Management or Cost Accounting Systems and Capital Budgeting
Management or cost accounting systems are part of an enterprise's information system and refer
to the internal cost tracking and allocation systems to track costs and expenditures. These are
internal rather than external accounting systems. There are no fixed rules governing how an entity
should keep track of cash flows internally, although there are many formal methods available for
users. Capital budgeting is basically a form of predictive cost accounting over a set time frame
which is used to analyze the costs of alternative projects or expenditures over the specified
period of time.
Managerial or cost accounting measures are the predominant financial drivers in day to day
business decision making affecting every aspect of the firm's activities. Good cost accounting is
vital to understanding the profitability of current activities and to predicting the profitability of
future activities. There are many examples of firms who discovered non-profitable services or
products once thorough cost accounting procedures were implemented. The bulk of this module
will focus on these types of accounting information systems.
The main objectives of managerial/cost accounting are (Hilton, 1988):
1) Providing managers with information for decision making and planning.
2) Assisting managers in directing and controlling operations.
3) Motivating managers towards the organization's goals.
4) Measuring the performance of managers and sub-units within the organization.
Basic cost classifications are demonstrated in Table 3. - Note, these classifications are not
exclusive, for example a cost may be fixed and indirect, or variable and direct for example.
Table 3. General Cost classifications
Variable Costs Variable costs change in total in proportion to the
level of activity. For example if a carmakers
production increases by 5%, its tire costs will
increase by about 5%.
Fixed Costs A fixed cost remains unchanged in total as the level
of activity varies. For example, the property tax on
a rental apartment is the same regardless of the
number of building occupants.
Direct Costs A direct cost is the cost of direct labor and material
used in making the product or delivering the
service.
Indirect Costs/Overhead Costs Indirect costs are costs of an activity which are not
easily associated with the production of specific
goods or services.
Opportunity Costs The benefit that is sacrificed when the choice of one
action precludes an alternative course of action.
Sunk Costs Costs that have been incurred in the past and cannot
be changed by current actions.
Full cost accounting describes how goods and services should be priced to reflect their true costs
(including environmental and other social costs). Depending on the type of accounting system
involved it can thus relate to national, financial, or managerial/cost accounting. With full cost
accounting, natural resources would be factored into calculations of a country's GDP; natural
resources would be redefined as assets on company ledgers; and environmental costs would be
built into a product's cost.
To confuse issues slightly, within each type of accounting system, the term full cost accounting
may be used to refer to either the full private (or bottom line) costs to an enterprise of an
activity, or more correctly, the full social costs to society of the activity including externalities
(such as health impacts resulting from ozone depletion). Externalities are costs not borne by the
responsible entity, for example, the ecological impacts of climate change resulting from
automobile emissions are not included in the price consumers pay for petroleum. In its correct
formulation, full cost accounting should refer to all social costs. However, this is difficult in
practice and many attempts at full cost accounting (particularly in managerial accounting efforts)
have stopped at the level of incorporation of private costs. Figure 1 demonstrates the difference
between current accounting systems, full “private” accounting systems, and full 'social”
accounting systems.
Management or cost accounting systems are part of an enterprise's information system and refer
to the internal cost tracking and allocation systems to track costs and expenditures. These are
internal rather than external accounting systems. There are no fixed rules governing how an entity
should keep track of cash flows internally, although there are many formal methods available for
users. Capital budgeting is basically a form of predictive cost accounting over a set time frame
which is used to analyze the costs of alternative projects or expenditures over the specified
period of time.
Managerial or cost accounting measures are the predominant financial drivers in day to day
business decision making affecting every aspect of the firm's activities. Good cost accounting is
vital to understanding the profitability of current activities and to predicting the profitability of
future activities. There are many examples of firms who discovered non-profitable services or
products once thorough cost accounting procedures were implemented. The bulk of this module
will focus on these types of accounting information systems.
The main objectives of managerial/cost accounting are (Hilton, 1988):
1) Providing managers with information for decision making and planning.
2) Assisting managers in directing and controlling operations.
3) Motivating managers towards the organization's goals.
4) Measuring the performance of managers and sub-units within the organization.
Basic cost classifications are demonstrated in Table 3. - Note, these classifications are not
exclusive, for example a cost may be fixed and indirect, or variable and direct for example.
Table 3. General Cost classifications
Variable Costs Variable costs change in total in proportion to the
level of activity. For example if a carmakers
production increases by 5%, its tire costs will
increase by about 5%.
Fixed Costs A fixed cost remains unchanged in total as the level
of activity varies. For example, the property tax on
a rental apartment is the same regardless of the
number of building occupants.
Direct Costs A direct cost is the cost of direct labor and material
used in making the product or delivering the
service.
Indirect Costs/Overhead Costs Indirect costs are costs of an activity which are not
easily associated with the production of specific
goods or services.
Opportunity Costs The benefit that is sacrificed when the choice of one
action precludes an alternative course of action.
Sunk Costs Costs that have been incurred in the past and cannot
be changed by current actions.
Full cost accounting describes how goods and services should be priced to reflect their true costs
(including environmental and other social costs). Depending on the type of accounting system
involved it can thus relate to national, financial, or managerial/cost accounting. With full cost
accounting, natural resources would be factored into calculations of a country's GDP; natural
resources would be redefined as assets on company ledgers; and environmental costs would be
built into a product's cost.
To confuse issues slightly, within each type of accounting system, the term full cost accounting
may be used to refer to either the full private (or bottom line) costs to an enterprise of an
activity, or more correctly, the full social costs to society of the activity including externalities
(such as health impacts resulting from ozone depletion). Externalities are costs not borne by the
responsible entity, for example, the ecological impacts of climate change resulting from
automobile emissions are not included in the price consumers pay for petroleum. In its correct
formulation, full cost accounting should refer to all social costs. However, this is difficult in
practice and many attempts at full cost accounting (particularly in managerial accounting efforts)
have stopped at the level of incorporation of private costs. Figure 1 demonstrates the difference
between current accounting systems, full “private” accounting systems, and full 'social”
accounting systems.
