2. To provide information for planning, controlling and organising.

The information provided by the costing system should be:

relevant

reliable

timely

succinct

presented in the desired format.

A cost system should be

cost effective

appropriate for the organisation

encourage managerial action.

Example Management Accounts

		Products
	A	B	C	Total
Materials	£4,800	£3,700	£6,500	£15,000
Wages	1,500	2,500	3,000	7,000
Prod. overhead	500	600	900	2,000
	-------	-------	-------	-------
Prod. cost	6,800	6,800	10,400	24,000
Admin. costs	700	800	500	2,000
Selling costs	300	400	300	1,000
	-------	-------	-------	-------
Total cost	7,800	8,000	1,200	27,000
Sales	10,240	10,800	8,960	30,000
Profit	2,240	2,800	----	3,000
(Loss)	----	----	(2,240)	----
Net profit margin	24%	26%	----	10%
	-------	-------	-------	-------

This performance statement is of the same business as the previous example of

financial accounts. However, it gives management much more information. It analyses the cost elements in respect to materials, labour and overheads allowing management to focus on costs which require investigation and control. It facilitates decision-making. E.g. should product C be discontinued?

Compared to the financial accounts the management accounting information which is much more comprehensive will allow management to better carry out their functions of planning, controlling organising and decision-making.

Cost classification

The management accountant will use cost information for two main reasons.

1. To ascertain the cost of a product. This information is used to value stock which is required for external reporting .

2. To assist management in the decision-making process.

Depending on the cost objective the costs will be classified into a number of categories.

(a) By nature of resource

(i) Materials

(ii) Labour

(iii) Other Expenses

(b) By type of cost

(i) Direct Costs

(ii) Indirect Costs - Overheads

(c) By function

Production, Administration, Selling and Distribution

(d) By the behaviour of costs

(i) Fixed or Periodic Costs

(ii) Variable Costs

(iii) Semi-fixed, or Semi-variable Costs

Cost Objectives

(a) Product costing

It is essential for an organisation to ascertain the cost of manufacturing a product. The information is used for two purposes:

1 to determine the value of closing stock which is required for the financial statements viz. the profit and loss account and the balance sheet.

Direct materials £X

Direct labour £X

Direct expense £X

-----

Prime cost £X

Production overheads £X

-----

Production cost £X

-----

2 Also some businesses use a cost plus pricing strategy. The product cost is calculated and a mark up percentage is added to arrive at a selling price which gives a reasonable gross profit which in turn can cover the non-production overheads and leave a satisfactory net profit.

(b) Decision making - Cost behaviour

The classification of costs into variable, fixed and semi-fixed is important in terms of decision-making and cost control, activities that comprise the fundamentals of the management accounting function.

Variable costs are those costs which increase/decrease with the level of production and sales. In a manufacturing company the variable production costs change directly with the level of production.

Fixed costs can be either committed fixed costs or discretionary fixed costs. Fixed costs are termed fixed because they do not change in response to changes in the level of activity. It should be noted that they are not fixed because they do not change because cost items like rent is often subject to revision.

Semi-fixed/semi-variable costs are costs which move in the same direction but not at the same rate as the level of activity. The semi-fixed/semi-variable cost contains a fixed and a variable element. For example, the electricity bill contains a fixed or standing charge and and the variable aspect which depends on usage.

Cost ascertainment

It is important that the management accountant can determine the variable and fixed costs and there are a number of techniques to assist in separating the fixed and variable elements of semi-fixed or semi-variable costs.

1 Analysing costs by direct observation of the resources required to convert materials into a finished product and applying costs to these activities. Direct materials, direct labour and machine time can be established quite easily.

2 By inspecting the accounts the accountant can classify costs as being variable or fixed.

3 High-low method. This method entails selecting the period of highest and lowest levels of activity and comparing the changes in costs that result from the two levels.

Example

Output 10000units £30000

15000units £40000

£40000 - £30000 = £10000/

15000units - 10000= 5000units = £2per unit.

The fixed costs therefore are £10000.

4 The scattergraph or regression chart.

Costs

Output

On the scattergraph total costs are plotted against output at a number of different activity levels. Then a ‘line of best fit’ is drawn through some of the coordinates. Where this line coincides with the Y axis this represents the level of fixed costs. Once this is established it is simple to calculate the other costs which are not fixed ie. the variable costs. The assumption is that at zero output the business still has to meet the fixed costs- the periodic costs related to time.