the importance and impacts ofcosting method on the process of managerial decision making

i

THE IMPORTANCE AND IMPACTS OFCOSTING
METHOD ON THE PROCESS OF MANAGERIAL
DECISION MAKING








BY
PHAM THI HOAI THANH
E0700060









BARCHELOR OF BUSINESS (ACCOUNTING) HONS
HELP UNIVERITY COLLEGE

MARCH, 2011
i

DECLARATION OF ORGINALITY AND
WORD COUNT

I hereby declare that the graduation project is based on my original work except
quotations and citations, which has been duly acknowledged. I also declare that it has
not been previously or concurrently submitted for any other course/degree at Help
University or other institutions. The word count is 11363 words.














PHAM THI HOAI THANH
March 28, 2011

ii

ACKNOWLEDGEMENT

First of all, I would like to express my sincere appreciation to my supervisor, Dr. Dao
Thi Thu Giang who has guided me throughout this thesis. Her constant guidance,

insightful suggestions, and constructive ideas are the essential inputs and encouragement
for me in order to complete this thesis.
Next, I would like to acknowledge to manager and all of employees in Ha Tinh Medical
Material Company who allowed and assisted me to collect all of necessary information
for me to get this thesis done. Without their contribution, I could not be able to gather
much information for my research.
Lastly, I would also like to extend my heartfelt gratitude to my friends for their
continuous support, encouragement and contribution, which have been crucial during the
presentation of this report.
My thesis cannot be finished without your supports.







iii

TABLE OF CONTENT


DECLARATION OF ORGINALITY AND WORD COUNT Error! Bookmark not
defined.
ACKNOWLEDGEMENT Error! Bookmark not defined.
TABLE OF CONTENT iii
ABSTRACT vi
LIST OF FIGURES vii
LIST OF TABLES viii
CHAPTER 1: INTRODUCTION 1

1.1 Introduction of topic 1
1.2 Problem statement 3
1.3 Issues expansion 4
1.4 Structure of the research 5
CHAPTER 2: LITERATURE REVIEW 6
2.1 Managerial decision-making process 6
2.1.2 Decision making process 9
2.1.3 Accounting information and its role in decision-making process 10
2.1.4 Managers and management accounting 12
2.2 The importance and impacts of costs accounting methods on decision-making
process of the managers using SWOT model analysis. 13
2.2.1 Costing methods
● Absorption costing 13
Figure 1: Absorption costing method 14
● Variable costing method 15
Figure 2: Variable costing method 16
iv

● Activity based costing system (ABC) 17
2.2.2 The importance and impacts of accounting methods on managerial decision
making process. 21
CHAPTER 3: RESEARCH AND METHODLOGY 26
3.1 Aims of the project 26
3.2 Research methodology 27
3.3 Data sources 28
3.4 Limitation 28
CHAPTER 4: CASE STUDY ANALYSIS 30
4.1 Introduction 30
4.1.1 Process of formation and development of the company 31
4.1.2 Facilities of the company 32

4.1.3 Company’s mission statement 33
4.1.4 Potention on production of the company 33
4.1.5 Potention on marketing of the company 34
4.1.6 Structure of Ha Tinh Medical Materials’ management structure 35
Figure 3: Structure of management team 36
4.1.7 Accounting policy adopted 37
4.2 Difference when using different cost accounting methods 37
4.2.1 Incurred expenses during the period of 2008 – 2009 37
Table 1: Total revenue for Vitamin A of Ha Tinh Medical Materials 38
Table 2: Direct material cost of Ha Tinh Medical Materials 39
Table 3: Direct labor cost of Ha Tinh Medical Material 40
Table 4: Manufacturing overhead cost of Ha Tinh Medical Materials 41
4.2.2 Cost of goods manufactured under absorption costing method and variable
costing method 42
Table 5: Cost of Vitamin A using absorption cost and variable cost method 42
v

4.2.3 A profit comparison using absorption costing and variable costing method to
calculate 43
Table 6: Cost of good sold for Vitamin A 43
Table 7: Gross profit for Vitamin A 44
Table 8: Variable cost of goods sold for Vitamin A 44
Table 9: Contribution margin for Vitamin A 45
Table 10: Difference between variable costing and absorption costing 45
CHAPTER 5: CONCLUSION AND RECOMMENDATION 47
5.1 Conclusion 47
5.2 Recommendation for calculating product cost of Ha Tinh 48
Medical Materials. 48
REFERENCE………………………………………………………………………… 51

vi

THE IMPORTANCE AND IMPACTS OFCOSTING METHOD ON
THE PROCESS OF MANAGERIAL DECISION MAKING


BY
PHAM THI HOAI THANH

MARCH, 2011


Supervisor: Dr. DAO THI THU GIANG


ABSTRACT

The purpose of this paper is to analysis the importance and impacts of cost accounting

method on decision-making process of managers. Cost accounting method can be
considered as the most concerning problem with an organization, according to different
costing methods will lead to different profit to a company, therefore choosing a suitable
costing method is very important for managers. There are three cost accounting
methods, namely absorption costing method, variable costing method, activity-based
costing method are analysis in this thesis. And SWOT model will be used to explore the
advantages and disadvantage of each method. After that, I make some recommendation
for calculating product cost of Ha Tinh Medical Materials Company.
vii

LIST OF FIGURES


Figure 1: Absorption costing method
Figure 2: Variable costing method
Figure 3: Structure of management team

viii

LIST OF TABLES


Table 1: Total revenue for Vitamin A of Ha Tinh Medical Materials Company.
Table 2: Direct material cost of Ha Tinh Medical Materials Company.
Table 3: Direct labor cost of Ha Tinh Medical Materials Company.
Table 4: Manufacturing overhead cost of Ha Tinh Medical Materials Company.
Table 5: Cost of Vitamin A using absorption cost and variable cost method
Table 6: Cost of good sold for Vitamin A
Table 7: Gross profit for Vitamin A
Table 8: Variable cost of goods sold for Vitamin A
Table 9: Contribution margin for Vitamin A
Table 10: Difference between variable costing and absorption costing
1

CHAPTER 1: INTRODUCTION

In this chapter, the whole picture about the ideas of this thesis will be depicted, and these
help users easy to follow and link them to each other to figure out the potential
relationship between cost accounting methods and managerial decision making process.
This chapter will cover the structure of this thesis, an introduction about the topic as well
as related issues.

1.1 Introduction of topic

Historical documentation about the origins of cost accounting is limited due to a fire at
the headquarters of the National Association of Accountants (NAA) in 1984. Many
irreplaceable documents were destroyed in that fire (Cheryl Cunagin and JohnL. Stancil,
1992). Therefore, no one can ensure and know about the accurate time that the cost
accounting methods were born. The role of accounting in the ancient world is coming
into clearer focus with new archaeological discoveries and innovative interpretation of
the artifacts.
Cost accounting is the process of accounting for cost, which begins with regarding and
classifying costs and ends with the preparing periodical statements and reports for
ascertaining and controlling costs. Today, cost accounting may be defined as the process
of measuring, analyzing, computing, and reporting the cost. There are different cost
2

accounting methods that managers can choose and help them to make better decision in
the future. These methods are absorption costing, variable costing, activity-based
costing, throughput costing, etc. Absorption costing is known as a traditional cost
accounting, this method makes no distinction between fixed and variable costs; in this
method, all manufacturing costs, both variable and fixed are treated as product costs
with non-manufacturing costs, for example, selling and administrative expenses, being
treated as period costs. Therefore, it is not well suited for cost volume profit
computation, which is important for good planning and controlling. So absorption
costing method might be the best costing method for the small company. However, there
are some managers and accountant think that using another method might better than
using absorption costing. One of these reasons might because the activity-based costing
is a modern accounting system, which segregates expenses based on specific activities
and then allocated the cost among individual items based on volume of activity, so this
method can reduce and allocate costs more efficiently. Different managers will not make
the same decision with the same information and report so making decisions will depend
on each manager’s philosophy. In fact, decision-making process is influenced by many
factors but in this thesis, we will put only intention on the importance and impact of cost

accounting methods.

3

1.2 Problem statement
As mentioned above, main ideas of this thesis are related to cost accounting methods,
their advantages and disadvantage, as well as their impact on the decision on making
process of managers.
In management accounting, cost accounting is that part of management accounting
which establishes standard and actual cost of operations, processes, departments or
product and the analysis of variances, profitability or social use of funds. Managers use
cost accounting information to make their decision making to reduce a company’s costs
and improve its profitability. As a form of management accounting, cost accounting
need not follow requirement of GAAP, because its primary users are internal managers,
rather than external users, and what to compute is instead decided pragmatically.
Cost accounting includes many methods but in this thesis, there are three cost
accounting methods that the author wants to focus: absorption costing method, variable
costing method, and activity-based costing method. The absorption costing method
seemed as the earliest of cost accounting. After that, variable costing method was
invented. Using traditional cost accounting methods is difficult for companies with
complex processes and manufacturing practices; therefore later activity-based costing
method was created out of the need to overcome these difficulties by dividing
production into its core activities. Depending on each case that manager will choose best
cost accounting method for their company, however nothing can be perfect, and each
method contain both advantages and disadvantages.
4

SWOT analysis is a strategic method for identifying business’s strengths and
weaknesses, and to examine the opportunities and threats in the wider environment of a
project or a business venture (market, industry, global situation). Using SWOT model,

all of the advantages and disadvantages of each cost accounting method will be judged
fairly. This method often uses in management aspect, the managers applied SWOT
model to evaluate the effectiveness and efficiency of the companies, cost budget, and
operation process. Analyzing cost accounting methods follow SWOT model, managers
will be easier to see the importance and impact of them on the decisions making process.

1.3 Issues expansion
After joining the World Trade Organization (WTO) in 2007 Vietnam has increasingly
opened the economy and trade. Vietnam pharmaceutical industry faces many challenges
so pharmaceutical companies will be innovated management strategy and reduce costs to
ensure competitiveness and survival. In this context, companies have actively deploying
innovative management method and running production, with particular emphasis on the
management for production costs. Therefore, in chapter 4 of this thesis, a real case of Ha
Tinh Medical Materials Company – one medicine manufacture will be use for analysis.
From this chapter, it is easy to understand about importance and impact of cost
accounting method on decision-making process of managers.
The chapter 4 will introduce about Ha Tinh Medical Materials Company, and then from
the collected cost information of this company, absorption costing method and variable
costing method will be applied.
5

1.4 Structure of the research
In this thesis, there are five chapters as follow:
 Chapter 1: Introduction
 Chapter 2: Literature review
 Chapter 3: Research and methodology
 Chapter 4: Case study analysis
 Chapter 5: Conclusion
In this thesis, five chapters will be linked each other in order to express the ideas that the
author would like to share. Chapter 1 and chapter 3 will consider as a background to

crease the general ideas of this thesis. Chapter 2 will focus on the theory of cost
accounting method and chapter 4 is a real case, playing a supplementary role for chapter
2. And last but not least, chapter 5 will conclude the findings after analyzing a real case
compared to the theory, and some recommendations for the company.







6


CHAPTER 2: LITERATURE REVIEW

Chapter 2 will provide information about managerial decision-making process, and
introduce about the history, calculation and contents of absorption costing, variable
costing, and activity-based costing method. Understanding managerial decision-making
process and cost accounting methods can help the managers know what kind of
information and how much of information they need to make efficient decisions. After
that, SWOT model will be applied to evaluate advantages and disadvantages of each
cost accounting method.

2.1 Managerial decision-making process
People make many decisions every day. Decisions can be made in different ways
depending on different purposes of various groups of people. Therefore, decision-
making is a reasoning or emotional process which can be rational or irrational, can be
based on explicit assumptions or tacit assumptions. However, managerial decision
making process can be only understood through four parts. They are:

 Decision in nature.
 Step in decision-making.
 Role of accounting information in decision-making.
7

 Managers and management accounting.
2.1.1 Decision in nature
A decision is an act requiring judgment that is translated into action. Decision-making is
the process by which people respond to opportunities and threats by analyzing options,
and making decisions about goals and courses of action.
Decision process could be associated from internal and external information and people
need to choose the best alternative for a good result.
Making decision is very important and everyone make many decisions everyday. For
example, we decide what to buy for our family when going to supermarket; we decide
what kinds of sports for good health. In another case we make another difficult decision
to go such as we are surrounded by the fire: to jump through the windows and risk to
killing yourself or to wait the firemen and risk being burned to death if they come too
late? What should we do? This is an important decision for us at the moment. More
important than these cases, we have to decide what kinds of job in the future to earn a lot
of money.
Our business or the affairs in our life is experiencing development and growth, we are
often faced with difficult decisions. We need to choose among many decisions; it is not
possible for us to do everything that we would like to do because time and resources are
always limited. In fact, our actions will have long reaching consequences, and will affect
the lives of others. Sometimes the pressure of having to act forces us to make a decision
that we may regret later. Sometimes this pressure causes us to waver and miss an
opportunity. For example: the representative of the UN and the general who commanded
8

the UN forces had been unable to make up their mind about the need for an air force

support and 7000 people were badly slaughtered.
There may be different styles associated with the way in which people make decisions,
or certainly that we seek different information with which to make us decisions. In
general, we ourselves, parents, children, sisters, friends, and bosses could affect our
decision, besides that following the research of a variety of aspects of decision making,
the decisions depend on sex, politics, consumers, economy, etc. Women tend to take
decisions based on emotive factors, they tend to consider the opinions of others and
weigh them up in relation to their own understanding of a decision and its causes and
effects. However, men tend to learn towards an instant solution and can be wary of
clouding issues by opening them up to too much discussion. Men tend to look at the
rights of the individuals involved and make what they intend to be fair and just
decisions.
In business, decision-making is an important of business success. Decisions are based on
a foundation of knowledge and sound reasoning can lead the company into long term
prosperity, conversely, decisions that are made on the basic of flawed logic,
emotionalism, or incomplete information can quickly put a business out of commission.
Sometimes the managers could not know every thing of various aspects, therefore when
it works, collective intelligence does come up with better solutions than could
individuals.

9

2.1.2 Decision making process.
Decision-making is usually defined as the act of making up your mind about something.
However, the process of decision-making is not as easy as it sounds. There are certain
important decisions that you have to make that have the ability to change the course of
your life. Thus, it is important to take decisions in a systematic way, so that the decision
you make has high chances of being successful (Proctor, R., 2009).
According to Hoggett, Edward, & Merlin, 2006, decision-making consists of four main
steps, such as, establishing goals, gathering available information on alternatives,

determining consequences of alternatives and choosing a course of action.
The first step and arguably the most important step in the decision-making are
establishing goals (or what are we trying to achieve?). It is a primary importance that we
should first determine or specify our task; we must identify each situation in which a
decision is needed and determine the goals we wish to achieve. Depending on then
values, motives, desires, and different situation help us have different decisions.
Once a decision maker has established the goal, it is necessary to gather available
information on alternatives. In this step, we determine what information we need as
information can help change our attitudes, beliefs or expectations. Gathering information
before making a decision helps managers get a better handle on the uncertainties.
We can gather some kind of information that we are prepared to making a choice. There
are: what is relevant and what is not relevant to the decision? What do you need to know
before you can make a decision or that will help you make the right one? Who knows,
who can help, who has the power and influence to make this happen (or to stop it)?
10

After gathering available information to help us determine the alternative available, then
the third step is determining consequences of alternatives. This step is the stage when we
have to assess each alternative we have come up with. We have to find out the
advantages and disadvantages of the information. At this stage, we can also select out
the information’s that is thought unfeasible or not serve our goal.
The final step deals with choosing a course of action. Once we have gone through the
previous 3 steps, after taking the alternatives available and the consequences of those
alternatives into consideration, we must choose a course of action and start to make the
goals that we wish to achieve realistic.

2.1.3 Accounting information and its role in decision-making
process
The need for a decision arises in our life and business because we are faced with a
problem and alternative courses of action are available, and we need more information

when making a decision. Therefore the information plays an important role in deciding
which option to make decision process. In business, accounting information is needed
before a decision is made.
Accounting is concerned mainly with identifying transactions and recording the
financial history of the transactions of an entity; therefore a major focus on accounting
information is on actual financial events, not on future events (Hogget, Edward, &
Merlin, 2006). Although accounting information is not future events, this information is
11

used often as a guide to future estimates of the different alternative consequences. The
managers of the business will want to know what things are being done so they need this
information in order to make plans for the future; they then need more updated
information in order to check whether actual performance is on target.
Accounting information is also very useful in providing decision makers with
information about the outcomes or results of their decision (Hoggett, Edward, & Merlin,
2006). Accounting information could be used by internal and external decision maker,
such as managers, investors, creditors, customers, etc. before it can be regarded as useful
in satisfying the need of various user groups, accounting information should satisfy the
following criteria: understandability, relevance, consistency, comparability, reliability,
objectivity.
Firstly, accounting information is understandability, which means the expression, with
clarity of accounting information in such a way that it will be understandable to users –
who are generally assumed to have a reasonable knowledge of business and economic
activities.
Secondly, it is relevance that means accounting information must help a user to form,
confirm or maybe revise a view in the context of making a decision. For example:
following accounting information of the business, we can understand their financial
condition, and can make decisions like: investing or not, lending money or not?
Next, other criteria of accounting information is reliability which means the accounting
information in reports is truthful, accurate, complete, and capable of being verified. All

12

of accounting information will be updated and filed day by day. It is necessary
information for a potential investor.
Finally, accounting information is prepared and reported in a standard way. In other
words, it is not biased towards a particular user group or vested interest.

2.1.4 Managers and management accounting
In business, managers (as internal decision makers) require special-purpose financial
reports to help in planning and controlling the operations of an entity (Hogget, Edward,
& Merlin, 2006). Following Hoggett, Edward, and Merlin in 2006, the manager need
answers to some questions as:
 How much profit is being earned?
 What product should be produced?
 What resources are available?
 What is the most efficient production process?
 What will be the effect of increasing or decreasing selling price?
 How much is owing to outsiders?
 Will cash be available to pay debts as they fail due?
 What are the comparative effects of owning or leasing facilities?
In order to answer theses and many other questions, managers must base on a lot of
information systems processed by different sciences; one of them is management
account.
13

Management accounting (also referred to as managerial accounting) is a specialized sub-
set of accounting concerned with focusing on internal needs of businesses, they provide
financial and other information to all levels of management (as managers, chief
executive officers, general managers, and account managers) in an organization to assist
them to carry out their planning, controlling, decision making responsibilities.

Management accounting has a function to prepare special purpose reports for internal
users, which are financial budgets, sale forecasts, performance reports, cost of
production reports and incremental analysis reports.
The activities of management accounting are cost behavior and cost volume profit
relationship, decision making through incremental analysis, capital budgeting, budgeting
for financial planning and control, flexible budgeting for performance evaluation, the
determination of manufacturing costs and costing systems, and accounting and reporting
for business segment operations.
2.2 The importance and impacts of costs accounting methods
on decision-making process of the managers using SWOT
model analysis.
2.2.1 Costing methods
● Absorption costing
The history of absorption costing is closely linked with the history of cost accounting.
However we cannot identify the time that absorption cost was invented because
14

historical documentation about the origins of cost accounting, as mentioned above, were
lost in a fire at the headquarters of the National Association of Accountants (NAA) in
1984.
Absorption costing method means that all of the manufacturing overhead costs are
absorbed by the manufactured goods along with direct material and direct labors cost. In
this method, both variable costs and fixed costs are calculated as inventory costs.
Therefore, absorption costing is also referred to as full costing. In other words,
absorption costing is the cost of a finished unit in inventory, which will include direct
materials, direct labor, and both variable and fixed manufacturing overhead in cost of
good manufactured.
Figure 1: Absorption costing method
Direct material
Direct labor

All
Manufacturing
overhead
When
costs
are 
incurred
Work in
process
inventory
on Balance
Sheet
When
goods
are 
finished
Finished
Goods
Inventory
on Balance
sheet
When
goods
are 
sold
Cost Of
Goods
Sold

For example, Company A produces and sales shoes, to make shoes, during 2009, this

company produced 200,000 units and 199,500 units were traded. Manufacturing costs
for 2009 was as follows: the direct material cost was $100 per unit, the direct labor cost
was $100 per unit, variable manufacturing overhead cost was $100 per unit, and fixed
manufacturing overhead cost of $80 per unit. In this example, variable manufacturing
cost per unit produced can calculate by direct material plus direct labor plus variable
manufacturing overhead $300 ($100 + $100 + $100). Therefore, total inventory cost per
unit produced was variable manufacturing overhead cost per unit produced plus fixed
15

manufacturing overhead cost per unit produced $380 ($300 + $80). With 199,500 units
that company A sold in 2009, cost of good sold is: $380 per unit x 199,500 units =
$75,810,000.
From this example, we can understand that the amount of cost when using the absorption
costing method would be treated as cost of good sold on the Income Statement.
In this case, company A produces 200,000 units in 2009, at the end of year this company
still remain 500 shoes, and $190,000 (500 units x $380 per unit) will remains an asset –
part of ending finished goods inventory on 2009. In absorption costing method, the
higher ending inventory will lead to lower expenses and higher net operating income. In
the next period, if these inventories are sold, fixed manufacturing overhead costs will be
included in the cost of good sold.
As a consequence, using absorption costing method, the amount of cost would be treated
as cost of good sold on the Income Statement, ending inventories will be carried forward
to the next period on the balance sheet, and this costing method is used for external
reporting.

 Variable costing method
As absorption costing method, variable costing method is a method of inventory costing
in which all-variable manufacturing costs (such as direct material cost, direct labor cost,
variable manufacturing overhead cost) are included as inventory cost. However, in
Variable costing method all fixed manufacturing costs are excluded from inventory costs

16

and are treated as a period cost, there are deducted totally from income in the period they
incur to calculate net profit.
Figure 2: Variable costing method
Direct material
Direct labor
Variable
Manufacturing
overhead
When
costs
are 
incurred
Work in
process
inventory
on Balance
Sheet
When
goods
are 
finished
Finished
Goods
Inventory
on Balance
sheet
When
goods

are 
sold
Expense
on
Income
Statement

Fixed manufacturing
overhead
 When costs are incurred 
Expense on Income
Statement

Using the same example above, company A produces and sales shoes. During 2009, this
company produced 200,000 units and 199,500 units were traded. Manufacturing costs
for 2009 was as follows: the direct material cost was $100 per unit, the direct labor cost
was $100 per unit, variable manufacturing overhead cost was $100 per unit, and fixed
manufacturing overhead cost of $80 per unit. Under variable costing method, total unit
product cost allocated by direct material plus directs labor plus variable manufacturing
overhead $300 per unit ($100 + $100 +$100). Therefore during 2009 the cost of goods
per unit will be $60,000,000 ($300 per unit x 200,000 units), and variable cost of goods
sold will be $59,850,000 on Income Statement. At the end of year, company A remains
500 shoes as ending inventory, and the amount of $150,000 ($300 per unit x 500 units)
will be reported on the Balance Sheet as the value of the ending inventory.
Under variable costing method, all of fixed manufacturing overhead costs are treated as
an expense of the period so ending inventory under this method lower than ending
inventory under absorption costing method. Therefore, net operating income reported by