Management & Cost Accounting For Dummies®

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Table of Contents


About This Book

What You’re Not to Read

Foolish Assumptions

How This Book Is Organised

Part I: Getting Started with Management and Cost Accounting

Part II: Understanding and Managing Costs

Part III: Planning and Budgeting

Part IV: Using Management Accounting for Evaluation and Control

Part V: The Part of Tens

Icons Used in This Book

Where to Go from Here

Part I: Getting Started with Management and Cost Accounting

Chapter 1: Planning and Control: The Role of Management Accounting

Understanding What Management Accountants Do, and Why

Distinguishing management from financial accounting

Identifying costs

Analysing costs

Planning and budgeting

Evaluating and controlling operations

Gathering information needed for decisions

Concentrating on Costs

Defining types of costs

Predicting cost behaviour

Driving overhead

Costing jobs and processes

Distinguishing relevant costs from irrelevant costs

Accounting for the Future: Planning and Budgeting

Analysing contribution margin

Budgeting capital for assets

Choosing what to sell

Pricing goods

Setting up a master budget

Flexing your budget

Exercising Control

Allocating responsibility

Analysing variances

Producing a cycle of continuous improvement

Getting Certified

Following the code of ethics

Becoming a chartered global management accountant

Chapter 2: Using Management Accounting in Your Business

Classifying Companies by Their Output

Checking out service companies

Perusing retailers

Looking at manufacturers

Measuring Profits

Earning revenues

Computing Cost of Sales

Incurring operating expenses

Measuring Net Profit

Working out the Operating Profit Margin

Meeting the Three Es of Performance

Making comparisons using the three Es

Assessing Asset Turnover

Putting Profitability and Productivity Together: Return on Capital Employed

Part II: Understanding and Managing Costs

Chapter 3: Classifying Direct and Indirect Costs

Distinguishing Direct from Indirect Manufacturing Costs

Costing direct materials and direct labour

Understanding indirect costs: Production overhead

Valuing Inventory of Materials and Finished Goods

Completing an inventory record

Finding out about First-In First-Out

Making use of Average Cost (AVCO)

Learning about Last-In First-Out

Examining the Treatment of Labour Costs within the Accounting System

Working with overtime premium

Analysing timesheets

Two Other Ways to Classify Costs

Assessing conversion costs

Telling the difference between product and period costs

Chapter 4: Allocating, Apportioning and Absorbing Overhead

Introducing Budgeting Overhead Costs

Charging Production Overheads into Products: Traditional Approach

Calculating overhead allocation

Allocating and apportioning overhead

Re-apportioning production service centre overhead

Absorbing overhead as part of product costs

Dealing with overhead as work is carried out

Reporting on overhead and overhead absorbed: Monthly management accounts

Taking Advantage of Activity-Based Costing for Overhead Allocation

Identifying the major activities in the organisation

Creating a cost pool for each activity

Determining the cost driver for each major activity

Assigning the cost of activities to products according to the product’s demand for activities

Working Through an Example: Rusbridge Limited

Chapter 5: Costing Products Flowing Through a Business

Tracking the Flow of Products

Following the Phases of Production and Sale

Accounting for direct costs and production overhead

Charging (debit) production costs to work-in-progress

Crediting work-in-progress when products become finished goods

Chalking up the inventory and charging Cost of Goods Sold

Creating the income statement

Cracking Cost of Goods Sold

Computing Units Sold

Chapter 6: Job Costing: Pricing Individual Orders

Keeping Records in a Job Costing System

Getting the paperwork in order

Allocating overhead

Completing the job cost calculation

Understanding the Accounting for Job Costing

Purchasing raw materials

Paying for direct labour

Paying for overhead

Requisitioning raw materials

Using direct labour

Applying overhead

Chapter 7: Process Costing: Tracking What’s Produced and How Much it Costs

Comparing Process Costing and Job Costing

Maintaining Process-Costing Books

Debiting and crediting

Keeping track of costs

Moving units through your factory – and through the books

Meeting the two key aspects of process costing

Demonstrating Process Costing in Action

Introducing the Process Account

Valuing the WIP: The Cost of Production Report as a workings table

Chapter 8: Observing How Variable and Fixed Costs Behave

Investigating Cost Behaviour

Understanding that how much you produce and/or sell affects variable costs

Discovering what causes fixed costs to change

Separating Semi-variable Costs into Variable and Fixed Components

Employing the high–low method

Analysing accounts

Using a scattergraph

Fitting a regression

Sticking to the Relevant Range

Part III: Planning and Budgeting

Chapter 9: Using Contribution Analysis to Make Better Decisions

Calculating the Contribution

Looking at the big picture: Total contribution

Narrowing your focus: Contribution per unit

Considering contribution as a proportion of sales: C/S ratio

Meeting Net Profit Targets with Cost-Volume-Profit Analysis

Drafting a cost-volume-profit graph

Finding the total contribution

Discovering contribution per unit

Using the C/S ratio

Bringing up Break-Even Analysis

Drawing a graph to find the break-even point

Employing the formula approach

Modifying to Achieve a Target Profit

Feeling Secure: Margin of Safety

Depicting margin of safety with a graph

Making use of formulas

Revealing volume: Profit volume graph

Juggling Variable and Fixed Costs: Operational Gearing

Identifying decision points – when to invest in fixed cost production methods

Deciding when to outsource products

Graphing operational gearing

Looking at the operational gearing formula

Using contribution with a mix of products

Chapter 10: Decision-Making within the Reality of Limited Capacity

Understanding the Reality of Limited Resources

Coping with limited capacity

Identifying limiting factors

Focusing on Relevant Costs

Distinguishing the relevant costs

Accounting for opportunity costs

Ignoring Certain Costs Safely: Irrelevant Costs

Diving into sunk costs

Considering committed costs

Chapter 11: Deciding on Long-Term Purchases: Capital Budgeting

Identifying Incremental and Opportunity Costs

Getting Your Money Back: The Payback Technique

Using the payback method

Finding the payback period

Understanding Time Value of Money and Net Present Value (NPV)

Homing in on NPV and decision-making

Calculating the present value

Working that NPV

Putting Payback and NPV into Practice

Task the first: Payback

Task the second: NPV

Tackling tax

Investigating Internal Rate of Return (IRR)

Looking beyond the Numbers: Qualitative Factors

Chapter 12: Naming Your Price: Approaches to Decision-Making

Differentiating Products to Decide on Prices

Taking All Costs into Account: Absorption Costing

Pricing at Cost-Plus

Calculating fixed mark-ups

Setting a cost-plus percentage

Considering problems with cost-plus pricing

Short-Term Pricing Based on Relevant Costs

Hitting Your Bull’s-Eye: Target Costing

Calculating your target cost

Knowing when to use target costing

Carrying out value engineering

Acting after value engineering is carried out

Chapter 13: Doing Deals between Company Divisions: Transfer Prices

Pinpointing the Importance of Transfer Pricing

Setting out the problem

Resolving discord and creating harmony

Negotiating a Transfer Price

Finding the selling division’s minimum transfer price

Setting the purchasing division’s maximum transfer price

Trying to meet in the middle

Managing with full capacity

Transferring Goods between Divisions at Cost

Setting the transfer price at variable cost

Establishing the transfer price at variable cost plus a mark-up

Basing transfer price on full cost

Positioning Transfer Price at Market Value

Chapter 14: Planning Budgets for the Future

Preparing a Manufacturer’s Master Budget

Budgeting backwards

Obtaining a sales budget

Generating a production budget

Setting a direct materials budget

Working on a direct labour budget

Building an overhead budget

Adding up the product cost

Fashioning a selling and administrative budget

Creating a cash budget

Constructing a budgeted income statement

Applying Master Budgeting to Non-Manufacturers

Budgeting for a retailer

Co-ordinating a service company’s budget

Moving Beyond Budgeting

Rolling forecasts and plans

Moving away from tradition

Part IV: Using Management Accounting for Evaluation and Control

Chapter 15: Using Flexible Budgets to Exert Control

Appreciating the Need to Control Your Business

Dealing with Budget Variances

Example exam question 1: Comparing the fixed budget and the actual results

Example exam question 2: Comparing a flexed budget and the actual results

Dealing with variances

Implementing a Flexible Budget

Separating fixed and variable costs

Comparing the flexible budget to actual results

Chapter 16: Variance Analysis: Flexing Standard Costs

Setting Up Standard Costs

Discovering the different types of standards

Establishing direct materials standards

Determining direct labour standards

Calculating the overhead rate

Adding up standard cost per unit

Identifying Factors that Give Rise to Variances

Working out the direct materials variances usage and price

Finding direct labour variances efficiency and rate

Calculating variable overhead variances

Figuring out fixed overhead variances

Viewing the full worksheet – cost variances

Reporting variances to management: Operating Statement

Remembering key facts that are always true

Watching out for other things

Teasing Out Variances

Focusing on the big numbers

Tracing little numbers back to big problems

Chapter 17: Establishing Accountability with Responsibility Accounting

Linking Strategy with an Organisation’s Structure

Allocating responsibility

Decentralising decision-making

Distinguishing controllable from non-controllable costs

Identifying Different Kinds of Responsibility Centres

Revenue centres: Scoring on sales only

Cost centres: Counting costs

Profit centres: Controlling revenues and expenses

Investment centres: Being responsible for the lot

Chapter 18: The Balanced Scorecard: Reviewing Your Business’s Report Card

Introducing the Balanced Scorecard: Key to Strategy

Making money: The financial perspective

Ensuring your clients are happy: The customer perspective

Keeping the clock ticking: The internal business perspective

Appraising the ability to change and improve: The learning and growth perspective

Demonstrating the Balanced Scorecard in Action

Sketching a strategy that incorporates all four perspectives

Identifying measures for the balanced scorecard

Testing Times: Exam Advice

Measuring performance

Contributing towards improved profits

Explaining performance measures

Chapter 19: Squeezing Out of a Tight Spot with the Theory of Constraints

Understanding the Nature of Constraints

Identifying manufacturing constraints

Considering service constraints

Managing Processes with the Theory of Constraints

Step 1: Identifying system constraints

Step 2: Exploiting the constraint

Step 3: Subordinating everything to the constraint

Step 4: Breaking the constraint

Step 5: Returning to Step 1

Putting you to the test: Exam tip

Part V: The Part of Tens

Chapter 20: Ten Key Management Accounting Formulas

The Accounting Equation: Working with Assets and Liabilities

Profit: Focusing on the Bottom Line

Cost of Goods Sold: Handling Inventory

Contribution: Measuring the Impact of Decisions on Profit

Cost-Volume-Profit Analysis: Considering the Effects of Changing Volume

Break-Even Analysis: Ensuring You Don’t Make a Loss

Calculating the Effect of Direct Materials Price Variance on Total Cost

Determining the Effect of Direct Materials Usage Variance on Total Cost

Future Value: Computing the Value of a Cash Investment

Present Value: Deciding How Much to Invest

Chapter 21: Ten Careers in Management Accounting

Corporate Treasurer

Chief Financial Officer

Financial Controller

Group Accountant

Financial Analyst

Cost Accountant

Budget Analyst

Internal Auditor

Fixed-Assets Accountant

Cash-Management Accountant

About the Authors

Cheat Sheet

Connect with Dummies


Language is a funny thing, necessary but full of pitfalls. After all, as humorist Franklin P. Jones wrote, ‘skating on thin ice can get you into hot water’! But if, as people say, accounting is the language of business, management accounting is the language inside a business. Accountants establish specific definitions for terms such as revenue, expense, gross profit, assets and liabilities. Everyone uses these same definitions when they announce and discuss these attributes, so that when a company reports sales revenue, for example, investors and other businesspeople understand how that figure was calculated. This way, companies, investors, managers and everyone else in the business community speak the same language – a language for which accountants wrote the dictionary.

Management accounting allows a company’s managers to understand how their business operates, and gives them the information needed to make decisions. It helps them plan their business’s activities and control its operations. For example, suppose that a marketing executive needs to set a price for a new product. To do so, that person needs to understand how much the product costs to produce, which is where management accounting comes in. Furthermore, the price needs to be set at an appropriate level so that at the end of the year (after the company sells all the products it’s supposed to sell at whatever prices it sets), the firm earns the profit and cash flow that it projected. Here, too, management accounting proves its usefulness.

We often take management-accounting classes, and we always like to point out to students who the users of management-accounting information usually are: the managers, marketing professionals, financial analysts and information systems professionals working within a company. All have a role not only in developing management accounting information, but also and more importantly in using it to make better business decisions.

About This Book

If you accept that management accounting is the language inside a business, clearly running a business without understanding this topic is pretty difficult. Therefore, we’ve written this book for businesspeople – present and future – who want to better understand how to use management accounting to make decisions and how management accountants develop the information in reality.

We have a confession to make: we really love to do accounting, especially management accounting. And better yet, we love to convey our knowledge and enthusiasm for it. We believe that contribution margin (see Chapter 9) is the greatest thing since sliced bread and that the theory of constraints can solve most of life’s problems (see Chapter 19).

In our view, an urgent need exists to redress the balance – to counter the bad rap that accounting gets for being boring (even financial accountants, of all people, trash their poor management brethren for being the most boring of all accountants). We want to show what we believe makes management accounting engaging and (yes) exciting, right here in this book.

Therefore, when you start reading our handiwork and find that you can’t put this book down, don’t blame us and our lame little puns. Instead, appreciate that after you start discovering accounting, it can be quite difficult to stop.

What You’re Not to Read

We tried to write this book so that it spellbinds you, so that you can’t stop reading until you’ve consumed every last word (though we don’t mind if you’re tempted to peek at the last few pages to see how it ends!).

That said, if you’re very busy, feel free to focus on the most important stuff that you need to know and skip some of these less important elements:

check.png Technical stuff: Anything marked with this icon is especially interesting to management-accounting geeks like us. But if you’re in a rush, you can skip these paragraphs safe in the knowledge that you aren’t missing anything essential.

check.png Sidebars: These fascinating grey-shaded boxes include additional information that we think you may like, but you can pick up management accounting just fine without reading them.

Foolish Assumptions

We assume that you’re one of the following:

check.png A college student taking a management-accounting course who needs some help understanding the topics you’re covering in class. Specifically, you’ll certainly find this book helpful supplementary reading if you’re taking the level 3 and 4 AAT courses, or operational or managerial level CIMA courses, or the fundamental ACCA courses.

check.png A businessperson or entrepreneur who wants to know more about how to collect accounting information to make better business decisions.

check.png A recent college graduate interested in pursuing a career in management accounting, perhaps as a chartered management accountant.

check.png A professional accountant or bookkeeper looking for a straightforward refresher in the basics of management accounting.

How This Book Is Organised

Each of the five parts of this book tackles a different aspect of management accounting. The following sections explain how we organise the information so that you can find what you need quickly and easily.

Part I: Getting Started with Management and Cost Accounting

Part I gives you a taste of what management accounting is and why it’s important. The chapters also review some important aspects of accounting that every businessperson needs to know. We hit profitability, efficiency, productivity and continuous improvement especially hard.

Part II: Understanding and Managing Costs

At its crux, management accounting is all about costs – be they direct, indirect, overhead or whatever – and how they behave. Part II explores the world of costs – what drives them up, down or sideways.

Part III: Planning and Budgeting

An important part of managing an organisation is planning for the future, and management accountants play a critical role in this process by preparing budgets, the topic of Part III. These budgets integrate information from every part of an organisation to develop a plan to meet managers’ goals.

Part IV: Using Management Accounting for Evaluation and Control

Accountants have a reputation for being control freaks, but it’s part of the job. Managers and management accountants not only plan but also need to control. This duty means that they monitor a company’s performance carefully and compare that performance to their budgets. In this way, managers can identify and address problems quickly, before they become crises. We describe how managers can flex their budgets – that is, prepare budgets that can adapt to changing facts and circumstances. Part IV also explains how to evaluate and control the activities throughout an organisation, including using responsibility accounting, variance analysis and two techniques that managers use to run their companies: the balanced scorecard and the theory of constraints.

Part V: The Part of Tens

The chapters in this part provide you with a quick reference to the most important formulas in the book. We also share some career options for management accountants.

Hop online and visit for a bonus Part of Tens chapter 'Ten Ratios to Know for Management Accountants', which includes helpful exam practice.

Icons Used in This Book

Throughout the margins of this book, we use certain symbols to emphasise important points. Watch for these icons:

tip.eps This icon marks simple hints that can help you solve problems on tests and in real-life management accounting situations.

remember.eps We use this icon to highlight information that’s especially important to keep in mind. Tucking these facts away helps you keep key concepts at your fingertips.

example.eps This icon pops up alongside examples (surprise, surprise!) that show you how to apply an idea to real-world accounting problems.

warning_bomb.eps Like building Titanic II, not every idea is a good idea. This icon alerts you to situations that require caution. Iceberg ahead!

technicalstuff.eps We just had to share these interesting snippets of knowledge with you. If you’re in a hurry, however, don’t panic; just skip them.

practice_costaccount.eps This icon shows where we provide an exercise for you to try, so that you get to put some of your recently acquired expertise into practice.

Where to Go from Here

All the chapters in this book are modular, and so you can study and understand them without reading other chapters. Just go through the table of contents and select a subject that you want to know more about. We provide cross references to topics in other chapters where appropriate, so that if you skip a foundational concept crucial to what you’re reading about, you know where to find what you need.

If you’re looking to discover management accounting from scratch, or to unlearn some aspect that you fear you’ve got wrong, start with Part I to get the basics under your belt. We take special care to explain all the fundamentals that some management accounting texts skip. If you’re a student with little or no background in accounting, make a point to read Chapter 2.

Management accounting itself is built on a few basic principles. In our experience, most students who have trouble with management accounting usually improve their performance after becoming more familiar with these basics. Therefore, to better understand these foundations, take a look at Chapter 3 (cost principles), Chapter 8 (cost behaviour) and Chapter 9 (contribution margin).

tip.eps If you’re studying for an accountancy exam, make sure that you know the relevant key formulas in Chapter 20.

Part I

Getting Started with Management and Cost Accounting


pt_webextra_bw.TIF For Dummies can help you get started with lots of subjects. Visit to learn more and do more with For Dummies.

In this part . . .

check.png Discover what management accountants do and why they do it.

check.png Find out what you can do to become a management accountant.

check.png Learn how different kinds of companies operate.

check.png Know how accountants measure profits, efficiency and productivity.

check.png Find out how managers apply continuous improvement.