Management Accounting & Cost Concepts
Financial Performance & Management Control - TUHH Institute of Management Accounting & Simulation, Hamburg · part of my Technology Management MBA · study notes for revision.
Everything up to now (Part A) looked outwards: balance sheets, IFRS rules, statement analysis - the numbers a company must publish for shareholders, banks and the tax office. This chapter opens Part B - management accounting and control, and the camera turns inwards. The question is no longer “what must we report?” but “which numbers help us run the business better?”.
Part B has five stops. This chapter covers the first two: the fundamentals (what management accounting is, why measuring pays, what controllers actually do) and the cost vocabulary (cost objects, direct and indirect, variable and fixed, why unit costs mislead). The chapters after this one build on these words - cost-volume-profit analysis, costing and pricing, and finally performance measurement systems with the Balanced Scorecard. The course reading for both blocks is Horngren’s managerial chapters 1 and 5.
Nothing here is mathematically hard. The difficulty is conceptual: the same euro can be direct or indirect, fixed or variable, depending on what you are looking at and why. Get the vocabulary precise now and the later chapters become almost mechanical.
1 · The map of Part B
Section titled “1 · The map of Part B”2 · What management accounting is - and how it differs from its siblings
Section titled “2 · What management accounting is - and how it differs from its siblings”Put simply: management accounting is the process of measuring and supplying operational and financial information so that it does three things at once - it guides what managers do, it motivates the behaviour the organisation wants, and it supports the culture and values needed to reach the strategy. Notice that only the first job is about numbers; the other two are about people. That double nature (information and behaviour) returns in section 11.
The three accounting “siblings” overlap but have different customers:
| Financial accounting | Management accounting | Cost accounting | |
|---|---|---|---|
| Who it serves | Outsiders: shareholders, creditors, tax | Managers inside the firm | Both, as the engine underneath |
| What it measures | Financial results, under binding standards (IFRS, HGB) | Financial and other information, whatever helps reach the organisation’s goals | Mainly financial information on the acquisition and consumption of resources |
| Freedom of design | Almost none | Designed for the decision at hand | Turns basic bookkeeping data into decision-facilitating information |
The link to remember: cost accounting takes the raw data of financial accounting (the same invoices, wages and depreciation) and reshapes it so that a manager can decide something with it.
3 · Does measuring actually pay?
Section titled “3 · Does measuring actually pay?”A mid-1990s study of North American companies split firms into those that manage by measurement and those that do not, then compared outcomes. The gap is not subtle:
| Outcome | Measurement-managed firms | Non-measurement-managed firms |
|---|---|---|
| Seen as the market leader in their industry over the past three years | 97% | 54% |
| Among the top third financially in their industry | 83% | 52% |
| Last major cultural or organisational change judged successful | 74% | 44% |
Correlation is not proof of causation (successful firms may simply afford better measurement), but the pattern is strong enough that the course treats it as evidence: organisations that measure systematically perform better and change more successfully. This is the empirical justification for the whole of Part B.
4 · The three purposes of cost accounting
Section titled “4 · The three purposes of cost accounting”Why run a cost accounting system at all? The German textbook classification gives three purposes, one facing outwards and two facing inwards:
A 2009 survey of German companies confirms that practice really does use cost accounting for exactly these purposes - the textbook list is not just theory. The course’s shorthand for the three is documentation, planning and control.
5 · Who does this work? The controller’s many faces
Section titled “5 · Who does this work? The controller’s many faces”Management accountants (in German firms, controllers) carry a reputation problem: the default mental image is the bean counter. The course lists eight stereotypes, arranged from unflattering to flattering:
- Bean counter / number cruncher negative - buried in figures, no feel for the business
- Brakeman / constrainer negative - the person who says no to every idea
- Inspector negative - checks up on people, hunts for mistakes
- Sniffer dog / detective mixed - digs out what is really going on
- Court jester mixed - allowed to tell uncomfortable truths to the top
- Internal consultant positive - advises line managers on their problems
- Economic conscience positive - reminds everyone what things cost
- Pilot / navigator positive - helps steer the company towards its goals
How do managers actually see them? A 2012 survey of managers (multiple answers allowed) gives a much friendlier picture than the stereotype:
| Role as seen by managers | Share of answers | Role as seen by managers | Share of answers |
|---|---|---|---|
| Navigator | 67% | Internal consultant | 12% |
| Sniffer dog | 59% | Economic conscience | 8% |
| Communicator | 52% | Inspector | 6% |
| Bean counter | 26% | Innovator | 4% |
| Change agent | 22% | Architect | 2% |
| Brakeman | 18% | Court jester | 2% |
Two out of three managers call their controller a navigator; only one in four still thinks “bean counter”. The unpopular images (inspector, brakeman) sit near the bottom.
Behind the images sit four concrete roles every management accountant plays:
| Role | What it involves |
|---|---|
| Financial reporting | Collecting and supplying the data for external reports to shareholders, creditors and others |
| Stewardship | Designing and running the internal control system that protects the company’s assets; designing and administering the budgeting system |
| Performance evaluation | Internal reporting on how well managers and units are performing |
| Business advisor | Helping managers run their businesses by providing strategic management accounting data on products, processes and technology |
The first two are the “keeper of the books and the assets” roles; the last two are where the navigator image comes from.
6 · Cost, cost objects, and how costs reach them
Section titled “6 · Cost, cost objects, and how costs reach them”Now the vocabulary. A cost is the value of resources sacrificed or given up to achieve a specific objective - money, materials, hours, machine time. The “specific objective” is the crucial phrase: costs are always of something. That something is the cost object: anything for which you want a separate cost measurement.
| Type of cost object | Example from the course |
|---|---|
| A product | One Porsche 911 |
| A service | One airline flight from Cologne/Bonn to Paris |
| A project | Rolling out the SAP accounting software |
| A customer | Everything a logistics group delivers for Amazon |
| An activity | Repairing a defective PC delivered by a manufacturer |
| A department | The management accounting department itself |
Costing happens in two moves. First all costs are accumulated in the bookkeeping (the plain total spent). Then they are assigned to the cost objects we care about:
Assignment itself comes in two flavours, and this is the first big classification:
- Related to the particular cost object and can be traced to it in an economically feasible, cost-effective way
- You can point at the invoice and say: this went into that
- e.g. the steel in a car, the eight participants paid for one focus group
- Related to the cost object only indirectly, or tracing would cost more than it is worth
- Shared across several objects, so they are allocated with some key (hours, floor space, headcount)
- e.g. the plant manager’s salary, the head-office lease
7 · A full product cost, line by line
Section titled “7 · A full product cost, line by line”The course example prices one product for a firm making 200,000 units. Two layers stack on top of each other: the costs of making the thing (cost of goods sold) and the costs of everything around it along the value chain (operating costs).
| Cost line | Per unit | Total for 200,000 units |
|---|---|---|
| Direct materials | 385 | 77,000,000 |
| Direct manufacturing labour | 53 | 10,600,000 |
| Direct machining | 57 | 11,400,000 |
| Manufacturing overhead | 45 | 9,000,000 |
| = Cost of goods sold | 540 | 108,000,000 |
| Research and development | 20 | 4,000,000 |
| Design of products and processes | 30 | 6,000,000 |
| Marketing | 90 | 18,000,000 |
| Distribution | 25 | 5,000,000 |
| Customer service | 15 | 3,000,000 |
| = Operating costs | 180 | 36,000,000 |
| Full product cost | 720 | 144,000,000 |
In one line: 385 + 53 + 57 + 45 = 540 for cost of goods sold, 20 + 30 + 90 + 25 + 15 = 180 for operating costs, and 540 + 180 = 720 per unit, which is 108m + 36m = 144m for the 200,000 units.
Three of the four manufacturing lines are direct (materials, labour, machining); the fourth, manufacturing overhead, is the allocated remainder. Keep this table in mind for section 10 - different decisions use different slices of it.
8 · Variable and fixed - how costs behave
Section titled “8 · Variable and fixed - how costs behave”The second big classification is not about where a cost goes but how it moves. The reference point is the cost driver: the activity whose level causes the cost, typically the number of units produced.
- Variable costs change in total in proportion to the cost driver. Double the output and total material cost doubles. Plotted against the driver, they are a straight line through the origin.
- Fixed costs do not change in total when the driver moves (within the range we are looking at). Rent, the plant manager’s salary, a fixed licence fee. Plotted, they are a flat line.
Concept in action: turning a fixed cost into a variable one
Section titled “Concept in action: turning a fixed cost into a variable one”A car-sharing service such as Zipcar lets individuals and businesses rent a car by the week, day or even hour: reserve online, walk to the car park, unlock the car with a card or an app, drive away. For a company, this converts the fixed cost of owning a car into a variable cost: you pay per hour of actual use, and if business slows or the cars are no longer needed you are simply not saddled with the fixed cost any more. Business customers already brought in 15% of the firm’s revenue, expected to double.
The two classifications combined
Section titled “The two classifications combined”Direct/indirect and variable/fixed are independent axes, so every cost lands in one of four cells. The course example uses a car assembly plant with the cost object “one car model”:
- Tyres used in assembling the car
- Each set clearly belongs to one car, and every extra car needs another set
- Salary of the supervisor on this model’s assembly line
- Belongs to this product alone, but does not rise when volume rises
- Power costs when electricity is metered only for the plant as a whole
- More cars burn more power, but nobody can say which kilowatt-hour went to which model
- Salary of the plant manager
- Serves every product in the plant, unchanged whether output goes up or down
9 · The unit-cost trap
Section titled “9 · The unit-cost trap”Unit costs (total cost divided by units) are everywhere in practice, and they are dangerous the moment they contain fixed costs. The course example: the president of a university jazz society is hiring a band for a party and gets three fee schedules - (1) a flat 1,000, (2) 500 flat plus 1 per person, (3) 2 per person. Nobody knows yet how many people will come.
| Attendees | Schedule 1 total | per head | Schedule 2 total | per head | Schedule 3 total | per head |
|---|---|---|---|---|---|---|
| 50 | 1,000 | 20.0 | 550 | 11.0 | 100 | 2.0 |
| 100 | 1,000 | 10.0 | 600 | 6.0 | 200 | 2.0 |
| 250 | 1,000 | 4.0 | 750 | 3.0 | 500 | 2.0 |
| 500 | 1,000 | 2.0 | 1,000 | 2.0 | 1,000 | 2.0 |
| 1,000 | 1,000 | 1.0 | 1,500 | 1.5 | 2,000 | 2.0 |
Read the columns. Under the pure fixed fee the cost per head falls from 20 to 1 as the room fills; under the mixed schedule it falls from 11 to 1.5; under the pure per-person fee it stays at 2 whatever happens. At exactly 500 guests all three cost the same. Which schedule is best therefore depends entirely on the expected turnout - the unit cost at one attendance level tells you nothing about another level.
That gives the rule that must be memorised in both directions:
| When the item is a variable cost | When the item is a fixed cost | |
|---|---|---|
| Total cost | changes with the level of the cost driver | stays the same |
| Unit cost | stays the same | changes - falls as volume rises, climbs as it falls |
10 · Different costs for different purposes
Section titled “10 · Different costs for different purposes”Go back to the full product cost of 720 in section 7. Which of those lines “count” as the product’s cost? The honest answer: it depends what the number is for. Lay the six value-chain stages out in a row:
- Product costs for financial statements - only the production stage. Inventories and cost of goods sold are valued at manufacturing cost; R&D, marketing and the rest are expensed as period costs. (This is the documentation purpose from section 4.)
- Product costs for reimbursement under government contracts - a wider slice, because contract rules typically allow design and other upstream costs to be recovered, not just factory costs.
- Product costs for pricing and product-emphasis decisions - the full value chain. If the price does not cover marketing, distribution and service too, the product loses money no matter how lean the factory is.
Same product, three different “costs”, all correct for their purpose. This is the “cost for which decision?” half of the chapter’s one idea.
11 · Two orientations: helping decisions vs steering behaviour
Section titled “11 · Two orientations: helping decisions vs steering behaviour”The final concept explains why cost systems are designed the way they are. Management accounting information does two very different jobs, and the design criteria pull in opposite directions:
- Cost accounting used to support a decision: which programme, which price, make or buy
- Design criterion 1: relevance and adequacy for the problem - which tends to make the system complex
- Design criterion 2: independent of the decision maker - the number should not change with who is asking
- Cost accounting used to influence managers who have cognitive limits and their own preferences (opportunism, motivation)
- Design criterion 1: understandable and adequate for the decision maker - simple enough to act on
- Design criterion 2: resistant to manipulation - people will game whatever they are measured on
The tension is real: the most decision-relevant system (many drivers, many allocations) is often the least understandable and the easiest to game, while a simple robust system may be too crude for a tricky decision. This is exactly why performance measurement and the Balanced Scorecard get their own chapter later.
Worked example
Section titled “Worked example”Three exercises from the course, with the model answers.
(a) Cost classification - a focus-group research firm
Section titled “(a) Cost classification - a focus-group research firm”A marketing research firm runs focus groups for consumer-product companies. Each group has eight participants who are paid a total of 9,000 per session; sessions take place in hotels, are led by an independent specialist (fixed retainer plus 3,600 per session) and are attended by one staff member. Classify each item as direct or indirect with respect to one focus group, and variable or fixed with respect to the number of groups run.
| Item | D / I | V / F | Why |
|---|---|---|---|
| A. Payments to the participants of a group | Direct | Variable | Paid per session, clearly for this one group; more groups, more payments |
| B. Annual subscription to a consumer magazine | Indirect | Fixed | One yearly bill that serves the whole firm; unchanged however many groups run |
| C. Phone calls confirming attendance (no call records kept) | Indirect | Variable (or fixed - discuss) | The calls are for a group, but without records they cannot be traced economically; total phone cost rises with more groups, though under a flat tariff it would behave as fixed |
| D. Hotel meals for participants | Direct | Variable | Ordered for this group’s people; every extra group adds meals |
| E. Lease of the corporate office | Indirect | Fixed | The roof over everything; rent does not move with the number of sessions |
| F. Recording tapes, sent to the client | Direct | Variable | Used in and identifiable with one session; each session consumes more |
| G. Petrol for company cars (monthly bills, no mileage breakdown) | Indirect | Variable | Fuel use grows with the sessions staff drive to, but no log links litres to a group |
The lesson from C and G: a cost can be physically caused by a cost object and still be indirect, purely because nobody keeps the records that would make tracing economically feasible.
(b) Average cost per unit - a plastics producer
Section titled “(b) Average cost per unit - a plastics producer”Fixed costs 645,000 per year, variable cost 7 per unit, output somewhere between 100,000 and 200,000 units. Average cost per unit at three volumes:
| Units | Fixed | Variable (7 × units) | Total | Average per unit |
|---|---|---|---|---|
| 100,000 | 645,000 | 700,000 | 1,345,000 | 13.45 |
| 150,000 | 645,000 | 1,050,000 | 1,695,000 | 11.30 |
| 200,000 | 645,000 | 1,400,000 | 2,045,000 | 10.23 |
The variable part stays at 7 per unit throughout; the whole drop from 13.45 to 10.23 comes from spreading the same 645,000 over more units (6.45, then 4.30, then 3.23 per unit). Quote a single “unit cost” for this firm and you have hidden the volume assumption.
(c) Step fixed costs - a beach-sand mining company
Section titled “(c) Step fixed costs - a beach-sand mining company”A company extracts minerals from beach sand. Its costs: a subcontractor charging 80 per tonne mined and returned, a government mining and environmental tax of 50 per tonne, and a barge operator charging 150,000 per month for each block of 100 tonnes per day of capacity (0 to 100 tonnes per day costs 150,000, 101 to 200 costs 300,000, and so on), payable in full even if less is shipped. Barges run 25 days a month. Current output: 180 tonnes per day.
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Variable cost per tonne. Subcontractor 80 + tax 50 = 130 per tonne. Both bills move one-for-one with tonnage.
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Fixed cost per month at 180 tonnes per day. 180 sits in the 101 to 200 block, so two barge blocks are needed: 300,000 per month. This is a step fixed cost - flat within each 100-tonne band, jumping at the boundary.
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Unit cost at 180 tonnes per day. Monthly tonnage 180 × 25 = 4,500 tonnes. Fixed cost per tonne 300,000 / 4,500 = 66.67. Total unit cost 66.67 + 130 = 196.67 per tonne.
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Unit cost at 220 tonnes per day. Monthly tonnage 220 × 25 = 5,500 tonnes. But 220 crosses into the 201 to 300 block, so the barge bill jumps to 450,000. Fixed cost per tonne 450,000 / 5,500 = 81.82. Total unit cost 81.82 + 130 = 211.82 per tonne.
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Why the unit cost rises with volume. Normally more output spreads fixed costs thinner. Here the second 150,000 block was spread over 80 extra tonnes per day (from 100 to 180), but the third 150,000 block is spread over only 20 extra tonnes per day (from 200 to 220). A whole new step of fixed cost, barely used, pushes the average up. The company would need to fill the third barge much further before the unit cost fell again.
Case corner
Section titled “Case corner”The Electronics Board mini-case - why a growing company needs cost accounting
Section titled “The Electronics Board mini-case - why a growing company needs cost accounting”The mini-case asks two things: summarise the company’s situation, and list as many reasons as possible why introducing a cost accounting system would help. The situation, in short, is a growing electronics business that has so far run on bookkeeping and gut feel, and is now making decisions (pricing, product mix, sourcing) without knowing what anything actually costs. The reasons map neatly onto the three purposes from section 4:
- Knowing what each product really costs - direct costs traced, indirect costs allocated with a sensible key - instead of a single blended figure. Without this, every other answer is guesswork.
- Pricing floors - the lowest price the sales team may accept without losing money on each order (the planning purpose, sales side).
- Make-or-buy decisions - comparing the internal cost of a component or board with a supplier’s quote (the planning purpose, procurement side).
- Deciding the production programme - which boards to push and which to drop when capacity is tight.
- Spotting loss-makers - products or customers that look busy but destroy margin; growth hides them until someone measures.
- Monitoring - period profit by product line, and whether costs are under control as volumes rise (the control purpose).
- Valuing inventories and cost of sales correctly for the external accounts (the documentation purpose), which becomes more demanding as the product range grows.
- Steering behaviour - giving managers understandable, hard-to-game targets (the decision-influencing orientation from section 11).
Car sharing as “concept in action”
Section titled “Car sharing as “concept in action””Zipcar’s business customers are a live example of section 8. Owning a fleet is a fixed cost: it is paid whether the cars move or not. Renting by the hour makes the cost variable with actual use, which is a gift in a downturn - the cars simply go back. The price of that flexibility is a higher cost per hour of use, so a company with steady, heavy usage may pay more in total. The management lesson is to choose a cost structure for its risk profile, not only for its average cost.
Key terms
Section titled “Key terms”| Term | What it means in plain words |
|---|---|
| Management accounting | Measuring and supplying operational and financial information that guides action, motivates behaviour and supports the strategy |
| Financial accounting | External reporting to shareholders, creditors and the state, governed by binding standards |
| Cost accounting | Measuring how resources are acquired and consumed; turns bookkeeping data into decision-facilitating information |
| Cost | Resources sacrificed or forgone to achieve a specific objective |
| Cost object | Anything you want a separate cost figure for: a product, service, project, customer, activity or department |
| Cost accumulation | Collecting costs in the books before assigning them |
| Cost assignment | Splitting the accumulated pool across cost objects, by tracing or by allocation |
| Direct cost | Related to the cost object and traceable to it in an economically feasible way |
| Indirect cost | Related only indirectly, or not worth tracing; assigned by allocation with a key |
| Cost driver | The activity whose level causes a cost, e.g. units produced |
| Variable cost | Changes in total in proportion to the cost driver; constant per unit |
| Fixed cost | Unchanged in total when the driver moves; per unit it falls as volume rises |
| Step fixed cost | Flat within a capacity band, then jumps to a new level (the barge example) |
| Decision-facilitating vs decision-influencing | Information designed to support a decision (relevant, complex, neutral) vs information designed to steer behaviour (understandable, manipulation-resistant) |
Test yourself
Section titled “Test yourself”- Define management accounting in one sentence and explain how cost accounting relates to financial accounting.
- A bakery makes several breads. With the cost object “the rye bread line”, classify each as direct/indirect and variable/fixed: rye flour; the salary of the supervisor who runs only the rye line; the bakery manager’s salary; gas for the ovens, metered for the whole bakery only.
- The jazz society expects 200 guests. Compute total and per-head cost under all three band schedules (1,000 flat; 500 plus 1 per head; 2 per head) and state which is cheapest.
- Name the three purposes of cost accounting and give one concrete decision for each.
- Why does the mining company’s unit cost rise from 196.67 to 211.82 when daily output goes up from 180 to 220 tonnes?
- What are the two orientations of management accounting information, and which two design criteria belong to each?
Revision summary
Section titled “Revision summary”Next: Cost-Volume-Profit & Break-Even → - how many do we have to sell before we make money?