Chapter 1 The fundamentals of costing Flashcards
1.1 Definitions and differences
Management information is any information prepared to assist management with planning, decision making and control. This includes financial and non-financial information, as well as historic, current, and future information.
Management accounting is the identification, generation, presentations, interpretation, and use of relevant information to prepare management accounts and schedules. This is a subset of management information.
Cost accounting is the production of cost information to assist management. This is a subset of management accounting.
Financial accounting is used by external users, the purpose is to record historical financial performance and position. It is required by statute and the format is prescribed by CA06, GAAP and IFRS. The scope covers the whole business and gives minimum required information. This information tends to be mostly financial.
Management accounting is used internally and to assist management in planning and controlling the business to make decisions. There is no legal requirement, and the format is by management discretion. The scope is flexible, and the information is financial and non-financial key performance indicators.
1.2 Basic cost accounting concepts
Cost objective: this is anything for which we are trying to ascertain the cost
Cost centre: a department, process, or function where costs can be accumulated
Cost unit: product or service for which costs are determined
Composite cost unit: this is a cost unit made up of two parts. Most commonly it is a service provided where a unit of production is hard to calculate and compare.
2.1 Cost classification – direct v indirect costs
When calculating the total cost of a cost unit or product or service, the total cost is made up of materials, labour and expenses.
Direct costs (prime costs): there are three elements, direct material costs (costs of material to make and sell a cost unit), direct labour costs (labour costs to make a cost unit) and direct expenses (other costs incurred in full as a direct consequence of making a cost unit).
Indirect costs are costs incurred which cannot be traced directly and in full to a cost unit. Materials used in negligible amounts are indirect material costs.
Production overheads are costs incurred (other than direct production costs) in producing the product or service. It includes indirect materials, indirect wages, and indirect expenses. Also called manufacturing or factory overheads. Only production overheads can be included in the value of inventories.
Other (nonproduction) overheads include:
- Administration overhead: includes costs incurred in directing, controlling, and administering the business
- Selling overhead: includes costs incurred in raising sales and customer retention
- Distribution overhead: includes costs incurred in packaging and delivering goods to customers
2.2 Product v period costs
Product costs are any costs incurred in the manufacture of goods/services. Product costs are included in inventory valuation and are therefore part of the cost of sales expense. Product costs include direct production costs and production overheads.
Period costs are costs deducted as an expense in the income statement in a particular period. Period costs are not included in inventory valuation.
2.3 Cost behaviour
Costs incurred by the business may change with activity levels. Fixed costs per unit of activity will fall as the activity level increases because the FC are being spread over more units.
Variable costs change in total as the level of activity changes (for example total direct materials cost increase as output levels increase). Variable costs per unit of activity remain constant as activity level changes.
Semi-variable costs have both a fixed and variable element. They are therefore partly affected by a change in the level of activity. Semi-variable costs are also called semi-fixed or mixed costs.
Stepped-fixed costs are constant with the relevant range for each activity level but when a critical activity level is reached, the total cost incurred increases to the next step.
Direct costs tend to be a variable cost, but in some instances, they can be fixed. Indirect costs can be fixed or variable.
2.4 Costs and control
Responsibility accounting is a system ensuring that responsibility for all the activities (costs and revenues) of the business can be assigned to individual managers to monitor and assess performance.
Responsibility centre is a department/function/process/product whose performance is the responsibility of a specific manager.
Controllable costs can be influenced/changed by a manager’s decisions.
Uncontrollable costs cannot be influenced/changed by a manager’s decisions within a given time period.
Most VCs are controllable in the short term. Most FCs are uncontrollable in the short term. A manager may not be able to control a cost because of the action of another manager.
3.1 Ethics and management information
Management information should be clear, accurate and complete and prepared on a timely basis. The code contains 5 fundamental principles:
- Integrity: be straightforward and honest in all professional/business relationships.
- Objectivity: do not allow bias, conflict of interest or undue influence of others in business judgements
- Professional competence and due care: maintain professional knowledge and skill at an appropriate level and act diligently
- Confidentiality: do not disclose client information without appropriate specific authority
- Professional behaviour: comply with relevant laws and regulations and avoid actions discrediting the profession
Threats to the code are familiarity, self-review, self-interest, intimidation, and advocacy. Safeguards to eliminate/reduce threats to an acceptable level include consulting with superiors, the line manager, those charged with governance and the ICAEW. If the threat cannot be reduced to an acceptable level refuse to remain associated with any information, consider obtaining legal advice on reporting on anything and consider resigning.
3.2 Ethics and relevance to management information
Cost accountants prepare and report information to assist management. Professional accountants should prepare and report information fairly, honestly and in accordance with relevant professional standards. Failure to mitigate any threat could lead to association with misleading information. This includes false statements, omitted or obscure statements and reckless statements.
4.1 Sustainability
The use of resources in such a way that they do not compromise the needs of future generations. Three key headings can be used to consider sustainability issues:
- Social
- Environmental
- Economic
4.2 Governance
The way organisations are directed and controlled by senior officers. The policies in place to manage the performance of three sustainability issues identified above. Boards of directors need to be actively considering what their organisations are doing to address sustainability.
4.3 Environmental, social and governance (ESG)
A set of criteria used to measure and report on sustainability. ESG is specific and measurable, whereas sustainability is a general term. ESG reporting is still voluntary, however many organisations publish sustainability reports to show their commitment.
