AF102 - W2 Managerial Cost Concepts and Practices

AF102 - W2
Managerial Cost Concepts and Practices
Managerial cost concepts

One of the most important tasks of Managerial Accounting is to determine the cost of:
 Products
 Services
 Customers
 Other items of Interest to Managers.
Therefore we need to understand the meaning of cost and the ways in which costs can be used to make
decisions, both for small entrepreneurial businesses and large international businesses .
All organisations possess a bundle of economic resources they intend to apply to their
particular purpose.
 A steel manufacturer has stockpiles of iron ore and blast furnaces to use in making steel.
 Department stores have merchandise and the warehouses and display counters to have this ready
for sale.
Organisations accumulate economic resources to enable them to create products (goods) or services.
For managers in big manufacturing companies like Fiji Water or Coca Cola to:
 Plan
 Direct and Control operations effectively
 good information is needed.
Managers would need answers to questions such as:
 What costs are involved in making a product or providing a service?

 If production volume is decreased, will costs decrease?
 What impact will automation have on total costs?
 How can costs best be controlled?
To answer these questions, management needs reliable and relevant cost information.
Manufacturing costs
Manufacturing consists of activities and processes that convert raw materials into finished goods.
Manufacturing costs are, therefore, typically classified as:

\
 Direct materials
 Direct labour
 Manufacturing overhead.
Direct materials are raw materials that can be physically and conveniently associated with the
finished product during the manufacturing process. (flour in bread).
Indirect materials on the other hand, are materials that:
a) Do not physically become a part of the finished product

b) They cannot be traced because their physical association with the finished product is too small
in terms of cost to trace.
AF102 - W2
Indirect materials are accounted for as part of manufacturing overhead.
Direct labour - the work of factory employees that can be physically and conveniently
associated with converting raw materials into finished goods is called direct labour.
Indirect labour - In contrast, the wages of maintenance people, timekeepers, and supervisors
are usually identified as indirect labour because their efforts have no physical association with the
finished products, or it is impractical to trace the costs to goods produced.
Indirect labour is classified as manufacturing overhead.
Manufacturing overhead consists of costs that are indirectly associated with the manufacture
of the finished product.
Manufacturing overhead includes indirect materials, indirect labour, depreciation on factory

buildings and machinery, insurance, taxes and maintenance of factory facilities.
Product versus period costs

One question managers often ask is:
‘How much does it cost to make this product or to provide this service?’
Managers need estimates of product costs to assess product profitability. This is done so that they
can decide whether to make the product in-house or to outsource it.
Sometimes, the managers need estimates to set product prices, as well as to value inventory and cost
of goods sold in the statement of financial position and statement of financial performance.
The problem is that managers need different measures of product for different purposes.
How then do we define ?
Product costs are costs that are a necessary

and integral part of producing the finished
product.
Therefore, we can say that, each of the manufacturing cost components (direct materials, direct
labour and manufacturing overhead) are product costs.
Product costs are recorded as inventory when incurred.
Under the matching principle, these costs are not expenses until the finished goods inventory is
sold.
The expense is cost of goods sold.

AF102 - W2
Period costs are costs that are matched with the revenue of a specific time period.
Also, not included as part of the cost of a salable product.
These are non-manufacturing costs and include selling and administrative expenses.
They are deducted from revenues in the period in which they are incurred in order to determine net
income.

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AF102 - W2

Managerial Cost Concepts and Practices

Managerial cost concepts

Managers would need answers to questions such as:

 What costs are involved in making a product or providing a service?

Manufacturing costs are, therefore, typically classified as:

Indirect materials on the other hand, are materials that:

a) Do not physically become a part of the finished product

Indirect labour is classified as manufacturing overhead.

Manufacturing overhead includes indirect materials, indirect labour, depreciation on factory

Product versus period costs

How then do we define ?

Product costs are costs that are a necessary

Product costs are recorded as inventory when incurred.

The expense is cost of goods sold.

Also, not included as part of the cost of a salable product.

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