Management and Cost Accounting For Dummies (UK Edition)
Management and cost accounting helps managers and other decision-makers understand how much their products cost, how their companies make money, and how to plan for profits and growth. To use this information, company decision-makers must understand management and cost accounting terms. When planning for the future, they follow a master budgeting process. To prepare this budget, and to understand how costs behave, the decision-makers should understand cost-volume-profit relationships, which explain how changes in volume or price affect profits.
Key Costs Related to Management and Cost Accounting
In accounting, a cost measures how much you pay for something. Management and cost accounting must give managers accurate cost information relevant to their management decisions. Here are several cost-related terms you encounter in management accounting:
Direct cost: Cost that you can trace to a specific product.
Indirect cost: Cost that you can’t easily trace to a specific product.
Materials: Physical things you need to make products.
Labour: Work needed to make products.
Production Overhead: Indirect materials, indirect labour and other miscellaneous costs needed to make products.
Variable costs: Costs that change in direct proportion with activity level.
Fixed costs: Costs that don’t change with activity level.
Semi-variable costs: Combination of fixed and variable costs.
Contribution: Sales less variable costs.
Product costs: Costs needed to make goods; considered part of inventory until sold.
Period costs: Costs not needed to make goods; recorded as expenses when incurred.
Work-in-process cost: Costs incurred for goods that are part-finished.
Finished goods cost: Costs incurred for goods completed but not yet sold.
Cost of goods manufactured: The cost of the goods completed during a period.
Cost of goods sold: The cost of making goods that you sold.
Controllable costs: Costs that you can change.
Non-controllable costs: Costs that you can’t change.
Conversion costs: Direct labour and overhead.
Incremental costs: Costs that change depending on which alternative you choose; also known as relevant costs and marginal costs.
Irrelevant costs: Costs that don’t change depending on which alternative you choose.
Opportunity costs: Costs of income lost because you chose a different alternative.
Sunk costs: Costs you’ve already paid or committed to paying.
Historical cost: How much you originally paid for something.
Cost per unit: Cost of a single unit of product.
Expense: Costs deducted from revenues on the income statement.
Cost driver: Factor thought to affect particular costs.
Process cost: Cost of similar goods made in large quantities on an assembly line.
Job order cost: Cost of a batch of specially made goods.
Absorption cost: Cost that includes direct and a share of production overheads.
Target cost: Cost goal set for engineers designing a product.
Elements that Go Into Creating a Master Budget
A master budget is a plan created to manage a company’s manufacturing and sales activity to meet profit and cash flow goals. Creating a master budget requires careful coordination of several smaller budgets covering all parts of the organisation; that way, the master budget is realistic but not complacent.
The master budget contains the following elements:
Direct materials budget
Direct labour budget
Manufacturing overhead budget
Selling and administrative budget
Capital acquisitions budget
Budgeted financial statements
Cost-Volume-Profit Relationships for Management and Cost Accounting
Management and cost accounting provides useful tools, such as cost-volume-profit relationships, to aid decision-making. Cost-volume-profit analysis helps you understand different ways to meet your company’s profit goals. This image describes the relationship among sales, fixed costs, variable costs and profit:
The bottom axis indicates the level of production – the number of units you make.
The left axis indicates value in pounds.
Where total sales equals total costs (‘x’ marks the spot), the company breaks even (the break-even point).
The shaded area to the upper right of this break-even point is profit.
The shaded region to the lower left is net loss.
Total variable costs are a diagonal line because the higher the production, the greater the variable costs.
The total fixed costs line is horizontal because regardless of the production level, fixed costs stay the same.
Total costs equal the sum of total variable costs and total fixed costs.