Managerial accounting

Professor: Dr. Bouchra El Bakkouri

2024/2025
Reflexion questions
• Why do you study this subject?
• What is the importance of managerial accounting?
• What is the link with the sports field?
Course Outcomes
• To learn the major management accounting concepts related to functions of
planning, directing, controlling and decision making.
• To be able to use management accounting tools for pricing, budgetary control,
cost allocation, and performance evaluation as well as the new developments in
management accounting knowledge and technique and how to access cost-
benefit analysis.
• To evaluate the costs and benefits of different conventional and contemporary
costing systems.
• To understand the principles, types, centers, and problems of responsibility
accounting and the role of a manager in the process of responsibility accounting.
• To develop the ability to collect, analyze and communicate quantitative and
qualitative information to assist management in making effective planning and
controlling.
Chapter 1: Introduction to Managerial
Accounting
• Definition and importance of managerial accounting.
• Identify managers’ three primary responsibilities
• Distinguish financial accounting from managerial accounting
• Describe the roles and skills required of management accountants
within the organization
• The organizational structure of accounting
• Current trends affecting management accounting
• Activity: distinguish between:
• Planning, directing and controlling
• MA and FA
Chapter 1 objectives
• Identify managers’ three primary responsibilities
• Distinguish financial accounting from managerial accounting
• Describe the roles and skills required of management accountants
within the organization
• Discuss the latest trends affecting management accounting
Managerial accounting
• Management accounting refers to accounting information developed for
managers within an organization.
• In other words, management accounting is the process of identifying,
measuring, accumulating, analyzing, preparing, interpreting, and
communicating information that helps managers fulfill organizational
objectives.
• This is the phase of accounting concerned with providing information to
managers for use in planning and controlling operations and in decision
making.
• That is people inside an organization who direct and control its operations
• In short, managerial accounting supports the decision making process
through planning and controlling operations.
Managerial accounting topics
• Some of the topics of managerial accounting follow:
• Determining the costs of products and services
• Product Pricing
• Cost Analysis
• Budgeting
• Profit Planning
Manager’s responsabilities
 Manager’s responsabilities: Planning
• From an accounting perspective, planning is the
communication of a company’s goals. Planning is achieved
through the budgeting process as a basis for decisions made by
managers.
• Budgets are the financial plans of a company. They identify the Examples:
o Generate more sales
sources or inflows of economic resources, and the uses or via opening new
outflows of economic resources of a company. stores.
• Budgets identify the source from which assets will be derived o Reduce labor costs by
reducing store hours
and how they will be used.
• They ultimately create benchmarks of profits, cash flows, and
the financial position that the company expects to achieve.
 Manager’s responsabilities: Directing
• While planning for the future, managers have to oversee
and supervise day-to day business undertakings.
• They have to delegate roles and responsibilities, guide
the employees on how to accomplish their tasks,
motivate and inspire them until the fulfillment of the Examples:
o Using daily/weekly sales
tasks, and respond to employees’ queries on how to pull reports to adjust
off their tasks. marketing strategies.
• Using a computerized accounting system, managerial o Using product cost
reports to adjust raw
accountants take into account and list all the assignments material usage.
and undertakings that must be realized.
• Some of these include running trial balances and
wrapping up accounting processes every end of the
month.
Manager’s responsabilities: Controling

• Controlling keeps all business activities on track

and identifies if the company’s objectives are
met.
Examples:
• This can be achieved by measuring performance, o Comparing budgeted sales
comparing actual performance with budgets, with actual sales to take
corrective actions.
and taking action when needed. o Comparing budgeted
• In evaluating and assessing the performance, product costs against actual
product costs to take
managers have different measures. corrective actions.
Decision making
• Good decisions are derived from tireless accession and assessment of
information. With good decisions comes business value.
• Managerial accounting supplies the information necessary to incite
decision-making processes.
• Also, the management team determines which among the other
possible choices or courses of action will support the company in
effectively achieving its objectives.
• Management is continually making decisions while it plans, directs,
and controls operations. Some examples of decisions:
• Price setting or product offerings
• Renovation of facilities
Financial accounting VS Managerial
accounting
• Managerial accounting and financial accounting are
two of the most prominent branches of accounting.
• They both deal with processing information which
is useful in decision-making; however, they have
notable differences that distinguish them from each
other.
• Managerial accounting processes economic
information to be used by management in making
decisions.
• Financial accounting involves the preparation of
general-purpose financial statements used by
various users in making informed decisions.
 Financial accounting VS Managerial
accounting
Issue Managerial Financial
Primary users Internal External
Purpose of information Plan, direct, control, decide Users make investing and lending
decisions
Primary accounting product Internal reports useful to management General purpose financial statements

What is included? Defined by management Determined by GAAP

Underlying basis of Internal & external transactions, focus on Based on historical transactions with
information future external parties

Emphasis Data must be relevant Data must be reliable and

Business Unit Segments of the business Company as a whole
Preparation Depends on management needs Annually & quarterly
Verification Internal audit External audit
 The organizational structure

A typical organizational structure for publicly held companies starts with the board of directors, elected by the
stockholders (owners) of the company to oversee the company. Because the board meets only periodically,
they hire a chief executive officer (CEO) to manage the day to day operations.
The organizational structure
• The CEO hires other executives
to run various aspects of the
organization, including the chief
operating officer (COO) and the
chief financial officer (CFO).
• The COO is responsible for the
company’s operations, and the
CFO is responsible for all of the
company’s financial concerns.
 The organizational structure
• The internal audit department reports to
the CFO or CEO for day-to-day
administrative matters. This internal audit
department also reports to a subcommittee
of the board of directors called the audit
committee.
• The audit committee oversees the internal
audit function as well as the annual financial
statement audit by independent CPAs.
• Both the internal audit department and the
independent CPAS report to the audit
committee for one reason: to ensure
management will not intimidate them or
bias their work.
Required Skills Of Managerial Accountants

• Today’s management
accountant requires solid
knowledge of both financial and
managerial accounting,
analytical skills, knowledge of
how a business functions, the
ability to work on a team, and
oral and written
communications skills.
Current Trends in Managerial Accounting
• Artificial Intelligence (AI) and Automation.
• Data Analytics and Business Intelligence.
• Cloud Accounting and Remote Work.
• Advisory Services.
• Environmental, Social, and Governance (ESG) Accounting.
• Enhanced Data Security.

These trends reflect the ongoing digital transformation in the accounting

field, pushing accountants to develop new skills and embrace technologies
that enhance their roles as strategic business partners.
Chapter 2: Understanding costs
• Types of businesses
• Types of businesses and costs
• Value chain
• Definition of cost, cost object and cost collection system
• Classification of costs
• Activity: Cost classification exercises.
Chapter 2 objectives
• Distinguish among service, merchandising, and manufacturing companies.
• Describe the value chain and its elements.
• Distinguish between direct and indirect costs.
• Identify the inventoriable product costs and period costs of merchandising
and manufacturing firms.
• Prepare the financial statements for service, merchandising, and
manufacturing companies.
• Describe costs that are relevant and irrelevant for decision making.
• Classify costs as fixed or variable and calculate total and average costs at
different volumes
 Types of businesses

• It is important to identify the type of

company you are working with in
managerial accounting.
• Depending on the type of company, you
will identify different costs and set up
reports differently.
 Types of businesses
• We distinguish between three business categories or types:
Type Definition Examples
Service Provides services to its customers, it could be defined as selling your Accounting firms, doctors,
rendering time, or also known as labor business. insurance companies, a
business Intangible mechanic shop, lawyer, etc.

Merchandising Sells physical goods or products to its customers. There are two Department stores, grocery
business subcategories because a merchandise business can be either a stores, dealerships, etc
wholesale business or a retail business. Wholesalers buy directly from
manufacturers and then they sell the merchandise to retailers, and the
retailers buy from wholesalers (sometimes directly from the
manufacturing company) and sell to their customers.
Manufacturing Is in charge of producing the physical goods that they sell to Makers of clothing, automobile
business wholesalers or retailers, and sometimes directly to the consumer. manufacturers, and other types
of factories that involve
production.
Types of businesses and costs
Service firms
• These companies sell services, they generally don’t have Inventory or
Cost of Goods Sold accounts (which makes it fairly easy to calculate
net income.)
• In addition to labor costs, service companies incur costs to develop
new services, advertise, and provide customer service.
Types of businesses and costs
Merchandising companies
• Merchandising companies sell tangible products, they have inventory.
• The cost of merchandise inventory is the cost merchandisers pay for the
goods plus all costs necessary to get the merchandise in place and ready to
sell.
• Because the entire inventory is ready for sale, a merchandiser’s balance
sheet usually reports just one inventory account called Inventory or
Merchandise Inventory.
• Merchandisers also incur other costs to identify new products and
locations for new stores, to advertise and sell their products, and to
provide customer service. Costs to be included in inventory include freight,
taxes, etc.
Types of businesses and costs
Manufacturers
• Three inventory accounts
• Raw materials -includes all raw materials used in manufacturing or building a
product.
• Work in process - includes all goods that are partway through the
manufacturing process but not yet complete (raw materials plus some labor).
• Finished goods - includes completed goods that have not yet been sold. While
most manufacturers sell their finished goods inventory to merchandisers,
some manufacturers sell their products directly to consumers (includes all
costs associated with the product)
Value chain
• Activities that add value to products and services and cost money.
 Value chain and managerial accounting
• The value chain is the process of
business functions that add value to
the customer user of a particular
product. Each of these processes
involves costs, that need to be
incorporated into the price of the
product or service.
• There are many business processes
that add usefulness for the end user.
Managerial accounting is a part of each
step.
 Value chain and managerial accounting

Research costs associated with developing a Specifications for the dimensions and
fuel-efficient and safe car engine characteristics for the car

Sheet metal used to build the car and the Advertising and promotion costs
assembly-line worker wages to build the car

Costs of providing warranty service to

Costs of delivering the car to the customer
the purchaser of the car

Cross-functional teams also work on R&D, design, production,

marketing, distribution, and customer service simultaneously
 How can we define a cost?
What do we mean by costing system?
What is a cost object?
Cost definition
• Can be defined as the amount of expenditure made in order to secure some
goods or services.
• Cost is monetary measures of resources sacrificed to achieve a specific
objective i.e. Acquiring any goods or services, Payment of rent, Insurance
expenses etc.
 Cost Accounting System
• A costing system is a framework used in managerial accounting to
determine the cost of products, services, or processes.
• It helps organizations track, allocate, and control costs, enabling effective
decision-making related to pricing, budgeting, and performance evaluation.
• Cost collection system
• Is Used to accumulate costs
• By classifying them into (Type of expense and Cost behavior )
• There are mainly two types of costing systems in managerial accounting:
• Job Order Costing
• Process Costing
• Some organizations also use Activity-Based Costing (ABC), which allocates
overhead costs based on activities that drive costs, providing a more
accurate representation of cost consumption.
 Costing systems: Job Order Costing
• Job Order Costing
• Definition: Job order costing is used when products
or services are customized or produced in small
batches. Each job or order is unique, and costs are
accumulated for each specific job (small
quantities).
• Application: This system is common in industries
like construction, custom manufacturing,
consulting, or specialized services.
• Cost Tracking: Direct materials, direct labor, and
allocated overhead are traced and assigned to each
individual job.
• Example: A construction company tracking costs
for each building project or a printing company
charging clients for different custom print jobs.
Costing systems: Process Costing
• 2. Process Costing
• Definition: Process costing is used when products are standardized and mass-
produced. Costs are accumulated for each process or department over a specific
period (large quantities).
• Application: This system is common in industries where production is continuous,
such as chemicals, food, and textiles.
• Cost Tracking: Direct materials, direct labor, and overhead costs are assigned to each
process, and unit costs are calculated by dividing total costs by the number of units
produced.
• Example: A soft drink manufacturer using process costing to track costs across
mixing, bottling, and packaging processes.
Job order costing VS Process costing

The key difference lies in how costs are accumulated and assigned: job order
costing focuses on individual jobs, whereas process costing aggregates costs for
entire production processes.
 Cost object
• A cost object is anything for which
managers want a separate measurement
of cost (cost of something)
• A cost object is any item, product, project,
department, or activity for which costs are
measured and assigned
• Examples: Cost per product, per student at
IMS, Cost of dept. of Accounting, Cost of
main campus or city campus etc.
• Video:
https://www.youtube.com/watch?app=de
sktop&v=zwiq9vbb_EU
Classification of costs
• Companies incur different types of costs that can be classified based on
certain characteristics.
• Each cost classification provides management with a different type of
information to be applied in analyzing different business situations.
• Costs can be classified into five categories:
• Behavior
• Traceability
• Controllability
• Relevance
• Function
• Any type of cost may be categorized using any one or a combination of the
five different classifications.
Classification of costs
Criterion Costs
Behavior Fixed
Variable
mixed
Traceability Direct
Indirect
Controllability Controllable
Incontrollabale
Relevance Sunk
Out of pocket
Opportunity
Function Product
Period
Classification of costs
• Classification by Behavior Costs can be:

• Fixed: a cost which does not change as the volume of activity (production)
changes. They do not change with the number of units produced or sold.
• Example: rent of an office or work space, salaries of administrative staff, taxes
• Variable: a cost which changes with changes in the volume of activity. The
more units produced, the higher the variable costs.
• Example: direct material (the more produce, the more needed), sales commissions
• Mixed: a cost which has both fixed and variable components. A portion of
the cost remains fixed, while the other portion varies with production or
sales.
• Example: (i.e. fixed salary + commission)
 Variable costs
• Variable costs vary in direct proportion to the
volume of activity; that is, doubling the level of
activity will double the total variable cost.
• Consequently, total variable costs are linear and
unit variable cost is constant.
• Examples of variable costs in a manufacturing
organization include direct materials, energy to
operate the machines and sales commissions.
• Examples of variable costs in a merchandising
company, such as a supermarket, include the
purchase costs of all items that are sold.
• In a hospital, variable costs include the cost of
drugs and meals which may be assumed to
fluctuate with the number of patient days.
Fixed costs
• Fixed costs remain constant over wide ranges of activity for a specified
time period. They are not affected by changes in activity.
• Examples of fixed costs include depreciation of equipment, property
taxes, insurance costs, supervisory salaries and leasing charges for cars
used by the sales force.
Example
• if the total of the fixed costs is £5000 for a month the fixed costs per
unit of activity will be as follows:

Because unit fixed costs are not constant per unit they must be interpreted
with caution. For decision making, it is better to work with total fixed costs
rather than unit costs.
 Classification of costs
• Classification by Traceability
• Traceability refers to the ability to track and follow the flow of costs and
financial transactions throughout the accounting process, ensuring that
all movements of assets, liabilities, and expenses can be documented
and traced back to their source.
• According to treaceability, costs can be:
• Direct: a cost which is incurred for the benefit of one specific product (cost
object)
• Example: Direct Materials: The raw materials used to create a product, such as steel used in
manufacturing cars or fabric used in clothing production. Direct Labor: The wages of
workers who are directly involved in the manufacturing process, like assembly line workers
or machine operators.
• Indirect: a cost which is incurred for the benefit of more than one cost object or
which cannot be easily or efficiently traced to a specific cost object
• Example: Factory Overhead: Costs such as rent, utilities, Indirect Materials: such as
lubricants for machines or cleaning supplies for the factory.
 Direct costs characteristics

• Variability: Direct costs tend to vary proportionally with the level of

production or the scale of the project. As you produce more units or work on
a larger project, direct costs increase.
• Allocation: Direct cost can be traced exclusively with a particular cost object.
• Example: Metal used to manufacture a car, Labor/ machine hours used to
manufacture that car.
 Indirect costs characteristics
• Stability: Indirect costs tend to remain relatively
stable even if the level of production or the number
of projects changes. They are not as sensitive to
changes in production volume as direct costs.
• Allocation: non-traceable cost so can not be traced
with a particular cost object, so it can be allocated /
assigned to cost objects: shared across various cost
objects.
• Examples:
• Indirect material (Loose tools)
• Indirect labor (Supervision)
• Other Indirect manufacturing costs (Utilities, Rent ...)
Classification of costs
• The higher the costs of a business, the lower its overall profitability. Thus,
business entities always need to focus on managing and controlling their costs.
• The majority of the costs are controllable by senior and middle management due
to their decision-making authority. Decisions relating to costs are taken by
managers and operational staff is required to work towards achieving the cost
targets
• Classification by Controllability of costs can be: controllable or uncontrollable
costs
• Controllable: a cost which can be affected (controlled) at the hierarchical level
which is being measured
• Example: Supplies Expense, Labor Costs
• Uncontrollable: Uncontrollable costs are those that a manager or department
cannot directly influence or control. These costs are typically determined by
external factors or higher-level decisions within the organization.
• Example: Depreciation of Equipment, economic conditions, such as inflation or interest
rates
Fixed costs are uncontrollable costs by nature
Variable costs are controllable costs
 Classification of costs
• For decision-making, costs and revenues can be classified according to whether they are
relevant to a particular decision.
• Relevant costs and revenues are those future costs and revenues that will be changed by
a decision, whereas irrelevant costs and revenues are those that will not be affected by
the decision.
• Example: if you wish to determine the costs of driving to work in your own car or using
public transport, the cost of the road fund taxation licence and insurance will remain the
same for both alternatives, assuming that you intend to keep your car for leisure
purposes. Therefore, the costs of these items are not relevant for assisting you in your
decision to travel to work by public transport or using your own car. Costs that remain
unchanged for all alternatives under consideration are not relevant for decision-making.
• Classification by Relevance Costs can be
• Sunk
• Out-of-pocket
• Opportunity
Classification of costs
• Sunk: a past cost which has already been incurred and cannot be avoided or
changed regardless of future actions
• Example: Research and Development Expenses (If a company has already spent $1
million on developing a new product, and then decides not to proceed with it, that $1
million is a sunk cost), Purchase of Equipment.
• Out-of-pocket: refer to actual cash expenditures that a company incurs.
These are costs that require a current or future outlay of cash. A must
• Example: wages, raw material
• Opportunity: a cost measured as the loss of potential benefits by choosing
one course of action over another.
• Example: Using Company Resources for a Specific Project: If a company uses its resources
to develop Product A instead of Product B, the opportunity cost is the potential profit
that could have been earned from Product B.
Additional considerations for relevance costs
• Sunk costs are irrelevant for decision-making, but not all irrelevant
costs are sunk costs.
• Opportunity costs are of vital importance for decision-making.
• If no alternative use of resources exists then the opportunity cost is
zero, but if resources have an alternative use, and are scarce, then an
opportunity cost does exist.
• Opportunity costs cannot normally be recorded in the accounting
system since they do not involve cash outlays.
• Some books do not include « out of pocket costs» in this
classification.
Classification of costs
• Classification by Function Costs can be:
• Product costs (inventoriable)
• Period costs
Product costs
• Product: also known as inventoriable costs, are all costs involved in the
acquisition or manufacturing of a product. These costs are initially
recorded as inventory on the balance sheet and are expensed as cost of
goods sold (COGS) when the product is sold.
• Example: direct material, direct labor, Indirect costs related to production, such as factory
utilities, depreciation of manufacturing equipment, and maintenance of production facilities
INVENTORY
• Some of the goods purchased or manufactured during a particular accounting year, may
not be sold during that year only.
• On the other hand, some of the goods, for which manufacturing process has been
started during a particular accounting year, may not be finished or saleable in the market
during that year, and consequently those semi-finished or incomplete goods cannot be
sold during that year.
• As a result, there might be some unsold stock of raw materials or work-in progress (i.e.
semi finished goods) or finished goods at the end of every accounting year which
becomes opening stock of next accounting year.
• According to accounting standards Inventory means asset held for sale in normal course
of business.
• Inventory is one of the major components of manufacturing and trading organizations & it is
important to put proper controls over inventory’s cost and its usage cycle.
• The Inventory of different types of entities usually include the following:
• Raw Material
• Work In Process (WIP)
• Finished Goods
INVENTORY FOR MANUFACTURERS
• Manufacturing organizations purchase raw materials from suppliers
and convert these materials into tangible products through the use of
labour and capital inputs (e.g. plant and machinery). This process
results in manufacturing organizations having the following types of
inventories:
• Raw material inventories consisting of purchased raw materials in stock
awaiting use in the manufacturing process.
• Work in progress inventory (also called work in process) consisting of partially
complete products awaiting completion.
• Finished goods inventory consisting of fully completed products that have not
yet been sold.
Inventoriable Product Costs for Manufacturers
• Inventoriable product costs for manufacturers typically include three
main components:
MANUFACTURING COMPANIES’ INVENTORY
ACCOUNTS
INVENTORY FOR MERCHANDISERS
• Merchandising companies such as supermarkets, retail departmental
stores and wholesalers sell tangible products that they have
previously purchased in the same basic form from suppliers.
• Therefore they have only finished goods inventories.
 Inventoriable Product Costs for Merchandisers
• For merchandisers, inventoriable costs (or costs that can be capitalized as
inventory) include all costs that are directly associated with acquiring or
producing inventory that will be sold to customers
• These costs include various components:
• Purchase Price: The actual cost of the inventory items purchased, including discounts and
rebates
• Freight-In: transportation costs incurred to bring inventory to the place of business. This
includes shipping charges and insurance during transit.
• Handling Costs: Costs associated with receiving, storing, and preparing inventory for sale.
This may include labor costs for handling inventory.
• Taxes and Duties: Any sales tax, import duties, or tariffs that are applicable at the time of
purchase
• Other Direct Costs: Any additional costs directly tied to the acquisition of the inventory
such as costs for packaging.
INVENTORY FOR SERVICE COMPANIES
• Service organizations such as accounting firms, insurance companies,
advertising agencies and hospitals provide tasks or activities for
customers.
• A major feature of service organizations is that they provide
perishable services that cannot be stored for future use.
• Therefore service organizations do not have finished goods inventory
but some service organizations do have work in process.
 Costs of inventory
The types of costs that need to be considered vary depending on the nature of the business: service, merchandising, or
manufacturing
The main distinction lies in the nature of production and inventory: service companies focus on labor and overhead,
merchandising companies on inventory purchases, and manufacturing companies on raw materials, production, and inventory
management.
Service Merchandising Manufacturing
Direct Material Costs: Costs of raw materials
used in production.
Cost of Goods Sold (COGS): The purchase Direct Labor Costs: Wages of workers directly
Direct Labor Costs: Wages of cost of goods resold to customers. involved in production.
employees directly providing the Purchasing Costs: Costs incurred in Manufacturing Overhead Costs: Costs
service (consultants, technicians). acquiring inventory, including transportation related to production that are not directly
Overhead Costs: Costs of supporting and handling. attributable to specific units, such as factory
the service, such as rent, utilities… Inventory Holding Costs: Costs of storing utilities, depreciation of machinery, and salaries
Operating Costs: Marketing, insurance, and managing inventory (warehousing). of production supervisors.
legal,... Administrative and Selling Costs: Work-in-Progress Costs: Costs of partially
Material Costs (if applicable): Costs for Salaries of sales staff, advertising, and completed goods that need further processing.
materials used in providing the service administrative expenses. Finished Goods Costs: Costs of completed
Overhead Costs: Rent, utilities, and other products ready for sale.
(e.g., tools or software).
expenses associated with store operations. Administrative and Selling Costs: General
and administrative costs, marketing, and
distribution expenses.
 Inventory valuation methods
There are several inventory valuation methods that businesses can use to assign a
value to their inventory. The most common inventory valuation methods are:
Weighted Average Cost
First-In, First-Out (FIFO) Last-In, First-Out (LIFO) Specific Identification
(WAC)
• The first items purchased • The last items purchased • This method calculates the • This method involves
are the first items sold, so are the first items sold, so average cost of all items in tracking the cost of each
the cost of goods sold the COGS is based on the inventory, based on the individual item in
(COGS) is based on the cost cost of the most recent total cost of all items inventory, so the COGS is
of the oldest inventory. purchases. divided by the total number based on the specific cost of
• The remaining inventory is • The remaining inventory is of items. the items sold.
valued at the cost of the valued at the cost of the • The COGS is then calculated • Often used in industries
most recent purchases. oldest inventory. based on the weighted where the cost of inventory
• Often used in industries • Often used in industries average cost of the is high and each item can be
where the value of where the value of inventory sold. uniquely identified, such as
inventory tends to increase inventory tends to decrease • Often used in industries the jewelry industry.
over time, such as the food over time, such as the tech where the cost of inventory
industry. industry. fluctuates significantly over
time (agriculture, energy...)
Reminder
Inventory Turnover Ratio
• This ratio measures how quickly a company's inventory is sold and
replaced. It indicates how many times a company's inventory is sold and
replaced over a specific period, usually a year.
• It's calculated as the cost of goods sold divided by average inventory.

• Average Inventory: This is typically calculated as the sum of the beginning

and ending inventory for the period divided by two.
Costs of inventories
• Sometimes, the inventories are damaged or become wholly or partly
obsolete.
• In such a case, the company should:
• Either have to incur more cost to bring them into saleable condition due to
which the cost may exceed the selling price
• Or sell them in the damaged / obsoleted form for which the selling price
would probably be lower than actual cost as demand of such obsoleted
product may have come down
• In such cases, the company needs to bring the inventories at their Net
Realizable Value.
 Net Realizable Value (NRV)
• According to International Accounting Standard 2 (IAS 2) NRV is:
• The estimated selling price in the ordinary course of business less the estimated
cost of completion and estimated cost necessary to make the sale.
• The net amount that an entity expects to realize from the sale of the inventory in
the ordinary course of business.
Period costs
• Period: Period costs are all costs that are not directly tied to the production
process. These costs are expensed on the income statement in the period
in which they are incurred, regardless of when the related revenue is
generated.
• Example: Salaries of office staff and executives who are not involved in the production
process, Rent for Office Space which is not related to manufacturing, Marketing and
Advertising Expenses..
Characteristics of period costs

Timing of recognition: the Not tied to inventory: associated

accounting period in which they with day to day operating
are incurred activities of the business

Period costs

Essential for determining the Help evaluate the efficiency and

profitability of a business for effectiveness of their operation
specific time period activities
Summary: Treatment of product and period
costs
 Summary: Why inventory valuation matters?
• Impact on Financial Statements:
• Balance Sheet: Inventory is an asset.
• Income Statement: Cost of Goods Sold (COGS) is
derived from inventory costs. Managerial
Accounting
• Decision-Making: Helps businesses price
products, manage costs, and assess Cost
profitability. Accounting
• Proper inventory accounting is essential for
determining the true profitability of a Financial
Accounting
business, as it impacts the cost of goods sold.
• Inventory errors can affect financial
statements and taxation, so accurate tracking
is critical.