CHAPTER 5

INTRODUCTION TO MANAGEMENT
ACCOUNTING:

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 Management Accounting:-
• The process of preparing and provide accurate and
timely financial and statistical information required by
managers to make day-to-day and short term
decisions.
• Management accounting generates monthly or
weekly reports for an organization’s internal users
such as department managers and the CEO.
• These reports may typically show the amount of
available cash, sales revenue generated, state of
accounts payable and accounts receivable, outstanding
debts, raw material and inventory.
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 Management Accounting:
 The three basic importance of management accounting
information are:

help to identify who has authority over

assets.

supports planning and decision-making.

provide a means of monitoring, evaluating, and

rewarding performance.

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 Comparing Financial Accounting and
Management Accounting
• both financial accounting and management
accounting
• are all about allocating scarce
Financial is the resources.
principle source of
information
accounting for decisions of how to allocate resources
among companies, whereas
• Management is the principle source of
information
accounting for decisions of how to allocate
resources
within a company.
• Management accounting provides information that;
– helps managers control activities within the firm, and
– to decide what products to sell, where to sell them,
how to
source those products, and so on. 4
 Financial Accounting
Mandatory for most companies
Follows GAAP/IFRS
Backward looking: focuses mostly
on reporting past performance
Emphasis on reliability of the
information
Provides general purpose
information. Investors, creditors,
regulators use the information
Provides a high-level summary of
the business
Reports almost exclusively in birr
denominated amounts
Managerial Accounting
Mostly optional
No GAAP/IFRS. Companies often
develop unique and company specific
management accounting system & rules.
Forward-looking: including estimates and
predications of future events and
transactions
Can include many subjective estimates
Provides many reports modified to
specific users
Can provides a great deal of detail
Communicates many nonfinancial
measures of performance, particularly
operational data such as units produced
and sold by product type.
Cost Accounting and management accounting

• Cost accounting:
– is the process of accounting for costs
– holds the accounting procedures relating to
recording of all income and expenditure and
the preparation of periodical statements and
reports with the object of ascertaining and
controlling costs.
• Management accounting involves collecting,
analyzing, interpreting and presenting all
accounting information, which is useful to the
management.
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 Cost Terms (concepts)

• Different categories
of terms are
cost
Behavior
different ways to look at
merely
costs or to segment and
cut up cost information.
Traceability
• They are not necessarily Relevance
complementary to or
mutually of
exclusive
other cost categories. Function

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 Classification by Behavior

Cost behavior means how a cost will react to

changes in the level of business activity.
 Total fixed costs: costs that do not change (in total) relative to
changes in business activity

Do not change when activity changes.

 Total variable costs: Variable costs: costs that increase or
decrease (in total) relative to increases or decreases in the level of
business activity.

Change in proportion to activity changes.

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 Classification by Traceability

Direct costs: costs that Indirect costs: costs that

are directly are NOT directly
traceable to some traceable to a product,
object such as a activity or
product, activity or department.
department. • Costs incurred for the
 Examples: material benefit of more than one
and labor cost for cost object.
a product.  Example: maintenance
expenditures
benefiting two or more
departments. 10
 Classification by Relevance:

A. Opportunity Costs
The potential benefit that is given up when one
alternative is selected over another.
The potential benefits foregone when a
decision is made.

Example: If you were not attending college,

you could be earning Br 20,000 per year.
Your opportunity cost of attending college for
one year is Br 20,000.

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B. Sunk Costs

Sometimes called “past costs.” These costs are

NOT relevant to the decision making process.

All costs incurred in the past that cannot be changed by any

decision made now or in the future.

Sunk costs should not be considered in decisions.

Example: You bought an automobile that cost Br

315,000 two years ago. The Br 315,000 cost is sunk
because whether you drive it, park it, trade it, or sell it,
you cannot change the Br 315,000 cost.

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Classification by Function:

1. Product Costs and

2. Period costs

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 1. Product Costs

• Product Costs: Include all costs that are required

to
• make a product
Product are: Direct Material, Direct Labour,
Manufacturing
costs Overhead
• They are included as part of inventory and shown on the
balance sheet until the product is sold.
• Product costs are often called “inventoriable costs” or
“manufacturing costs”.
• When the product is sold, the costs are “matched” to the
sales revenue and reported on the income statement as
cost of goods sold

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 Product Costs

Direct Direct Manufacturing

Material Overhead
Labor

The
Product

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 2. Period costs
• Period costs are selling andgeneral
administrative expenses with
identified
the accounting period in which they are
incurred, and charged against sales
revenue in the same period.
• They are also called period expense.

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Accounting for Manufacturing Operations

Steps in the Manufacturing Process:

Convert raw Sell
Buy raw
materials into finished
materials.
finished goods.
goods.

Direct Direct labor Cost

materials and of
costs. manufacturing goods
overhead sold.
costs. 16
 Direct Materials

Raw
materials & Can be
component traced
parts that directly and
become an conveniently
integral part to products.
of finished
products.

If materials cannot be traced directly to

products, the materials are considered indirect
and are part of manufacturing overhead.
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 Direct Labor

Includes the payroll cost of direct workers.

Direct labor Wage

×
hours rate
Those employees
The cost of employees who who work directly
do not work directly on the on the goods being
goods is considered manufactured.
indirect labor and is part of
manufacturing overhead.
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 Manufacturing Overhead

All manufacturing costs other than

direct materials and direct labor.

Includes:
• Indirect materials.
• Indirect labor. Does not include
selling or general
• Machinery and and
equipment administrative
costs. expenses.
• Cost of
regulatory 20