CAP1 Management Accounting Session 1 Notes

CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland

CAP1 MANAGEMENT ACCOUNTING SESSION 1 – INTRODUCTION NOTES

By the end of this session, you should:

Be able to explain the role of the Management Accountant in an organisation.

Be able to explain the different ways of categorising costs


Contents

Syllabus .................................................................................................................................... 3

Organisational objectives and the role of the management accountant ........................ 3

Role of management accounting - Chapter Reference 1.1 and 1.2 (Pages 1 to 8) ..... 3

Ethical Issues - Chapter Reference 1.5 (pages 16 to 20) ................................................. 5

Management Accounting Today - Chapter Reference 1.3 and 1.6 (Pages 8 to 11 and 20 to 21) .................................................................................................................................... 6

Cost Classification - Chapter Reference 2.2 (pages 30 to 40) ....................................... 8

Analysing Costs between fixed and variable .................................................................... 10


Syllabus Organisational Context

Budgetary Control

Standard Costing & Variances

Cost and Management Accounting

Decision making

Key Points to Note : • Continuous assessment - 15% • Final Exam – 85% • Move from knowledge based to competency based exams

Organisational objectives and the role of the management accountant

Outline the role of management accounting in the achievement of organisational objectives

Distinguish profit making businesses and other types of organisations

Describe the operating environment of the management accountant; internal and external

Describe the management accounting system

Outline the role of management accounting in running the business

Outline possible ethical issues facing the management accountant

Cost Classification

Explain basic cost classifications, revenue classifications and typical terms used by management for planning

Analyse cost by cost function and type

Explain cost behaviour patterns, to include fixed, variable and semi-variable costs

Explain how cost behaviour patterns vary on an activity basis and per unit basis

Distinguish between contribution and gross margin

Role of management accounting - Chapter Reference 1.1 and 1.2 (Pages 1 to 8)

Planner e.g. budgeting

Information provider e.g. operating statements

Controller e.g. budgetary control

Motivator e.g. providing budgets

Decision maker e.g. relevant costing

Planning 1. Establishing Objectives 2. Short or long Term 3. Levels of Planning, for example, Strategic, Tactical and Operational


Types of Organisations

Manufacturing

Service Companies

Not for Profit organisations

Decision Making Stages in Decision Making Planning Phase

1. Set Objective 2. Identify ways to achieve objective 3. Make a decision about best way to achieve objectives

Implement Decision Control Phase

1. Gather information about actual results 2. Compare actual to plan results 3. Revise original objectives if necessary

Types of Decisions 1. Product Mix 2. Sales Price 3. Credit Terms to offer to customers 4. Sources of Finance to use 5. Capital Expenditure 6. Setting Budgets for marketing spend

Responsibility Accounting & Responsibility Centres

Cost Centre – A production, service or location, function, activity or item of equipment whose costs can be identified and recorded.

Profit Centre – Part of Business for which both costs and revenues are identified.

Investment Centre – Managers responsible for investment decisions as well as costs and revenues.

Revenue Centre – Only accountable for revenue

Financial Accounting is recording of transactions and summarising them in periodic financial statements for external users. Duties of Financial Accountant:

Maintaining bookkeeping system of nominal ledger,

Accounts payable control,

Accounts receivable control,

Preparation of Statutory accounts

Information prepared by financial accountant is at too high a level for individual managers. Cost and management Accountant provides this more detailed information

Cost Accounting

Careful evaluation of resources used within the company,


Techniques employed are designed to provide financial information about the future performance.

Historical cost of product or service

Management Accounting

Forward Looking – Budgets and Forecasts

Provision of non financial information to managers

Provide advice based on information to management

Include involvement in planning, decision making and control

Ethical Issues - Chapter Reference 1.5 (pages 16 to 20) Ethical issues facing the management accountant

Corporate Social Responsibility Vs maximising shareholder wealth

Ethical investment

Short term opportunism Vs Long term sustainability

Decisions impacting adversely on stakeholder groups e.g. suppliers, employees etc.

Examples of Unethical Behaviour by Management Accountant

Not accruing for unpaid expenses,

Delaying maintenance expenditure in an effort to reduce costs,

Inflating closing inventory valuations in order to increase reported profits. Why motivates this unethical behaviour?

Financial Incentives offered to management,

Promotion Opportunities and

Avoid Scrutiny Code of Conduct Principles underlying the code of conduct are:

Integrity,

Objectivity,

Professional Competence and

Confidentiality.

Resolution of Ethical Conflict 1. Discuss with Superior 2. Confidential Discussion with Independent Advisor 3. Withdraw / Resign from assignment 4. Inform Organisation / Regulatory Authorities


Management Accounting Today - Chapter Reference 1.3 and 1.6 (Pages 8 to 11 and 20 to 21)

Users of Management Information

Internal Users External Users

Employees

Management

Investors

Customers / Suppliers

Competitors

Government

General Public

Lenders

Internal Activities of a Company

• Production • Research & Development • Product Design • Marketing • Sales and Delivery • Customer Service • Human Resources

Changing Competitive Environment

• Customers Expectations Excellent Service High quality products at low price, Variety and range of products.

• Shorter Product Life Cycles • Increased International Competition • Technological Advances and Improvements

Difference between Management and Financial Accountant

Management Accountant Financial Accountant

What Parts of organisation Whole Organisation

When Monthly (prospective) Annual (Retrospective)

Who Internal Managers External Users

Why Planning & Control Financial Decisions

How Free Format Prescribed Format (GAAP)

Key Attributes Relevance & Timeliness Verification and Precision

Management Accounting is concerned with the provision of information to internal management to hep direct and control the organisations operations. Primarily concerned with Planning, Decision Making and Control.


Financial Accounting is concerned with the provision of information to shareholders, creditors and other users outside of the organisation to assist them in making financial decisions. Primarily concerned with stewardship. Computers in Management Accounting

Speed of information availability

Checks can be incorporated to validate input for reasonableness

Electronic Storage

Maintenance required to prevent corruption of data from virus attack

Adaptability of information e.g. coding structures and report writers

Computers in Management Accounting

Capture of information e.g. bar coding

Immediate update / amendment of data

Can handle a large of volume of data quickly

Output can be presented in a variety of formats

Ability to model/analyse information e.g. spreadsheet modelling

Ability to present and transfer information e.g. graphs, e-mail attachments etc. Characteristics of Financial Information

Accurate

Complete

Cost Effective

Understandable

Reliable

Available to Users via appropriate delivery channels

Timely Factors affecting Quality of Information

Source of Information

Type of Information – Financial or non-financial

Methods of recording and processing data – Manual or computerised

Presentation of Information


Cost Classification - Chapter Reference 2.2 (pages 30 to 40) Classification of Costs

Element – Material, Labour and Expense

Separating costs into fixed and variable elements

Nature – Direct or Indirect

Behaviour – Variable, Fixed, Semi Variable or Stepped Fixed

Function – production or non-production costs, for example, Selling, distribution or administration costs

Fixed Costs

Activity (units)

Total

fixed

costs (£)

£5k

Fixed

costs

per unit

(£)

Activity (units)Activity (units)

Total

fixed

costs (£)

£5k

Fixed

costs

per unit

(£)

Activity (units)


Variable Costs

Changes in Fixed and Variable costs in total and on a per unit basis

Total Cost Cost Per Unit

Variable Cost Total Cost changes as the activity level changes

Cost per unit remains the same as activity changes

Fixed Cost Total fixed costs remain the same as activity levels change

Cost per unit decreases as activity level increases

Semi Fixed / Stepped Costs

• Costs are fixed until certain trigger points are breached e.g. number of supervisors

• If one supervisor is required for 10 staff then the supervisor’s salary costs will remain fixed until more than 10 staff are employed when a second supervisor will be required

Activity (units)

Total

variable cost

(£)

30

Variable costs

per unit (£)

Activity (units)

1

10

10

20

2 3 1 2 3

Activity (units)

Total

variable cost

(£)

30

Variable costs

per unit (£)

Activity (units)

1

10

10

20

2 3 1 2 3

Activity (no of staff)

Total semi-

fixed costs

(£k)

60

20

20

40

3010

Activity (no of staff)

Total semi-

fixed costs

(£k)

60

20

20

40

3010


Semi Variable Costs

Cost separation is the process of separating the fixed and variable elements of a semi-variable cost : Methods

• High – Low Method • Scatter graph method

Analysing Costs between fixed and variable

Example 1 You have been provided with the following information regarding costs incurred over the past two months: June 3,000 units 7,500 July 2,000 units 6,000 Expected output in August is 4,000 units. Requirement What will the variable and fixed costs be? Solution Use the High / Low Method: Step 1 Calculate the variable cost per unit Cost at high Volume - Cost at low volume High activity level – Low activity Level 7,500 – 6,000 = 1,500 3,000 – 2,000 1,000 = 1.50 Variable Cost per unit

Activity

Total semi-

variable costs

(£)

Variable element

Fixed element

Activity

Total semi-

variable costs

(£)

Variable element

Fixed element


Step 2 Calculate the fixed costs Once you know the variable cost per unit you can calculate the fixed costs. You can select either activity level given in the question to calculate the fixed cost.

Activity Level of 3,000 units Total Cost 7,500 Variable Cost (3,000 X 1.50) (4,500) Fixed Cost 3,000 Activity Level of 2,000 units Total Cost 6,000 Variable Cost (2,000 X 1.50) (3,000) Fixed Cost 3,000 Step 3 Calculate the Cost at 4,000 units of output Fixed Cost 3,000 Variable Cost (4,000 X 1.50) 6,000 Total Cost 9,000 Question 1 Over the last two months the following production costs were incurred by Department XZ: Level of activity Production cost May 3,180 units €15,405 June 4,200 units €18,873 In July budgeted production was 5,000 units. What is the budgeted production cost for July? Example A company manufacturing a single product has the following costs at two different activity levels: Activity level (units) 30,000 50,000 Total costs (€) 189,000 303,000 Variable costs are constant at all activity levels, but fixed costs increase by €4,000 every 20,000 units. Requirement What is the total costs at an activity level of 35,000 units? Solution We need to make an adjustment to the total costs before we put them into the formula. The reason for this is because each activity level has a different amount of fixed costs. Total Costs at 50,000 units 303,000 Additional Fixed Costs ( 4,000) 299,000 Variable Cost per unit……. 299,000 – 189,000 = 110,000 = 5.50


50,000 – 30,000 20,000

Activity Level of 30,000 units Total Cost 189,000 Variable Cost (30,000 X 5.50) (165,000) Fixed Cost 24,000

Activity Level of 50,000 units Total Cost 303,000 Variable Cost (50,000 X 5.50) (275,000) Fixed Cost 28,000

Costs at 35,000 units of output Fixed Cost 24,000 Variable Cost (35,000 X 5.50) 192,500 Total Cost 216,500 Alternative Method Only difference between costs at 30,000 and 35,000 units is the additional variable costs. The fixed costs are the same. Total Costs at 30,000 units 189,000 (35,000 – 30,000) X 5.50 27,500 216,500 Question 2 A company manufacturing a single product has the following costs at two different activity levels: Activity level (units) 25,000 35,000 Total costs (€) 185,000 255,000 Variable costs are constant at all activity levels, but fixed costs increase by € 5,000 every 10,000 units. Requirement What are the fixed costs at an activity level of 28,000 units?


Scatter Graph Approach • Plot all previous activity levels & costs on a graph • Draw a line of best fit, using your judgement • Use line to determine cost for other activity levels • The intercept of the line on the vertical axis should be the fixed cost, i.e. cost

when activity level is zero • We can then calculate the approximate variable cost by substitution into one

of our existing data points Cost Behaviour Summary

Total Cost Cost per Unit

Variable Total cost changes as activity level changes

Cost per unit remains the same even when the activity level

changes

Fixed Total cost remains the same even when the activity level

changes

Cost per unit goes down as activity level goes up

Semi-Variable

Includes a fixed element and a variable element

Includes a fixed element and a variable element

Stepped Total cost remains the same but only for a set time period or level

of activity

Cost per unit goes down as activity level goes up (within each time period or level of

activity)

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

- 100 200 300 400 500 600 700 800


Example 3 Classify the following costs according to their behaviour:

Cost Behaviour

Petrol

Quarterly Rent for Factory

Telephone Bill

Raw Materials

Depreciation of one and two machines

Electricity Bill

Petrol

Example 4 Classify the following costs as one of the following:

Production

Selling

Distribution

Administration

Finance Costs to be classified:

Cost Function

Print Cartridges for General Office

Salary of Factory Supervisor

Salary of Payroll Supervisor

Interest Charge on Overdraft

Sales staff commissions

Road Tax for delivery vans

Direct Cost

• A Direct Cost is incurred on a specific product, service, job or batch • Direct Cost include:

• Direct Materials, for example, Flour for Bread, • Direct Labour, for example, Production Workers Wages, • Direct Expense, for example, Plant hire • Total of Direct Costs = Prime Cost

Indirect Costs

• Indirect Costs cannot be traced to a specific product, service, job or contract. • Indirect costs can be either manufacturing or non manufacturing. Indirect

costs are also referred to as overhead. • Manufacturing Overhead is apportioned to product and services.


• Non Manufacturing overhead is charged to the SOCI in the period it is incurred. Non manufacturing overhead is made up of administration, selling, distribution and finance costs.

• Examples of Manufacturing Overhead are: Indirect Materials, for example, glue, oil, Indirect Labour, for example, factory supervisor, Indirect Expense, for example, factory rent, machine depreciation

Example 5 Classify the following costs by element and by nature

Cost Material / Labour / Expense ( by Element)

Direct / Indirect (by Nature)

Hire of Plant – Specific Job

Factory Supervisors Salary

Depreciation on Equipment

Factory Workers Salary

Packing Materials for Finished Goods

Oil for Machines

Example of Cost Card

Direct Material Direct Labour Direct Expense PRIME COST Variable Production Overhead MARGINAL PRODUCTION COST Fixed Production Overhead TOTAL PRODUCTION COST Non Production Overhead Administration cost Selling Cost Distribution Cost TOTAL COST Profit Sales Price

X X X X X X X X

X X X X X X

Companies set their selling price to achieve a particular mark up or margin:

Mark Up on cost – Selling price is set to achieve a particular mark up on cost of producing the product.

Margin of Selling Price – Price is set to achieve a percentage of profit on the selling price

Example 6 A Ltd has estimated the cost of producing its latest product as €7.50 per unit. What is the selling price if the company wants to achieve :

(a) A mark up of 20%, or (b) A margin of 25%.


Solution (a) To calculate the selling price per unit :

Cost X 100 + Mark Up 100 7.50 X 100 + 20 = 7.50 X 120 = 9.00 100 100 (b) To calculate the selling price per unit:

Cost / (1 – Margin) where the margin is expressed as a percentage 7.50 / (1 – 0.25) = 10.00 Product Costs and Period Costs Product costs

• Costs associate with a particular product/service • Include direct & indirect costs (manufact. overheads) • Initially recorded as part of the value of inventory • Treated as expenses (cost of sales) when inventory is sold

Period costs (non-manufacturing costs) • Don’t relate specifically to a particular product/service • Treated as expenses in period in which incurred • Never included in the value of inventory

Relevant and Non Relevant Costs

• Used in the process of decision making. • A relevant cost will impact on the decision being made, whereas an irrelevant cost

will not.

Sunk Cost

• A Sunk cost is a cost that has already been incurred or committed to and cannot be changed by any future action to be taken.

• Example : A company carried out market research to assess customer interest in a new product. The market research findings were favourable and the company is now assessing whether to begin manufacturing and selling the new product.

• In assessing whether the product should be produced the money spent on the market research is a sunk cost and not relevant to the decision to produce the product. The market research costs were already committed to and irrespective of whether the product is produced or not these costs have been committed to.

Opportunity Cost

• The opportunity cost is relevant is evaluating the consequences of one course of action over another.

• In decision making a company must include all relevant costs as well as benefits foregone if the resources were committed to the next best alternative.

• This approach ensures that profits are maximised.


Documents

CAP1 Management Accounting Session 1 Notes