Management accounting Colleges
Module 1
Lecture 1: Introduction to cost management
Definition of management accounting
The IMA definition of management accounting states that: management
accounting involves partnering in management decision making, planning, and
performance measurement to assist in the formulation and implementation of an
organization’s strategy.
How an organization succeeds
- An organization succeeds by implementing a strategy, that is, a plan for
using resources to achieve sustainable goals within a competitive
environment.
- Strategy must have a long-term focus and adapt to the changing
environment.
- Cost management is used to develop cost and ither information to help an
organization achieve its strategic goals.
Strategic focus of cost management
- Cost management information consists of financial and nonfinancial
information that is developed and used to implement the organization’s
strategy.
- Cost management is the development and use of cost management
information by the management accountant.
Basic cost management concepts
What is a cost?
- A resource used to achieve a specific objective (production).
Costs are assembled into meaningful groups called cost pools
- By type (costs of labor, costs of material)
- By source (department 1, department 2)
- By responsibility (manager 1, manager 2)
What is a cost driver?
- A variable that causes a change in total cost (e.g., production volume)
What is a cost object?
- Any product, service, customer, activity or organizational unit to which
costs are assigned.
Direct and indirect costs: cost assignment
- Cost assignment is the process of assigning costs to cost pools or from the
cost pools to cost objects.
- Direct costs can be conveniently and economically traced to a specific cost
object.
E.g. cost of steel and tires to an e-bike.
- Indirect costs cannot be traced conveniently or economically to a cost
object.
E.g. salary cost of a manager overseeing the whole production plant
assigned to a cost object according to an allocation schedule.
,Management accounting Colleges
Be careful
- The direct/indirect cost classification depends on the choice of the cost
object.
- Cost may be direct for some cost objects, yet indirect for other cost
objects.
Two cost objects: individual bike vs. production plant.
Costs of salary of a manager overseeing the production plant is
indirect for individual bike but direct for production plant.
- Costs are not only classified whether they are direct or indirect, but also
whether they are fixed or variable.
Variable and fixed costs: cost behavior
Variable costs do change in proportion with volume of a cost driver, such as
production or sales quantity.
- E.g., material costs such as steel and tires are variable costs; they increase
with the number of bikes produced.
Fixed costs do not change in proportion with volume of a cost driver, at least not
within the relevant range.
- E..g, supervision costs for production plant or for specific assembly line;
independent of whether 1 or 1000 bikes are produced and sold.
Total dollars Cost per unit
Variable costs Change in proportion Unchanged in relation to
with output output
More output = more cost
Fixed costs Unchanged in relation to Change inversely with
output output
More output = lower cost
per unit
Multiple classifications of costs
,Management accounting Colleges
Cost may be classified as:
- Direct/indirect
- Variable/fixed
Are direct costs always variable and indirect costs always fixed? No.
The multiple classifications give rise to various cost combinations:
- Direct and variable
- Direct and fixed
- Indirect and variable
- Indirect and fixed
Direct-indirect/fixed-variable matrix
- Bike example: cost object = e-bike produced
Cost drivers
Cost drivers provide two roles for the management accountant
1. Assigning costs to cost objects.
2. Explaining cost behavior.
I.e., how total cost changes as the cost driver changes.
Linear approximation and relevant change
A cost function is a mathematical representation of how a cost changes with
changes in the level of the cost driver.
Cost function assumptions:
- Variations in the level of the cost driver the variations in the related total
costs.
- Cost behavior is approximated by a linear cost function within the relevant
range.
, Management accounting Colleges
Graphical depiction of costs
Total, average and marginal costs
- Total cost (TC) = FC + VC
- Average cost (AC): also called unit cost, is the total cost per unit of output
(=TC/X)
- Marginal cost (MC): additional cost incurred in producing an additional unit
of output
Slope of total cost function at output level of interest, i.e. first
derivative = dTC/dX
Be careful
Unit costs should be used cautiously.
- Are fixed costs per unit useful for decision-
making?
- How do fixed costs per unit react to changes
in volume?
- As volume increases, total fixed costs are
spread over more cost driver units, but the
marginal cost of producing one more unit
does not change.
Relevant vs. irrelevant costs
Module 1
Lecture 1: Introduction to cost management
Definition of management accounting
The IMA definition of management accounting states that: management
accounting involves partnering in management decision making, planning, and
performance measurement to assist in the formulation and implementation of an
organization’s strategy.
How an organization succeeds
- An organization succeeds by implementing a strategy, that is, a plan for
using resources to achieve sustainable goals within a competitive
environment.
- Strategy must have a long-term focus and adapt to the changing
environment.
- Cost management is used to develop cost and ither information to help an
organization achieve its strategic goals.
Strategic focus of cost management
- Cost management information consists of financial and nonfinancial
information that is developed and used to implement the organization’s
strategy.
- Cost management is the development and use of cost management
information by the management accountant.
Basic cost management concepts
What is a cost?
- A resource used to achieve a specific objective (production).
Costs are assembled into meaningful groups called cost pools
- By type (costs of labor, costs of material)
- By source (department 1, department 2)
- By responsibility (manager 1, manager 2)
What is a cost driver?
- A variable that causes a change in total cost (e.g., production volume)
What is a cost object?
- Any product, service, customer, activity or organizational unit to which
costs are assigned.
Direct and indirect costs: cost assignment
- Cost assignment is the process of assigning costs to cost pools or from the
cost pools to cost objects.
- Direct costs can be conveniently and economically traced to a specific cost
object.
E.g. cost of steel and tires to an e-bike.
- Indirect costs cannot be traced conveniently or economically to a cost
object.
E.g. salary cost of a manager overseeing the whole production plant
assigned to a cost object according to an allocation schedule.
,Management accounting Colleges
Be careful
- The direct/indirect cost classification depends on the choice of the cost
object.
- Cost may be direct for some cost objects, yet indirect for other cost
objects.
Two cost objects: individual bike vs. production plant.
Costs of salary of a manager overseeing the production plant is
indirect for individual bike but direct for production plant.
- Costs are not only classified whether they are direct or indirect, but also
whether they are fixed or variable.
Variable and fixed costs: cost behavior
Variable costs do change in proportion with volume of a cost driver, such as
production or sales quantity.
- E.g., material costs such as steel and tires are variable costs; they increase
with the number of bikes produced.
Fixed costs do not change in proportion with volume of a cost driver, at least not
within the relevant range.
- E..g, supervision costs for production plant or for specific assembly line;
independent of whether 1 or 1000 bikes are produced and sold.
Total dollars Cost per unit
Variable costs Change in proportion Unchanged in relation to
with output output
More output = more cost
Fixed costs Unchanged in relation to Change inversely with
output output
More output = lower cost
per unit
Multiple classifications of costs
,Management accounting Colleges
Cost may be classified as:
- Direct/indirect
- Variable/fixed
Are direct costs always variable and indirect costs always fixed? No.
The multiple classifications give rise to various cost combinations:
- Direct and variable
- Direct and fixed
- Indirect and variable
- Indirect and fixed
Direct-indirect/fixed-variable matrix
- Bike example: cost object = e-bike produced
Cost drivers
Cost drivers provide two roles for the management accountant
1. Assigning costs to cost objects.
2. Explaining cost behavior.
I.e., how total cost changes as the cost driver changes.
Linear approximation and relevant change
A cost function is a mathematical representation of how a cost changes with
changes in the level of the cost driver.
Cost function assumptions:
- Variations in the level of the cost driver the variations in the related total
costs.
- Cost behavior is approximated by a linear cost function within the relevant
range.
, Management accounting Colleges
Graphical depiction of costs
Total, average and marginal costs
- Total cost (TC) = FC + VC
- Average cost (AC): also called unit cost, is the total cost per unit of output
(=TC/X)
- Marginal cost (MC): additional cost incurred in producing an additional unit
of output
Slope of total cost function at output level of interest, i.e. first
derivative = dTC/dX
Be careful
Unit costs should be used cautiously.
- Are fixed costs per unit useful for decision-
making?
- How do fixed costs per unit react to changes
in volume?
- As volume increases, total fixed costs are
spread over more cost driver units, but the
marginal cost of producing one more unit
does not change.
Relevant vs. irrelevant costs
