated using different cost segregation technique.
Extra cost incurred when one additional unit is
produced. Differ across different ranges of production Cost function
quantities because the efficiency of production Formula to which the total cost of the firm will be computed
process changes.
Y = A + B(X)
● Average cost per unit
Total cost to produce divided by no. of units Other terms commonly used in the study of Management
manufactured Accounting
● Cost Allocation
● Sunk cost Process of assigning costs in a cost pool. TRacing
Cost that has been paid or incurred. They do not and reassigning costs to one or more cost objectives
affect future costs and cannot be changed by any such as departments, customers, or products.
current or future actions, such as historical or
committed costs. ● Cost Objective
Activity or resource for which a separate
Ex: long-term lease contracts measurement of costs is desired. Ex: departments,
products, and segments or territories.
● Out-of-pocket costs
Cost that requires the payment of cash or other assets
in the future as a result of their incurrence.
● Cost Object
Costs classified in relation to organization’s activity and its Activity for which costs are accumulated and
behaviour measured.

Cost behaviour ● Cost Measurement

How cost will react to changes in the level of activity First step in estimating or predicting costs as a
function of appropriate cost drivers.
Activity
Measure of the organization’s output of products and services ● Cost Accounting
Calculation of costs for the purpose of planning and
Cost driver controlling activities, improving quality and
Activity that causes costs to change or activity that incur costs efficiency, and making decisions.

● Variable cost ● Control

Total = varies Management’s systematic effort to achieve objectives
Per unit = constant by comparing performance to plans and acting to
correct differences between them.
Directly proportional to the changes in activity/cost
driver. ● Cost Estimate
Process of determining how a particular cost behaves
Relevant Range - assumed range of activity, which
reflects the company’s normal operating levels and ● Cost Pool
the relationship of cost behaviour is valid. Collection of costs to be assigned to a set of cost
objectives
● Fixed cost
Total = constant ● Common Costs
Per unit = varies Cost of facilities and services that are shared by
 users.

● Capacity Costs
Fixed costs of being able to achieve a desired level of
production or to provide a desired level of service
while maintaining product or service attributes, such
as quality.

● Committed Fixed Costs

Expenditures that require a series of payments over a
long-term period of time.

● Common Costs
Non-traceable costs incurred for the benefit of one or
more than one functional classification or business
unit.

● Discretionary Fixed Costs

Programmed costs. Expenditures which are fixed as a
result of management policy.

● Marginal Costing
Variable costing. Assigns only variable
manufacturing cost to products.

CHAPTER 3: PRODUCT COSTING

● Job Order Costing
Costing method in which costs are accumulated for “How income be correctly measured?”
each job, batch or customer order.
Absorption Costing Method
● Process Costing Costs the product with all manufacturing costs regardless of
Materials, labor and FOH are charged to cost centers. whether the manufacturing cost is variable or fixed.

Cost assigned to each unit = Total cost charged to the Fixed OH is treated as unexpired costs to be held back as
cost center/no. of units produced inventory, and charge to revenue later as goods are sold.

This method cannot be used to prepare a segment income

reporting under contribution margin which is one of the best
measures in evaluating the performance of a segment.

● Direct Materials, Direct Labor, Variable and Fixed

OH are initially applied to inventory. Considered as
Product cost. Becomes expense as sold; COGS.

Income Statement

Sales xx
Less: COGS xx
Gross Profit xx
Less: Selling and Admin Exp.
Variable xx
Fixed xx xx
Net Income xx
Fixed OH per unit = Total Fixed costs/Units produced will decrease and Fixed OH that were previously
COGS = (VC per unit + FC per unit) x units sold deferred in inventory under Absorption Costing are
Ending inventory = Ending units x COGS released, plus the current Fixed OH charged against
income.

Variable (Direct) Costing Method Under Variable Costing, only Fixed OH for the
Cost of the product must include only those production costs current year have been charged against revenues.
that vary directly with the volume of production.
➢ Production > Sales
Fixed OH is not treated as product costs, rather, as an expired Net Income: AC > VC
cost to be immediately charged to revenue as incurred.
When more units are produced than sold, part of the
● Only Direct Materials, Direct Labor and Variable OH Fixed OH of the current period are deferred in
are initially applied to Inventory and considered as inventory to the next period under Absorption
Product Cost. Becomes expense as sold; COGS. Costing. Only that portion is charged against income
● Fixed OH is charged immediately to revenues as for the year.
Period Cost. Expense as incurred.
Under Variable Costing, all Fixed OH for the current
year are immediately charged against income as
period cost.

Income Statement presentation using Standard Costing

Income Statement
In Absorption Costing Method, production volume variance
Sales xx appears whenever actual production deviates from the
Less: Variable Costs xx expected volume of production, which was used in computing
Variable COGS xx the predetermined fixed OH rate.
Variable Selling & Admin Exp. xx xx
Contribution Margin xx When using standard costs, all production must be stated at
Less: Fixed Costs standard.
Fixed Manufacturing OH xx
Fixed Selling & Admin Exp. xx xx It is important to note that:
Net Income xx ➢ Expected production volume = Actual production
volume
COGS = Variable Cost per unit x units sold No variance
Ending inventory = Ending units x COGS
➢ Expected volume > Actual volume
Absorption Method and Variable Method Variance is unfavorable because usage of facilities is
less than expected, and fixed OH is underapplied.
*Net Income variance = Ending inventory variance
*This variance is comprised of the Fixed OH ➢ Expected volume < Actual volume
Variance is favorable because usage of facilities is
Observations regarding sales and production of units: more than expected, and fixed OH is overapplied.

➢ Production = Sales Reconciliation of Variable Costing and Absorption Costing

Same net income will be realized regardless of the
method used. Pro forma reconciliation:

➢ Production < Sales Absorption to Variable Costing

Net Income: AC < VC Net Income per Absorption Costing xx
Add: Fixed OH in beginning inventory xx
When more units are sold than produced, inventories Less: Fixed OH in ending inventory xx
 Net Income per Variable Costing xx ➢ Relevant range
Limit within which the volume of activity can vary
Variable Costing to Absorption where sales and costs relationship remain valid.
Net Income per Variable Costing xx
Less: Fixed OH in beginning inventory xx ➢ Sales mix
Add: Fixed OH in ending inventory xx Relative combination of products that compose a
Net Income per Absorption Costing xx company’s total sales. Applicable only in a multiple
product line companies.
CHAPTER 4: COST VOLUME PROFIT ANALYSIS
Basic CVP Equation:
CVP Analysis Sales - Variable Cost = Contribution Margin - Total Fixed
● Key factor in planning and controlling, and the best Costs = Profit
tool to profit maximization.
● Study of effects of volume of output on revenues, Some basic underlying assumptions about CVP analysis
expenses and net income. ➢ Relevant range
● Analytical technique for studying the relationship CVP analysis is valid only within the company’s
between fixed costs, variable costs, sales volume and relevant range of activity. If an activity was made
profits. beyond this point, the relationship of fixed cost,
volume and variable costs may vary.
Breakeven Point in CVP analysis
The point at which total sales will just cover total costs - no
profit, no loss. ➢ Cost behaviour identified
Breakeven analysis would help management determine: Costs are classified as fixed and variable only, no
➢ The number of unit sales required to breakeven more mixed cost, as mixed cost was assumed to have
➢ The peso amount of revenues needed to achieve a been segregated already.
specified profit level.
➢ The effect on profits if selling price, fixed cost, and ➢ Linearity
variable cost changes. The selling price and the unit variable costs are
➢ The required selling price needed to cover a projected constant over all sales volumes within the company’s
fixed cost change. relevant range of activity.

Basic CVP terms: ➢ Sales and production volume are equal

➢ Break-even point If sales and production are not equal, some amount of
Point where no profit, no loss. variable and fixed costs are treated as assets
Total sales = total cost (inventories) rather than expense. If inventories
remain fairly stable between adjacent time periods,
➢ Contribution Margin there will be no significant effect on the CVP
Excess of sales over all variable costs analysis.

➢ Contribution Margin ratio CVP assumes no beginning, no ending inventory.

Contribution margin divided by total sales
➢ Activity measure
➢ Contribution Margin per unit Volume of units produced is the only cost driver.
Selling price per unit less all variable cost per unit
➢ Constant sales mix
➢ Margin of safety In a multiple product line, sales mix is assumed to be
Excess of actual or budgeted sales over break-even constant throughout the year.
sales.
The amount by which sales could decrease before Uses of CVP analysis
losses may occur. ➢ It will provide management with cost and profit data
for profit planning, policy formulation and decision
➢ Margin of safety ratio making.
Margin of safety divided by actual or budgeted sales ➢ It will provide data in determining the optimal level
and mix of output to be produced with available
 resources. *At the breakeven point, the total contribution margin = total
➢ It will help the management to predetermine the fixed costs.
required volume of production and sales to achieve a
desired profit. Some limitations of Breakeven analysis
➢ Total revenue function is based on the assumption
Basic formulas of Break-even Point (BEP) that the price per unit is constant regardless of the
volume of sales and production, which is normally
Single product line: not realistic.
➢ At very low outputs, the cost per unit might be high
Equation approach because the labor force would not be producing
BEP = Sales - Variable costs - Fixed costs enough units and learn how to produce them
efficiently, and since the demand is low, the company
Contribution margin approach will produce at low volume and will not buy raw
BEP in units = Total fixed costs/CM per unit materials in bulk, thus it cannot take advantage of
BEP in pesos = Total fixed costs/CM ratio quantity discounts.

Determining the desired sales to earn a desired profit At high volumes, the firm might have to employ
a. Desired sales if net income is before income tax labor on an overtime basis, on rush jobs, or to utilize
its equipment which are less efficient, both of which
Total FC +Desired pre− would lead to a higher variable unit costs.
Desired sales∈units= Cost Structure
CM per unit
b. Desired sales if net income is after income tax The relative proportion of its fixed and variable costs.

Desired sales in units = Highly mechanized process has large investment in plant and
Total fixed costs + (Desired profit after tax/1-tax rate) equipment, which results in a cost structure dominated by
CM per unit fixed costs.

Breakeven point for multiple product lime The greater the proportion of fixed costs in a firm’s structure,
The company has to pre-determine the sales mix where such the greater will be the impact on profit from a given
sales mix will be considered as one package (composite unit) percentage change in sales revenue.
as in a single product line. The following steps should be
done: Operating Leverage
1. Determine the sales mix or set the planned sales mix Extent to which the organization uses fixed costs in its cost
2. Determine the contribution margin for each product structure.
3. Determine the weighted contribution margin(WCM) OL is greater in firms with a large proportion of fixed costs,
per unit low proportion of variable costs, and the resulting high
contribution margin ratio.
No. of unit in the mix for each product x
Corresponding cm per unit High % of FC = High degree of Operating Leverage

4. Get the sum of the WCM per unit to get the total In business, high degree of OL means that relatively small
weighted contribution margin(TWCM) and considers amount or percentage of change in sales will result in a
that as the single CM per unit. relatively large change in operating income.
5. Determine the combined units by
Total Fixed costs To the management accountant,
TWCM ● OL is the ability of the firm to generate an increase in
net income when sales revenue increases.
● It is the firm’s ratio of fixed cost to variable cost
If the amount to be determined is the desire sales
with profit, the same approach will be done, except
Operating Leverage factor:
that the numerator will be Total FC + desired profit
Contribution Margin
before tax.
Net Income
6. Multiply the combined units derived from step 5 with
the no. of each product in the mix.
Degree of operating leverage:
 Percent change in Net Income be grouped or pooled to similar activities for a so-
Percent change in sales called activity centers so that a single cost driver will
be used.
Operating Leverage factor
A measure, at a particular level of sales, of percentage impact ➢ Cost driver
on net income of a given percentage change in sales revenue. Mechanism used to link a given activity’s pool of
costs.
Percentage change in NI:
% change in sales x Operating Leverage factor Any factor that causes costs to change in that pool of
costs. It measures the amount of resources used by a
*Since a firm with relatively high Operating Leverage has specific product.
proportionally high fixed expenses, the firm’s break-even
point will be relatively high. ➢ Cost function
Created from the activity’s costs and the planned cost
The optimal cost structure for an organization involves a driver activity level.
trade-off. Management must weigh the benefits of high
operating leverage against the risks of large committed fixed
costs and the associated high break-even point. Reasons or Factors affecting the use of Activity-Based
Costing
CHAPTER 5: ACTIVITY BASED COSTING AND
SERVICE COST ALLOCATION ➢ The competitive environment, which will impact the
degree of accuracy needed and the level or degree of
Activity Based Costing (ABC) System product costing errors the company could tolerate.
Cost allocation system that focuses on activities performed to ➢ The homogeneity or heterogeneity of the products
manufacture a product or service. It is a transaction based produced.
costing. ➢ The complexity of the production process.
➢ The volumes of each product produced.
Activities ➢ The costs of measuring and collecting activity and
Fundamental cost accumulation point cost data.
➢ The impacts that more accurate and relevant data will
Activity Based Management have on managerial behavior.
Activities defined for ABC can also be used for cost
management and performance evaluation purposes. Steps in developing ABC system
➢ Assemble similar actions and classify costs
Eliminates costs that are Non-value-added Classify the major activities that pertain to the
manufacture of specific products and allocate
Non-value-added activities overhead costs to the appropriate cost pools.
● Add cost to, or increase the time spent on a product
or service without increasing its market value. ➢ Select cost drivers
● Can be eliminated without deterioration of product Identify the cost driver that has a strong correlation to
quality and value through reduced total production the accumulated in the activity cost pool
time and thus, increases profitability.
● Example: use of JIT production systems ➢ Identify cost functions
Compute the activity-based overhead rate per cost
Purpose of Activity-Based Costing driver.
Trace costs to products/service instead of arbitrarily allocating
costs. ➢ Assign costs to products
Assign overhead costs for each activity cost pool to
Major components of ABC and their relationships products or services using the cost drivers.
➢ Activity center
Management wants the costs of a set of activities to Comparing ABC to the Traditional Volume-based Costing
be reported separately.
Traditional Costing System
ABC requires that all activities in the company must Allocates unit-based overhead to products on the basis of
predetermined plant-wide or department-wide volume of unit- Budgeted cost is usually the basis of allocating costs.
based output rates.
Allocating actual costs burdens the operating
ABC System departments with the inefficiencies of the service
Allocates overhead to the identified activity cost pools, and department managers.
costs are then assigned to products using related cost drivers.
After allocating service department’s costs, such
Advantages of Activity-Based costing amounts are added to the operating departments own
➢ ABC could accurately measure profitability of costs and are now included in its performance
products because it has more number of cost pools evaluations and in the determination of their
used to assign overhead. As global competition individual profitability.
increases, product mix, pricing, and other decisions
require better product cost information.
➢ ABC points out efficiency and effectiveness of the
measures for all costs generating activities. CHAPTER 6: STANDARD COSTING FOR COST
➢ Many managers have discovered that control of costs CONTROL
is best accomplished by focusing directly on efficient
uses of activities, not by focusing on products, and Standards
therefore, can make better management decisions. Benchmark or Norm for measuring performance.
In management accounting: It relates to the quantity and cost
Limitations of Activity-Based Costing system of inputs used in manufacturing goods or providing service.
➢ The higher analysis and measurement of costs that
accompany multiple activity center and cost drivers, Managers are expected to:
and ● Pay the lowest possible prices that are consistent with
➢ The necessity still to allocate some costs arbitrarily the quality of output desired.
This is a question of how much should be paid for the
Service or Support Department’s Cost Allocation to quantity of the input to be used.
Operating Departments
● Consume quantity of materials at the minimum
Operating departments possible, again, at desired quality of output.
Include sub-units to which the main activities are carried out. This is a question of how much of the input should be
used per unit of output.
Service departments
Departments within an organization that do note engage Setting Standard Costs
directly in the operation of the business, but provide assistance No single form of standard is appropriate for all situations.
to the operating department. Data must be adjusted in terms of changing economic
conditions, changing demand and supply situations, and
Procedures in Allocation Service Department Costs changing technologies.
➢ Proper selection of allocation base
Measure of activity that acts as a cost driver. Accounting and Disposition of Standard costs

➢ Allocating the costs of interdepartmental services Variance

Also called reciprocal services where a particular Difference between actual and standard cost
service department provides services for each other.
Most common methods used are direct method and “When such variances be investigated?”
step method. Answer is based on subjective judgements, hunches and rules
of thumb only.
➢ Allocating costs by behavior
Variable cost can be directly allocated to the The management must set an acceptable range of performance
departments using a cost driver, while fixed costs can to serve as basis in determining whether a variance should be
be allocated using predetermined rates or lump-sum investigated or not.
amounts. ● Variance is within the range
They are assumed to be caused by normal factors.
➢ Deciding to allocate the actual or budgeted costs
 ● Variance falls outside the range
It is more likely to be caused by abnormal factors. ➢ Performance evaluation
When top management receives variance reports
General rule: Variance should only be investigated if the highlighting the operating performance of
anticipated benefits are greater than expected costs. subordinate managers, the top management would be
able to know when costs were not controlled and by
Management may set its top and bottom measures of the which managers.
allowable limits, called control limits, which will be used in
determining whether the variance is significant or not. Overhead variances:
A company must specify an operating level of capacity.
Functions of Standard Costing System
➢ Accumulating of the actual costs of manufacturing Capacity
operations or service activities. Refers to any measures of activity.
➢ Following through manufacturing operations and its Kinds of capacities:
progress. ➢ Theoretical capacity
➢ Evaluating performance using the reports of Estimated maximum potential activity for a specified
variances from standard. period. Assumes that all factors are operating in a
technically and humanly perfect manner. It disregards
Benefits of using standard costing system realities such as machinery breakdowns work
➢ Motivation stoppage such as special holidays and disturbances.
The basic criterion in setting standards is
“achievability”. As standards are achievable, and ➢ Normal capacity
workers are informed of rewards for standards Based on historical and estimated future production
attainment, those workers are likely to be motivated levels and cyclical fluctuations. It represents a
to strive and do their best to accomplish the tasks reasonably attainable level of activity, but will not
assigned to them. provide costs that are most similar to actual historical
costs.
➢ Clerical efficiency
A company using standard costs usually utilize less ➢ Expected capacity
clerical time and effort in determining costs Represents the short-run anticipated level of activity
necessary for decision making than in an actual cost by the firm for the upcoming period. However,
system. practical capacity may be a more appropriate base to
calculate a predetermined overhead rate.
➢ Planning
Managers can use current standards to estimate what Practical capacity
future amounts or quantities and costs in the next Reflects the cost of unused resources.
period of operation. This is best achieved through
flexible budgets. The concept of unused resources makes a distinction
between the cost of resources attainable for
➢ Controlling manufacturing and the costs of resources actually
Controlling function starts with the establishment of used for that purpose.
standards that provide a basis of comparing actual
costs to determine variances, if any. ➢ Practical capacity
Highlights the fact that some capacity is idle.
Variance analysis -The process of comparing actual
and standards and identifying the variance as Idle capacity
favorable or unfavorable and trying to seek Indicated by the size of the underapplied overhead at
explanations for those differences. the end of the period.

➢ Decision making Practical capacity is the theoretical capacity is

Standard cost information facilitates many decision reduced by ongoing, regular operating interruptions
makings. Use of actual cost information in such a (such as holidays, downtime, and set up time) that
decision could be inappropriate because the actual could be achieved during regular working hours.
cost may fluctuate from period to period.
The production or service volume that a firm could
achieve during normal working hours with
consideration given to ongoing-expected operating
interruptions.