Topic 11

1. Topic 11 Management and Cost Accounting: Basic Concept

2. Learning Objectives • Purpose of management accounting • Identifying various factory costs. • Differences between product costs and period costs. • Differences between direct costs and indirect costs. • Differences between prime costs and conversion costs. • Knowing the meaning of absorption overhead rate.

3. Types of accounting information Management Accounting Financial Accounting Internal Users Managers Employees External Users Investors Bankers/Lenders Suppliers Government authorities

4. The needs for management accounting • Decision making. • determine the objective • determine the existing alternatives • evaluate and compare the alternatives • choose the alternative Decision can be classified into: • long term or short term decision example: decision on company’s policy, structure and long term planning. • special decision example: decision on investment activities. c. operation decision example: decision on daily operation and normal activities of the company.

5. The needs for management accounting • Planning • determine objectives, policies, strategies and actions on how to achieve the company’s goals. • Budget • a quantitative/financial planning that consists of financial sources information about how to achieve the objectives.

6. The needs for management accounting • Control and evaluate performance • comparison between the result of operation and achievement with the planned budget. • Inventory valuation • determine the value of ending inventories (raw materials, work-in-progress, or finished goods) for the purpose of preparing financial statements. • Determination of cost of production and services • setting the selling price, cost of goods sold and profitability.

7. Elements of costs 1. Raw material cost • cost of direct materials used in the production. • Direct labour cost • cost of people’s energy and skills used directly in the production. 3. Factory overhead • all manufacturing costs other than direct raw material cost and direct labour cost. • examples: salaries for managers, engineers, accountants, supervisors; wages for cleaners and security guards; indirect raw materials cost; depreciation expenses for factory building and machinery.

8. Classification of costs 1. Product costs • costs which can be associated directly with the production process and the flow of goods to be manufactured. • comprises of raw materials cost, direct labour cost and factory overhead. 2. Period costs • costs which cannot be associated directly with the production of goods. • type of expenses which are reported in the income statement • examples: general administrative expenses, and selling expenses.

9. Classification of costs • Direct costs • directly associated with manufacturing. • consists of mainly raw material cost (direct materials) and direct labour cost. • may also consists of direct expenses depending on the type of production, for instance, the production of a batch of special/limited edition of Mercedes Compressor 2.0; a production of a costume designed according to a customer order such as an official costume worn by Yang DiPertuan Agong. • Indirect costs • costs incurred in the manufacturing but cannot be directly associated with manufacturing. • consists of factory overhead and period cost.

10. Classification of costs • Prime costs • a combination of raw material costs and direct labour costs. • also direct costs. • absorbed into a product directly because the amount of the respective costs in any one unit of a product can be estimated. • examples, a prime cost to produce a wooden chair: cost of raw material = RM 6.00 per chair cost of direct labour = RM10.00 per chair Prime cost = RM16.00 per chair =======

11. Classification of costs • Conversion costs • a combination of direct labour costs and factory overhead costs. • costs involved in the process of converting raw material into finished goods. • Factory overhead cost is an indirect cost and it is absorbed into each unit of product based on an overhead absorption rate. • Various methods are used to determine overhead absorption rate. Example is by comparing between the factory overhead costs and the direct labour costs.

12. Overhead absorption rate For example, direct labour for the month of January 2007 to produce 50 unit of wooden chairs is 10,000 hours and the rate of direct labour per hour is RM5. Therefore, Direct labour cost = 10,000 hrs x RM5/hrs = RM50,000 Factory overhead cost for the month of January 2007 is RM75,000. Therefore, Overhead absorption rate = Factory overhead costs Direct labour costs = 75,000/50,000 = 150% If the direct labour cost per unit of wooden chair is RM10, then the factory overhead cost per unit of wooden chair = RM10 x 150% = RM15.00

13. Illustration on cost concepts Assume that Northridge Company manufactures and sells pre-hung metal doors. Recently, it has decided to start selling pre-hung wood doors as well. An old warehouse that the company presently owns will be used to manufacture the new product. To manufacture and sell there pre-hung wood doors, Northridge identifies the following costs:

14. Illustration on cost concepts (continued) • The material cost (wood) for each door is RM10. • Labour costs involved in constructing a wood door are RM8 per door. • Depreciation on the new equipment used to make the wood door using the straight-line method is RM25,000 per year. • Property taxes on the old warehouse used to make the wood doors are RM6,000 per year. • Advertising costs for the pre-hung wood doors total RM2,500 per month or RM30,000 per year. • Sales commissions related to pre-hung wood doors sold are RM4 per door. • Maintenance salaries for old warehouse are RM28,000 per year. • Salary of plant manager in charge of pre-hung wood doors is RM70,000 per year. • Cost of shipping pre-hung wood doors is RM12 per door sold. These manufacturing and selling costs can be assigned to the various categories shown as follows:

15. Assignment of costs to cost categories

16. Assignment of costs to cost categories (continued) Assume that Northridge Company produces 10,000 pre-hung wood doors the first year. The total manufacturing costs are: The manufacturing cost per unit (cost to produce one pre-hung wood door) is RM30.90.

17. Assignment of costs to cost categories (continued) Product costs = Raw Materials + Direct Labours + Factory Overheads = Cost of Production = RM309,000. Period costs = 30,000 + (4 x 10,000) + (12 x 10,000) = RM190,000. Factory Overhead = 25,000 + 6,000 + 28,000 + 70,000 = RM129,000. Prime costs = Direct materials + Direct Labour = (10 x 10,000) + (8 x 10,000) = RM180,000. Conversion costs = Direct Labours + Factory Overhead = 80,000 + 129,000 = RM209,000.

18. Exercise 1: Cost Concepts Giant Company specializes in manufacturing different models of racing bicycles. A new model, the Jaguar, has been well accepted. As a result, the company has established a separate manufacturing facility to produce these bicycles. The company produce 1,000 bicycles per month. Giant’s monthly manufacturing cost and other expenses data related to these bicycles are as follows:

19. Exercise 1: Cost Concepts (continued) • Rent on manufacturing equipment (lease cost): RM2,000 / month. • Insurance on manufacturing building: RM750 / month. • Raw materials (frames, tires, etc.): RM80 / bicycle. • Utility costs for manufacturing facility: RM1,000 / month. • Supplies for general office: RM800 / month. • Wages for assembly line workers in manufacturing facility: RM30 / bicycle. • Depreciation on office equipment: RM650 / month.

20. Exercise 1: Cost Concepts (continued) • Miscellaneous materials (lubricants, solders, etc.): RM1.20 / bicycle. • Property taxes on manufacturing building: RM2,400 / year. • Manufacturing supervisor’s salary: RM3,000 / month. • Advertising for bicycles: RM30,000 / year. • Sales commissions: RM10 / bicycle. • Depreciation on manufacturing building: RM1,500 / month. Instructions: • Categorize the above items according to product costs: direct materials, direct labour, and factory overhead, period costs, prime costs, and conversion cost. • Compute product costs, period cost, factory overhead, prime cost, and conversion costs for a month.

21. Exercise 1: (a) Assignment of costs to cost categories

22. Exercise 1: (a) Assignment of costs to cost categories

23. Exercise 1: (b) Assignment of costs to cost categories Product costs = Raw Materials + Direct Labour + Factory Overhead = (Direct materials + Misc. materials) + Direct Labour + Factory Overhead = (80 x 1,000) + (30 x 1,000) + [(1.20 x 1,000) + 2,000 + 750 + 1,000 + (2,400 / 12) + 3,000 + 1,500] = 80,000 + 30,000 + 9,650 = RM119,650. Period costs = 800 + 650 + (30,000 / 12) + (10 x 1,000) = RM13,950. Factory overhead = RM9,650. Prime Costs = Direct Materials + Direct Labour = 80,000 + 30,000 = RM110,000. Conversion costs = Direct Labour + Factory Overhead = 30,000 + 9,650 = RM39,650.