Management and Cost Accounting For Dummies (UK Edition) - dummies
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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:

  • Sales budget

  • Production budget

  • Direct materials budget

  • Direct labour budget

  • Manufacturing overhead budget

  • Selling and administrative budget

  • Capital acquisitions budget

  • Cash 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.