Management Accounting

Types of cost classification and calculation

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Introduction to Management Accounting

Management accounting is also termed as managerial accounting that combines norms which are related to costing and budgeting. This unit of accounting is significantly used by the managers in order to collect data for making a good use of accounting information for decision making (Ward, 2012). From past few decades, management accounting is being used in corporate world to decide financial matters within the organization. The case scenario of Jeffrey and Son’s manufacturing company is taken into consideration for making present report. Furthermore, cost report is prepared for a manufacturing unit while using various performance indicators to find out the areas of potential improvements. The purpose as well as the nature of the budgeting process is explained to the budget holders of Jeffery and Son’s Ltd. In this respect, different kinds of budgets such as a production budget in units; materials purchases budget and a cash budget are prepared. At the end of the report, variance in budget is identified along with possible causes and recommended corrective actions.


Different types of cost classification

Manufacturing company bears expenses at the time of production of goods and services, which is generally known as “Cost”. Nonetheless, there are various cost incurred during the production process that are further classified into various categories. In general form, the cost is classified on the basis elements; namely behaviors, nature and function. Following points will explain the cost classification:

Elements of cost: The cost includes three major elements which are Material, Labor and Expenses. Material is used to produce finished goods, labor put efficiency in production and expenses are occurred in whole process. However, these elements are further divided into direct and indirect forms such as direct material and indirect material (Zimmerman and Yahya-Zadeh, 2011).

Nature of Expense: On the basis of nature of cost, it is divided into material, labor and expenses. Within the manufacturing company, the remuneration paid to workforce is considered as labor cost. Material cost, on the other hand, is paid against the purchase of raw material that is used by the company for successful accomplishment of manufacturing process. All the expenses made for providing services are expenses for a manufacturing unit (Nørreklit, 2010).

Functions/Activities: According to the functions of different departments of business, the cost is classified as per the expenses made by respective departments. For example:  Production cost,  Selling cost, Administration cost, Marketing cost, Distribution cost and R&D cost are included in function based cost.

Behavior of Cost: Volume is the base of deciding behavior of cost. On the other hand, the cost which is based on the volume of production is categorized into behavioral category. Cost of production changes as per the production volume of a specific time span. According to the behavior, cost is classified into three major categories such as Fixed cost, Variable cost and Semi variable cost (McGowan, 2010). Fixed cost does not modify at any level of production or remains same at any production volume. However, variable cost has a nature of change due to alteration in production volume. Semi-variable cost has characteristics of both fixed and variable cost. It can be said that to a specific level that a cost remains fixed and after this level, it leads to change. This kind of cost which occur in production process is called as semi-variable cost.

Calculation of Unit cost by using unit costing method

In general phenomenon, Job costing is referred as a method that is used by an organization to compute cost for a job which is different and unique in nature and is to be performed as per specific requirements of customers. The use of such costing methods allows manufacturers to consider direct and indirect cost of the job at a same time.

Interpretation of variance

Material variance - A favourable variance is counted in respect with material use. The expenses made on material in variable however, there no change in per unit cost and nature of material is variable. Because of it, the units are produced in a proportion. A single reduction in material cost will lead to reduction in material cost (Cinquini and Tenucci, 2010). The actual cost of material is decreased to due to decrease in production units.

Labour cost- The labour cost is increased by £1000 which is beyond to actual figures.  Nonetheless the actual variance was found to £1900 this figure was found because estimated labour cost per unit was £9 but in actual it occurred to be £10.  The labour cast is also variable expenses as a single use of labour cost is needed to pay attention (Prior, 2004). The difference amount of labour cost is to be compensated in the variance as budgeted computation of 20000 units was done and actual computation of 18000 units was done at £10.

Fixed overhead- In respect with the fixed overhead there is not seen any variance as such expenses is fixed in nature. With the increase or decrease in units of production there will be no change in fixed expenses.

Electricity- The electricity expenses are of semi variable in nature as these remain same to a certain level. In other words, such expenses are seen of mixture of both fixed and variable expense. As per the calculation there is no change found in the fixed proportion as well as the significant amount of variable portion has also been decreased.

Maintenance- Maintenance charges are called to be stepped cost.  The amount of such cost is increased with a single increased in production volume.  There is not found any change in maintenance cost due to reduction of 100 units.

Various areas of potential improvements using performance indicators

With the help numerated performance indicators the management of Jeffrey and Son's is able to assess potential improvement:

Financial statements- Making use of financial statements the company can identify the changes that are held business. In case decrease in sale and profitability is noticed that the company has to take step for improving. The change in financial values represents the opportunities of finding ways to improve (Keown, 2005).

Product and services quality – Through considering quality of products as well as assessing the defects in products, the company can improve the manufacturing process. For this monitoring in overall operational performance is must. This allows improving quality of products and overcoming negative impacts.

Customer satisfaction- Through assessing the satisfaction level of customer’s improvements can be made in existing products. Through considering, feedbacks and complaints of customer’s areas of improvements can be identified (Burns and Scapens, 2000).

Ways to reduce cost and enhancing value and quality

 Different ways are present with the help of which Jeffrey and Son's can raise quality of its services and can reduce overall cost. Such ways are:

Total quality management: It is regarded as one of the most effective method through which business can enhance quality. Through this tool it is possible for business to determine the major areas where cost can be reduced and in turn quality can be enhanced easily (Bhimani and Bromwich, 2009).

Management audit: Through this method it is possible for business to monitor internal operations within the workplace and it is possible to bring changes where improvement is possible. This will influence staff members to carry out standard performance with the aim to accomplish quality work.


Purpose and nature of budgeting process for Jeffery and Son's Ltd

The general definition of budgeting process is explained as a plan of making future expenses. In other words, budget is referred to as a monetary plan that is used by managers to determine possible expenditures and income of business (Kaplan and Atkinson, 2015). Many authors indicated that purpose of budget includes estimation of probable income and expenditure for a business entity for a specific period of time.  The points below represent the various purposes of budget:

  • The main purpose of budget is to estimate future income and expenditure
  • To determine the expected profitability of the company (DRURY, 2013)
  • It purposes at providing financial framework to the managers that could help in decision making
  • To compare estimated output with actual performance (Banks, 2008).

Here, in the case of Jeffrey & Son’s manufacturing Ltd, the prepared budget purposes at finding out incomes and expenditures for a specific time span.

Nature of budgeting process

Budgeting process is defined as financial tool which is used for setting anticipations for incomes and expenses for upcoming time. While adopting budgeting process, the organization can estimate availability of cash to operate business functions as well as to control over the expenses (Cooper and Kaplan, 2008). Making use of budgetary process, the maintained entity can get rid of the negative variance. In the below points, the nature of budgeting process is explained:

  • With the help of budgeting process, one can assess financial situation of company
  • The future amount of cash generated from the sales activities can be discovered along with the cash generated from other activities (Tsay, 2008).
  • The process defines necessary expenditure such as purchase of raw materials, labor, production overheads and promotions
  • With the help of budgeting process surplus or deficit can be determined by deducting  estimated expenses from forecasting revenues (Nørreklit, 2010.)
  • Reviewing and revising the budget prepared for future actions.
  • Comparing actual outcome with the budget
  • At last, conducting a variance analysis

In relation to the given business scenario, budget is prepared by the managers of Jeffrey & Son's through forecasting expected incomes and expenses for near future. With the help of budgets, managers of different departments pay attention towards sales volume and prepare the plan for enhancing sales as well as reducing cost of business to earn good profits. Nonetheless, major task is of making an effective coordination between activities in budgeting process (Zikmund, 2012). The in depth investigation made into budgets prepared for Jeffrey & Son's noticed that the company has chosen incremental budgeting technique to prepare budgets. While making use of incremental budgeting system, the mentioned entity is anticipating future incomes and expenditures. However, it also compares actual results with budgeted figures for determining variance and takes corrective action to overcome negative variance, if any.

Use of appropriate budgeting technique

The evidence of information provided in respect with Jeffrey & Son's manufacturing company and application of management accounting concept has shown that the mentioned company is going to prepare budgets using incremental budgeting system. Nonetheless, there have been countered some problems for using incremental budgeting system. As per a major problem, the management of company is witnessed with neglecting volatility in the market and its impacts on budgets at the time of budgetary process (Vance, 2002). The budgeted figure prepared on the basis of incremental budgeting tactic does not include market volatility. As a result of using such system of budgeting, company can see huge impacts on budgeted and actual figures (Standard Costs and Variance Analysis. 2007). There can be seen huge difference between budgeted and actual figures of mentioned company. The market volatility is neglected hence, the company fails to meet the budget figures and there can be seen negative variance. For getting the best results, the company is in specific needs of having change in the existing budgeting method. The organization and its current scenario indicate to make use of “Zero base budgeting”. Looking towards the budgeting needs of company, “Zero base budgeting” is recommended to be used for preparing budgets.

The use of new budgeting methods will allow management of Jeffrey & Son's manufacturing company to overcome the limitations of incremental budgeting. After using such method, the company can consider the volatility of market into budgeting process. This method will also helpful in having a positive variance between budgeted and actual figures.  This is to be bring into consideration that “Zero base budgeting” allows management positively estimate operational cost and anticipate revenues while considering the market behaviour (Bhimani, and Bromwich, 2009). With the help of Zero base budgeting process, the company can come closer to budgeted figures and can have a positive variance in budgets. In addition to that market changes can be analysed and prepared on the basis of market volatility and its impact.

Responsibility centers

By undertaking the reconciliation operating statement of enterprise, following departments of firm are required to alter their operating strategies so as to overcome variance and they are as follows:

Production department: With the motive to reduce excess material consumption production department of firm must employ advanced tools. Further, main focus must be on reducing wastage by utilizing resources in effective manner (Tsay, 2008).

Human resource department: Labour variance of entity is favourable and this is leading to rise in profitability level. Further, it is suggested to firm to indulge into forecasting as variance is taking place due to decline in labour charges


The report above discussed about different types of cost classification and calculation of the unit costing and total job cost by using Job Costing method. In a nutshell, Jeffrey & Son's manufacturing company is advised to make use of “Zero base budgeting” so as to gain positive outcomes and remove uncertainties from budgeted figures. On the basis of this report, it can be said that to improve the position the company is required to reduce consumption of material.


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