Topic 1 Introduction and Review of Basic Concepts

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1 ACT202 Cost and Management Accounting 1-1 Topic 1 Introduction and Review of Basic Concepts Objectives On completion of the successful study of this topic you will be able to: Explain the way in which cost accounting supports management accounting and financial accounting Explain the role of management accounting in sustainability decisions Explain the way in which management accountants influence strategic decisions Describe the need for planning and control in a business and relate one to the other; Recall prior learning with regard to cost classifications; Define a range of cost accounting terminology; Explain cost behaviour in terms of cost objects and cost drivers; Describe the master budget and explain its benefits Describe the advantages of budgets Prepare the operating budget and its supporting schedules Horngren, Datar, Raja, Wynder, Maguire, Tan (2014). Cost Accounting: A Managerial Emphasis, Edition 2nd, Pearson Australia, Frenchs Forrest NSW. Chapters 1, 2, 3, 4 and 10 Lecture Presentation You should listen to the Topic01 presentation after pre-reading this topic study guide and the text (refer to the reading above) and then read the required reading again to reinforce the concepts.

2 ACT202 Cost and Management Accounting 1-2 Introduction You will find that the study guides for this unit are often fairly brief because the explanations in your textbook are often relatively simple and do not need further explanation. Sometimes we will feel that you might need some help with understanding the textbook, or we may wish to extend or discuss the textbook material. Then the study guide topic will be a little longer. This particular topic is based largely upon the material you have already covered in CMA101. For this reason you should not have difficulty revising much of that material by reading three chapters of the textbook. Some of it you will be able to scan due to its familiarity. However, take special notice of the new terminology introduced to you in this book. So What is This Thing Called Management Accounting? Management accounting provides information that assists managers to make decisions, and decisions are about the future, so management accounting is forward looking. This can be contrasted with financial accounting which seeks to report on the outcome of past decisions to provide an evaluation of performance and identify what the position is after the latest period of operations. Managers have a focus on managing resources to best effect. They develop strategies and implement them. The first part of Chapter 1 in your textbook discusses this positioning of management accounting. Planning, Control and MAS Design When you studied budgeting in CMA101 you were introduced to the idea of planning and control. You should revise this material by reading the next section of your textbook. In this reading you will then proceed to think about the issues that impact on the design of a management accounting system. Later, in topic 6, we will consider the human element in greater detail. At present you are being re-introduced to a variety of important factors that provide context for the material in topics You should now revise Chapter 1 of Horngren (2014) et.al. Self Study Activity 1.1 Access MyAccountingLab and work through the study plan for Chapter 1

3 ACT202 Cost and Management Accounting 1-3 Terminology and Cost Classifications Your next reading starts by pointing out that management accounting has seen significant developments over the last part of the 20 th century. However, many of the older practices are still widely in use. We therefore distinguish between the more traditional approaches and the newer ones by calling them conventional and contemporary, respectively. In your prior studies you were introduced to a variety of ways of classifying costs. Examples are their relationship to the cost object (direct and indirect) and their behaviour with regard to activity levels (variable and fixed). This reading reminds you of these cost classifications and also presents the more recent notion of a value chain. With a better understanding of costs, and having broken them down according to their classification and behaviour, it is possible to put the costs together again in a different configuration to provide a picture of the costs of manufacture and derive product costs. So, having broken total costs down into categories we reconstruct them into something more meaningful and useful to managers in their decision making role. You should now revise Chapter 2 of Horngren (2014) et.al. View the supplementary video A YouTube lecture explaining absorption costing and variable costing. Download (from Learnline) and read the supplementary readings on the Advantages & Disadvantages of Using Absorption Vs. Variable Costing and on the Management Accounting Framework Self Study Activity 1.2 Access MyAccountingLab and work through the study plan for Chapter 2 Cost behaviour The next section of your textbook revisits the work you have already done on cost behaviour, distinguishing between variable costs and fixed costs and ways they are sometimes combined. It also discusses modern trends in the pattern of costs within business. Cost drivers You should pay particular attention to the use of the term cost driver. This is an expression that was introduce when activity based costing (ABC) was developed, because ABC is based on identifying the cause of cost variability.

4 Cost $ ACT202 Cost and Management Accounting 1-4 Hence it pays particular attention to what drives costs. Unfortunately the expression has been adopted by some writers when discussing conventional costing methods, which usually are less exacting with regard to what drives a cost and focus more on a convenient way of allocating costs based on a plausible relationship. (If this is confusing, think about the conventional way of adding equipment maintenance costs, equipment depreciation, indirect labour, factory cleaning costs, set up costs, electricity, canteen and HR and then allocating the total to production on the basis of labour hours or machine hours. Neither of these measures can be said to drive all of the costs in the aggregate!).this will be discussed further when you look at ABC in Topic 5 and you will then have a better understanding of any objections to its use to denote an allocation base. Variable and fixed costs Do you remember this? Total costs = variable costs + fixed costs Variable costs Fixed costs Production units We must also recognise that fixed costs cannot be fixed over time and also they are not fixed over all levels of activity. For example, if Chris s ice cream van has so many sales that one van cannot meet the demand, he will need to hire another van, employ another seller, etc. A manufacturing business will have fixed costs that relate to making the plant available but there could come a point at which an extra plant is needed and fixed costs will go up suddenly in a big step. We therefore say that the fixed costs are fixed over a relevant range (such as the number of ice creams sold). The same is true of smaller resources that have a maximum capacity such as a computer, a piece of equipment, administration people working in a legal office

5 ACT202 Cost and Management Accounting 1-5 Cost Estimation You should be familiar with ways to estimate the amount of costs that are variable, fixed and so on. You have studied and been examined on the highlow method and scattergraphs and you are aware of regression analysis. If this is hazy for you, you will need to look more closely at the content of the next reading. You may not be asked to apply regression analysis or multiple regressions but you should know what they are and understand the concept of their use. You should now revise Chapter 3 of Horngren (2014) et.al. Self Study Activity 1.3 Access MyAccountingLab and work through the study plan for Chapter 3 Cost-volume-profit analysis This chapter presents the cost-volume-profit (CVP) analysis model and illustrates how managers use that model to help answer important what-if business questions. CVP analysis also helps management accountants alert managers to the risks and rewards of decisions they are considering by illustrating how the bottom-line is affected by changes in activity levels and/or key pricing or cost components. CVP analysis is based on several assumptions, one of which is that fixed costs can be distinguished from variable costs. However, whether a cost is variable or fixed depends on the time period for the decision and also the range of activity (relevant range) being considered The concepts of contribution margin, contribution margin income statement, break-even, target operating profit, along with other measures were introduced. These are nuts and bolts concepts that the you should understand if you are to grasp the material covered in future chapters. The use of sensitivity analysis was embedded into the discussions in this topic and is a valuable tool that you can use to determine the expected outcome from various scenarios.

6 ACT202 Cost and Management Accounting 1-6 You should now revise Chapter 4 of Horngren (2014) et.al. Self Study Activity 1.4 Access MyAccountingLab and work through the study plan for Chapter 4 Budgeting In CMA101 you were introduced to the concept of Budgeting. Budgets are a primary financial planning tool used by businesses and other organisations. You should be familiar with how businesses use and prepare budgets (the cash budget is presented in the Appendix) as part of the management process. You would have been introduced to the basics of responsibility accounting particularly as it relates to the concept of controllability. In later topics in this unit the concepts of planning, responsibility centres and responsibility accounting with be developed in more depth. In addition, the human factor in budgeting will be emphasised. For now you will need to understand the importance of budgeting, even if the budget targets are not achieved. And your understanding should extend to the concept that a budget is the financial expression of the goals for the upcoming period. And that budgets are more than just a planning tool, but help achieve coordination and communication, are useful as a framework for evaluating performance, and can be used to motivate employees. An important observation from you studies of budgets todate is that an effective budget requires a well-thought-out strategy. You should now revise Chapter 10 of Horngren (2014) et.al. Download (from Learnline) and read the supplementary about Michael Porter's Five Forces Link to and view the web pages Budgeting What is a Master Budget? and What Is the Budget Cycle? and the Advantages of Budgeting Self Study Activity 1.5 Access MyAccountingLab and work through the study plan for Chapter 10

7 ACT202 Cost and Management Accounting 1-7 A Further Reminder: Information for Decision-making (quoted from CMA101) When you make a decision you are making a choice between alternatives. For your decision to be an informed decision you really need to be aware of ALL alternative options and also the likely outcome of each. If you do not know what all the alternatives are you are not fully informed and an option that is not considered might be better than any that you can choose; Decisions are about the future, and you make a selection on the basis of the desired outcome or the best likely outcome, so you need to understand the likely outcome of the options. One area in which we need information is the likely impact of a decision on costs, and we have discussed above the likely change to costs due to making certain decisions. But what kinds of decisions may need to be made in a business? The following is a small selection of them: Amount of purchases to make When to make purchases Which products to make Whether to close a plant or retail outlet Whether a quality initiative should be undertaken Whether operations are under control How to expand operations Amount of labour required What selling price to charge Whether you can afford to sell a product at the market price The best use of scarce resources Whether to outsource functions Whether to accept a special order at a special price

8 ACT202 Cost and Management Accounting 1-8 For the tutorial session scheduled for this topic undertake the following activity. Your response may be referred to in the class discussion and you may be called upon to discuss your answer. There are five parts to this activity. TUTORIAL ACTIVITY Part (a) Attempt questions 1-26, on page 25 of Horngren (2014) et. al. Part (b) Attempt question 2-41, on page 72 of Horngren (2014) et. al. Part (c) Attempt questions 3-20 and 3-21, on pages of Horngren (2014) et. al. Part (d) Attempt question 4-51, on page 164 of Horngren (2014) et. al. Part (e) Attempt question 10-32, on page 409 of Horngren (2014) et. al. Record your responses for parts (a) to (e) in the Learnline Journal set up for this purpose. Be prepared to discuss your responses in class. Your responses need only be in draft or point form, however they will need to be sufficient for other students to understand your main points. Summary In this topic you have been asked to revise material that you studied previously and have been introduced to some new concepts and terminology. We started by thinking about what management accounting is and its role in a firm. Its relationship to decision making and the responsibilities of managers was addressed, as were some recent trends in management accounting. You were then reminded of costing terms and concepts, including product costing, and you were re-introduced to the need to understand cost behaviour when making various decisions. The techniques for analysing the behaviour of costs and ways to apply that knowledge were reviewed. Finally we reviewed the meaning of decision-making and informed decisions and considered the kind and range of decisions that might need to be made in business. We will now proceed to further develop an understanding of various product costing methods. Then we will examine more closely some issues related to budgeting. Budgets are a basis for performance evaluation so the next topics will present ways to analyse actual costs by comparing them to expectations contained in the budget and the actions that can be motivated by these analyses. Finally we will see how to implement transfer pricing and make pricing and product mix decisions.