TOPIC 1- MANAGEMENT SCIENCE

Management science is a wide and interdisciplinary study of solving complex problems and making
strategic decisions as it pertains to institutions, corporations, governments and other types of organizational
entities. It is the study of problem-solving and decision-making in organizations, applying the scientific
method to management, enabling managers to make decisions for an organization and improve its
performance. Management science generally entails discovering, developing, defining, and evaluating the
goals of the organization and the alternative policies that will lead toward the goals, getting the organization
to adopt the policies, scrutinizing the effectiveness of the policies that are adopted, and initiating steps to
change policies that are ineffective or inadequately effective

Management science is known to make a much greater contribution to a broader area that is the application
of management science models for the purpose of decision making at all levels of management may it be top,
middle or lower management levels.

COSTS CONCEPTS AND CLASSIFICATIONS

According to Function
1. Manufacturing costs - incurred in the factory to convert raw materials into finished goods. It includes
cost of raw materials used (direct materials), direct labor, and factory overhead.
2. Non-manufacturing costs - not incurred in transforming materials to finished goods. These include
selling expenses (such as advertising costs, delivery expense, salaries and commission of salesmen) and
administrative expenses (such as salaries of executives and legal expenses).

According to Ease of Traceability

1. Direct costs - those that can be traced directly to a particular object of costing such as a particular
product, department, or branch. Examples include materials and direct labor. Some operating expenses
can also be classified as direct costs, such as advertising cost for a particular product.
2. Indirect costs - those that cannot be traced to a particular object of costing. They are also called
common costs or joint costs. Indirect costs include factory overhead and operating costs that benefit more
than one product, department, or branch.

According to Timing of Charge against Revenue

1. Product costs - are inventoriable costs. They form part of inventory and are charged against
revenue, i.e. cost of sales, only when sold. All manufacturing costs (direct materials, direct labor, and
factory overhead) are product costs.
2. Period costs - are not inventoriable and are charged against revenue immediately. Period costs include
non-manufacturing costs, i.e. selling expenses and administrative expenses.

According to Behavior in Accordance with Activity

1. Variable costs - vary in total in proportion to changes in activity. Examples include direct materials,
direct labor, and sales commission based on sales.
2. Fixed costs - costs that remain constant regardless of the level of activity. Examples include rent,
insurance, and depreciation using the straight line method.
3. Mixed costs - costs that vary in total but not in proportion to changes in activity. It basically includes a
fixed cost potion plus additional variable costs. An example would be electricity expense that consists of
a fixed amount plus variable charges based on usage.
According to Relevance to Decision Making
1. Relevant cost - cost that will differ under alternative courses of action. In other words, these costs
refer to those that will affect a decision.
2. Standard cost - predetermined cost based on some reasonable basis such as past experiences,
budgeted amounts, industry standards, etc. The actual costs incurred are compared to standard costs.
3. Opportunity cost - benefit forgone or given up when an alternative is chosen over the other/s.
Example: If a business chooses to use its building for production rather than rent it out to tenants, the
opportunity cost would be the rent income that would be earned had the business chose to rent out.
4. Sunk costs - historical costs that will not make any difference in making a decision. Unlike relevant
costs, they do not have an impact on the matter at hand.
5. Controllable costs - refer to costs that can be influenced or controlled by the manager. Segment
managers should be evaluated based on costs that they can control.

KEY TAKEAWAYS
Costs according to function include: manufacturing and non-manufacturing costs.
Ease of traceability: direct and indirect costs.
Timing: product and period costs.
Behavior: variable, fixed, and mixed costs.
Relevance: relevant, standard, opportunity, sunk, and controllable costs.

NATURE OF COST
Costs can be classified in a number of different ways.
Element: costs are classified as materials, labour or expenses (overheads).
Nature: costs are classified as being direct or indirect.
Behaviour: costs are classified as being fixed, variable, semi-variable or stepped fixed.
Function: costs are classified as being production or non-production costs.

Classification by element
The main cost elements that you need to know about are materials, labour and expenses.
 Materials- all costs of materials purchased for production or non-production activities. For example, raw
materials, components, cleaning materials, maintenance materials and stationery.
 Labour costs- all staff costs relating to employees on the payroll of the organisation.
 Expenses- all other costs which are not materials or labour. This includes all bought-in services, for
example, rent, telephone, sub-contractors and costs such as the depreciation of equipment.

Classification by function Production costs

Production costs are the costs which are incurred when rawmaterials are converted into finished goods and
part-finished goods(work in progress).
Examples of production costs
 Direct materials- the direct materials that go into making a product. For example, cloth in the
manufacture of shirts.
 Direct labour- the cost of labour directly engaged in making a product. For example, the wages of the
machinists making the shirts.
 Direct expenses - the cost of expenses directly involved in making a product. For example, the royalties
paid to a designer, or the freight charges for special materials used to make the shirts.
 Variable production overheads - overheads that vary in direct proportion to the quantity of product
manufactured. For example, code of fuel used to run machinery.
 Fixed production overheads - overheads that are fixed whatever the quantity of product manufactured.
For example, rent of the factory.

Classification by function non-production costs

Non-production costs are costs that are not directly associated with the production processes in a
manufacturing organisation.

Examples of non-production costs

 Administrative costs- the costs involved in running the general administration departments of an
organisation, for example, the accounts department.
 Selling costs - costs associated with taking orders from customers who wish to buy an organisation's
products (sales department costs) and also marketing costs.
 Distribution costs- the costs involved in distributing an organisation's finished products, such as the cost
of running the warehouse or delivery costs.
 Finance costs- the costs that are incurred in order to finance an organisation, for example, loan interest.

COST CLASSIFICATION ON FINANCIAL STATEMENTS

KEY TAKEAWAYS

 Cost accounting is used internally by management in order to make fully informed business
decisions.
 Unlike financial accounting, which provides information to external financial statement users, cost
accounting is not required to adhere to set standards and can be flexible to meet the particular needs
of management.
 As such, cost accounting cannot be used on official financial statements and is not GAAP-compliant.
 Cost accounting considers all input costs associated with production, including both variable and
fixed costs.
 Types of cost accounting include standard costing, activity-based costing, lean accounting, and
marginal costing.
Understanding Cost Accounting

Cost accounting is used by a company's internal management team to identify all variable and fixed
costs associated with the production process. It will first measure and record these costs individually, then
compare input costs to output results to aid in measuring financial performance and making future business
decisions. There are many types of costs involved in cost accounting, each performing its own function for
the accountant.

Types of Costs

 Fixed costs are costs that don't vary depending on the level of production. These are usually things
like the mortgage or lease payment on a building or a piece of equipment that is depreciated at a
fixed monthly rate. An increase or decrease in production levels would cause no change in these
costs.
 Variable costs are costs tied to a company's level of production. For example, a floral shop ramping
up its floral arrangement inventory for Valentine's Day will incur higher costs when it purchases an
increased number of flowers from the local nursery or garden center.
 Operating costs are costs associated with the day-to-day operations of a business. These costs can
be either fixed or variable depending on the unique situation.
 Direct costs are costs specifically related to producing a product. If a coffee roaster spends five
hours roasting coffee, the direct costs of the finished product include the labor hours of the roaster
and the cost of the coffee beans.
 Indirect costs are costs that cannot be directly linked to a product. In the coffee roaster example, the
energy cost to heat the roaster would be indirect because it is inexact and difficult to trace to
individual products.