ACCT20001 Cost Management
Cost Management Notes:
Table of Contents
Week 1: Accounting Information for Management ............................................................................ 2
Week 2a: Fundamental Cost Concepts ............................................................................................... 5
Week 2b: Resource Flow and Basic Cost Classification ....................................................................... 8
Week 3a: Basic Cost Accumulation and Assignment:........................................................................ 10
Week 3b: Job Costing: ..................................................................................................................... 13
Week 4a: Process Costing ................................................................................................................ 14
Week 4b: Indirect Cost Allocation .................................................................................................... 18
Week 5: Activity-Based Costing (ABC) .............................................................................................. 21
Week 6a: Cost-Volume-Profit (CVP) Analysis.................................................................................... 24
Week 6b: Cost Estimation ................................................................................................................ 26
Week 8: Short-Term Decisions ......................................................................................................... 30
Week 9: Long-Term Decisions .......................................................................................................... 34
Week 10: Introduction to Budgeting ................................................................................................ 39
Week 11: Flexible Budgets, Standard Costs and Variance Analysis ................................................... 43
Week 12: Variance Analysis of Indirect Costs ................................................................................... 46
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ACCT20001 Cost Management
Week 1: Accounting Information for Management
1) Differentiate between financial accounting and managerial accounting, and explain how cost
accounting is related to both.
Financial accounting focuses on external reporting that is directed by authoritative guidelines /
prescribed accounting principles, whereas management accounting measures and reports financial
information as well as other types of information that are intended primarily to assist managers in
fulfilling the goals of the organisation.
Categorical differences include:
Regulations
Management Accounting
Generally prepared for
internal use
Preparation not governed
by external regulations
Range and detail of information
May encompass financial,
non-financial and
qualitative information
Very detailed to highly
aggregated
Reporting interval
Reports produced at
intervals dictated by
decision-making and control
needs of the information
users
May include historical an
current information but also
provides info on expected
future performance and
activities
Time period
Financial Accounting
Generally prepared for
external use
Prepared according to
accounting regulations and
guidelines imposed by law
Financial information
Broad based and intended
to provide a high level
overview of the position
and performance of an
organisation over a period
of time
Typically produced annually
(can be bi-annually or
quarterly)
Provide information on the
past period performance
and position
Cost accounting measures and reports financial and non-financial information related to the
organisation’s acquisition or consumption of resources, and provides information for both management accounting and financial accounting.
2) Explain what is meant by ‘cost management’ and how it is related to managerial accounting and cost accounting
Cost management describes the actions undertaken by managers in the short-run and long-run
planning and control of costs that increase value for customers and lower the costs of products and
services.
It is important to recognise the importance of prior management decisions that commit the
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ACCT20001 Cost Management
Week 2a: Fundamental Cost Concepts
1. Explain the concept of a cost object and how specification of the cost object is critical to
classification of costs.
Cost is defined as a resource sacrificed of forgone to achieve a specific objective.
A cost object refers to anything for which a separate measurement of costs is desired. i.e, we want
to know the cost of a cost object.
A costing system typically accounts for costs through cost accumulation and cost assignment.
Cost accumulation is the collection of cost data in some organised way through an accounting
system.
Cost assignment is a general term that encompasses both (1) tracing accumulated costs to a cost
object (direct costs), and (2) allocating accumulated costs to a cost object (indirect costs).
Many accounting systems accumulate actual costs, which are costs incurred (historical costs) as
distinguished from budgeted or forecasted costs.
Costs are assigned different depending on the cost object.
2. Explain cost drivers, variable costs and fixed costs.
A cost driver (/cost generator/cost determinant) is any factor that affects total costs. i.e. a change in
the level of the cost driver will cause a change in the level of the total cost of a related cost object.
Costs that do not vary in the short run and have no identifiable cost driver in the short run may in
fact have a cost driver in the long run.
A variable cost is a cost that changes in total proportion to changes in the related level of total
activity or volume, whereas a fixed cost is a cost that does not change in total despite changes in the
related level of total activity or volume.
Fixed and variable costs have the following underlying assumptions:
Costs are defined as variable or fixed with respect to a specific cost object
Time span must be specified. E.g. rent (fixed) may change over time
Total costs are linear.
There is only one cost driver. The influences of other possible cost drivers on total costs are held
constant or deemed to be insignificant
Variations in the level of the cost driver are within a relevant range
3. Explain the key characteristics that distinguish direct costs from indirect costs.
Direct costs of a cost object are costs that are related to the particular cost object and that can be
traced to it in an economically feasible (cost-effective) way.
Indirect costs of a cost object are costs that are related to the particular cost object but cannot be
traced to it in an economically feasible (cost-effective) way. Indirect costs are allocated to the cost
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ACCT20001 Cost Management
Week 2b: Resource Flow and Basic Cost Classification
1. Distinguish between service-sector, merchandising-sector and manufacturing-sector companies
Service-sector companies provide services or intangible products to their customers e.g. consulting.
The operating-cost line items for service companies will include costs from all areas of the value
chain (production of services, marketing etc). There is likely no cost of goods sold line item though,
as only services or intangible products are sold.
No inventory in service-sector and thus no costs of purchase.
Merchandising-sector companies provide tangible products they have previously purchased in the
same basic form from suppliers e.g. book store
Merchandise purchased from suppliers but not sold at the end of an accounting period is held as
stock.
Costs of purchase = Net Purchases + Freight-In
NB: does not include freight out/delivery, depreciation, warehousing costs
Manufacturing-sector companies provide tangible products that have been converted to a different
form from that of the products purchased from suppliers.
At the end of an accounting period, a manufacturer has stock that can include direct materials, work
in progress or finished goods e.g. computer companies
Costs of purchase = Net Purchases + Freight-In + Costs of conversion
2. Correctly classify a given cost as direct vs indirect and inventoriable vs not inventoriable given a
description of the cost, the cost object and the type of organisation
Merchandising and manufacturing companies differ from service companies in their holding of
stocks.
Inventoriable costs (or stock-related costs) are costs associated with the purchase of goods for
resale (in the case of merchandise stock), or costs associated with the acquisition and conversion of
materials and all other manufacturing inputs into goods for sale (in the case of manufacturing
stocks). Inventoriable costs become part of cost of goods sold in the period in which the stock item is
sold.
FYI: ‘absorption costing’ is used to describe the method in which all manufacturing costs are inventoriable (vs variable costing where only variable manufacturing costs are inventoriable). Fixed
costs under variable costing are treated as period costs.
FYI: Operating costs are all costs associated with generating revenues except cost of goods sold.
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ACCT20001 Cost Management
Week 3a: Basic Cost Accumulation and Assignment:
1. Distinguish and explain the relationships between cost driver, cost pool and allocation base
A cost driver is any factor that affects total costs.
A cost pool is a grouping of individual cost items. Cost pools can be very broad (e.g. company-wide
total-cost pool for telephones) to very narrow (e.g. costs of operating a car used by a travelling
salesperson)
A cost-allocation base is a factor that is the common denominator for systematically linking an
indirect cost or group of indirect costs to a cost object. A cost-allocation base can be financial (e.g.
direct labour costs) or non-financial (e.g. kms travelled). E.g. kms travelled may be used as a base for
allocating motor vehicle operating costs among different sales districts.
****need input from lecture
2. Distinguish actual costing from normal costing and explain the rationale behind normal costing
Actual costing is a costing method that traces direct costs to a cost object by using the actual directcost rate(s) times the actual quantity of the direct-cost input(s), and allocates indirect costs based on
the actual indirect-cost rate(s) times the actual quantity of the cost-allocation base.
Actual costing requires a lot of information and thus the information is not very timely. Thus, normal
costing is used.
Normal costing is a costing method that traces direct costs to a cost object by using the actual
direct-cost rate(s) times the actual quantity of the direct-cost input, and allocates indirect costs
based on the budgeted indirect-cost rate(s) times the actual quantity of the cost-allocation base(s).
NB: both actual costing and normal costing trace direct costs to jobs in the same way – this is
because these costs are known. Difference is the costing of indirect costs, using an actual indirect
cost rate vs a budgeted indirect cost rate – this is because these costs by definition cannot be traced
to jobs.
3. Compute a predetermined overhead rate, and use the rate to assign overhead to production
Refer to tute sheet xx
4. Describe alternative methods of dealing with period-end under or over allocated indirect costs
As a result of using budgeted indirect-cost rates (normal costing), there may be a need for
adjustments when there are inaccuracies.
Underallocated indirect costs occur when the allocated amount of indirect costs in an accounting
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