Financial accounting looks backwards and outwards. It reports what happened to people outside the business, in a format the law and the standards prescribe, once a year. Management accounting looks forwards and inwards. It gives managers the numbers they need to price a job, decide whether to make or buy, set a budget, and see whether last month went to plan. There is no prescribed format, no statutory deadline and no audit. The only test is usefulness.
Because it is internal, management accounting can be as detailed and as frequent as managers want. Most businesses report monthly. The cost of producing the information has to be worth the better decisions it enables, which is itself a management accounting judgement.
| Classification | Categories | Used for |
|---|---|---|
| By element | Materials, labour, expenses | Building a cost card |
| By function | Production, administration, selling and distribution, finance | Reporting by area of responsibility |
| By behaviour | Fixed, variable, semi variable, stepped | Forecasting, flexing budgets, break even |
| By traceability | Direct or indirect | Deciding what is prime cost and what is overhead |
Behaviour is the classification that earns marks
A fixed cost stays the same in total as output changes, so the cost per unit falls as volume rises. A variable cost stays the same per unit and rises in total. A semi variable cost has both parts, like a phone contract with a standing charge and a per minute rate. A stepped cost is fixed within a range and then jumps, like a supervisor for every twenty staff.
The high low method separates a semi variable cost. Take the highest and lowest activity levels, divide the difference in cost by the difference in units to get the variable cost per unit, then substitute back to find the fixed element. Watch for a stated step change in fixed costs between the two levels, because you have to strip that out before dividing.
Prime cost and total production cost
Prime cost is direct materials plus direct labour plus direct expenses. Add production overhead and you get total production cost. Add non production overheads, administration and selling, and you get total cost. Knowing which layer a figure sits in is what lets you answer a question such as which costs are absorbed into inventory, because only production costs are.
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