The chapter looks at the relevant elements of cost for decision making, then looks at the various techniques including breakeven analysis. Other important business decisions are whether to source components internally or have them brought in from outside, and whether to continue with operations if they appear uneconomic. The chapter examines the techniques useful in helping to make decisions in these areas.
Elements of a decision A quantitative decision problem involves six parts: a An objective that can be quantified Sometimes referred to as 'choice criterion' or 'objective function', e. It is therefore common to find an objective that will maximise profits subject to defined constraints. For example, in order to minimise costs of a manufacturing operation, the available alternatives may be: i to continue manufacturing as at present ii to change the manufacturing method iii to sub-contract the work to a third party.
Relevant costs for decision making The costs which should be used for decision making are often referred to as "relevant costs". CIMA defines relevant costs as 'costs appropriate to aiding the making of specific management decisions'. To affect a decision a cost must be: a Future: Past costs are irrelevant, as we cannot affect them by current decisions and they are common to all alternatives that we may choose.
Any costs which would be incurred whether or not the decision is made are not said to be incremental to the decision. Similarly, the book value of existing equipment is irrelevant, but the disposal value is relevant.
Common Concepts and Techniques of Managerial Accounting
Other terms: d Common costs: Costs which will be identical for all alternatives are irrelevant, e. Opportunity cost Relevant costs may also be expressed as opportunity costs. An opportunity cost is the benefit foregone by choosing one opportunity instead of the next best alternative. Example A company is considering publishing a limited edition book bound in a special leather. The cost was incurred in the past for some reason which is no longer relevant.
The leather exists and could be used on the book without incurring any specific cost in doing so.
Managerial Accounting Concepts and Techniques
The better of these alternatives, from the point of view of benefiting from the leather, is the latter. The relevant costs for decision purposes will be the sum of: i 'avoidable outlay costs', i. This total is a true representation of 'economic cost'. Now attempt exercise 5. Exercise 5. The job would require the following materials. Calculate the relevant costs of material for deciding whether or not to accept the contract.
You must carefully and clearly explain the reasons for your treatment of each material. The assumptions in relevant costing Some of the assumptions made in relevant costing are as follows: a Cost behaviour patterns are known, e. Cost-volume-profit CVP analysis CVP analysis involves the analysis of how total costs, total revenues and total profits are related to sales volume, and is therefore concerned with predicting the effects of changes in costs and sales volume on profit.
It is also known as 'breakeven analysis'.
The technique used carefully may be helpful in the following situations: a Budget planning. The volume of sales required to make a profit breakeven point and the 'safety margin' for profits in the budget can be measured. The basic principles of CVP analysis CVP analysis is based on the assumption of a linear total cost function constant unit variable cost and constant fixed costs and so is an application of marginal costing principles. The principles of marginal costing can be summarised as follows: a Period fixed costs are a constant amount, therefore if one extra unit of product is made and sold, total costs will only rise by the variable cost the marginal cost of production and sales for that unit.
What is cost and management accounting?
This is the extra contribution from the extra output and sales. Sabre Products Ltd. Cost is an expense incurred to a particular unit. In other way, cost is what the business sacrifices in order to produce one unit of product. Accounting is the art and science of recording, classifying, summarizing, and analysing inputs to make a sense of the information related to financial, management, or cost.
Cost accounting is the art and science of recording, classifying, summarizing, and analysing costs to help management make prudent business decisions. Direct costs are directly involved in producing goods. That means direct costs can be directly identified as being used in the production of goods. For example, we can talk about direct material and direct labour that are used in producing goods. These costs we can identify as direct costs. Understanding these two types of costs is important since we would be using these costs in computation of cost of sales per unit for a particular product.
That means these costs remain similar within a broad range of spectrum. Plus, the per unit fixed cost changes as the production increases or decreases. For example, rent is a fixed cost. Even if the production increases or decreases, the business needs to pay the same rent month in and month out.
Variable cost is exact opposite of fixed cost. Variable cost changes as per the increase or decrease of production units. But even if the total variable cost changes, per unit cost per unit remain same irrespective of changes in production units. For example, the cost of raw material is a variable cost. The total cost of raw material changes if the production increases or decreases.
But per unit cost of raw material remains same even if the production increases or decreases. In semi-variable costs, both components are present. Semi-variable costs are the combination of fixed costs and variable costs. This sort of wages will be called semi-variable wages.
Cost accounting is much more than a cost statement. But still, cost statement will give us an idea about how to compute cost of sales per unit for a particular product —. MNC Factory has the following information and from the below-furnished information, you need to calculate per unit cost of sales. Management accounting is the process of collecting, analyzing, and understanding the financial statements , statistical, and qualitative information to make sense of how the business is going and what to do in near future.
Management accounting helps to make short term decisions and also helps strategize for future big events. The idea behind management accounting is to prepare periodical reports which can educate and inform the managers of the company to make effective decisions.
- Cost Benefit Analysis;
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- Differences Between Cost Accounting and Management Accounting.
- How Management Accounting Differs from Other Accounting Practices.
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Even if management accounting is much different than financial accounting and cost accounting cost accounting is one of the sub-sets of management accounting , it gathers information from both of this accounting in producing periodical reports for management. The exact motto of these reports is to help management get all the information at finger tips and use the information to make effective decisions for the business.
Since there is no statutory requirement, these reports are articulated as per the need of the management. Since we know that management accounting periodical reports serve a great purpose of making effective decisions for management, we need to know the importance of management accounting in business. Here are the top-most factors —. There are many tools used in management accounting. Following are top-most which are frequently used —. Both cost accounting vs management accounting help management make effective decisions. But their scope and tools are completely different.
- Previous articles.
- Differences Between Cost Accounting and Management Accounting.
- Does management accounting deals only with cost?.
As management accounting depends a lot on cost accounting to prepare reports, cost accounting happens to be a sub-set of management accounting.