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FIA MA1 2013 notes
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FIA – MA1 Management Information For exams in 2013
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Notes
ExPress Notes FIA MA1 Management Information
Page | 2 © 2013 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
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Contents
About ExPress Notes 3
1. The nature and purpose of cost and management accounting
7
2. Source documents and coding 14
3. Cost classification and measurement 17
4. Recording costs 24
5. Providing information 34
6. The spreadsheet system 42
ExPress Notes FIA MA1 Management Information
Page | 3 © 2013 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
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START About ExPress Notes
We are very pleased that you have downloaded a copy of our ExPress notes for this paper. We expect that you are keen to get on with the job in hand, so we will keep the introduction brief.
First, we would like to draw your attention to the terms and conditions of usage. It’s a condition of printing these notes that you agree to the terms and conditions of usage. These are available to view at www.theexpgroup.com. Essentially, we want to help people get through their exams. If you are a student for the ACCA exams and you are using these notes for yourself only, you will have no problems complying with our fair use policy.
You will however need to get our written permission in advance if you want to use these notes as part of a training programme that you are delivering.
WARNING! These notes are not designed to cover everything in the syllabus!
They are designed to help you assimilate and understand the most important areas for the exam as quickly as possible. If you study from these notes only, you will not have covered everything that is in the ACCA syllabus and study guide for this paper.
Components of an effective study system
On ExP classroom courses, we provide people with the following learning materials:
• The ExPress notes for that paper • The ExP recommended course notes / essential text or the ExPedite classroom
course notes where we have published our own course notes for that paper • The ExP recommended exam kit for that paper. • In addition, we will recommend a study text / complete text from one of the ACCA
official publishers, but we do not necessarily give this as part of a classroom course, as we think that it can sometimes slow people down and reduce the time that they are able to spend practising past questions.
ExP classroom course students will also have access to various online support materials, including:
• The unique ExP & Me e-portal, which amongst other things allows “view again” of the classroom course that was actually attended.
• ExPand, our online learning tool and questions and answers database
ExPress Notes FIA MA1 Management Information
Page | 4 © 2013 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
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Everybody in the World has free access to ACCA’s own database of past exam questions, answers, syllabus, study guide and examiner’s commentaries on past sittings. This can be an invaluable resource. You can find links to the most useful pages of the ACCA database that are relevant to your study on ExPand at www.theexpgroup.com.
How to get the most from these ExPress notes
For people on a classroom course, this is how we recommend that you use the suite of learning materials that we provide. This depends where you are in terms of your exam preparation for each paper.
Your stage in study for each paper
These ExPress notes
ExP recommended course notes, or ExPedite notes
ExP recommended exam kit
ACCA online past exams
Prior to study, e.g. deciding which optional papers to take
Skim through the ExPress notes to get a feel for what’s in the syllabus, the “size” of the paper and how much it appeals to you.
Don’t use yet Don’t use yet Have a quick look at the two most recent real ACCA exam papers to get a feel for examiner’s style.
At the start of the learning phase
Work through each chapter of the ExPress notes in detail before you then work through your course notes.
Don’t try to feel that you have to understand everything – just get an idea for what you are about to study.
Don’t make any annotations on the ExPress notes at this stage.
Work through in detail. Review each chapter after class at least once.
Make sure that you understand each area reasonably well, but also make sure that you can recall key definitions, concepts, approaches to exam questions, mnemonics, etc.
Nobody passes an exam by what they have studied – we pass exams by being efficient in being able to prove what we know. In other words, you need to have effectively input the knowledge and be effective in the output of what you know. Exam practice is key to this.
Try to do at least one past exam question on the learning phase for each major chapter.
Don’t use at this stage.
ExPress Notes FIA MA1 Management Information
Page | 5 © 2013 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
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Your stage in study for each paper
These ExPress notes
ExP recommended course notes, or ExPedite notes
ExP recommended exam kit
ACCA online past exams
Practice phase Work through the ExPress notes again, this time annotating to explain bits that you think are easy and be brave enough to cross out the bits that you are confident you’ll remember without reviewing them.
Avoid reading through your notes again. Try to focus on doing past exam questions first and then go back to your course notes/ ExPress notes if there’s something in an answer that you don’t understand.
This is your most important tool at this stage. You should aim to have worked through and understood at least two or three questions on each major area of the syllabus. You pass real exams by passing mock exams. Don’t be tempted to fall into “passive” revision at this stage (e.g. reading notes or listening to CDs). Passive revision tends to be a waste of time.
Download the two most recent real exam questions and answers.
Read through the technical articles written by the examiner.
Read through the two most recent examiner’s reports in detail. Read through some other older ones. Try to see if there are any recurring criticisms he or she makes. You must avoid these!
The night before the real exam
Read through the ExPress notes in full. Highlight the bits that you think are important but you think you are most likely to forget.
Unless there are specific bits that you feel you must revise, avoid looking at your course notes. Give up on any areas that you still don’t understand. It’s too late now.
Don’t touch it! Do a final review of the two most recent examiner’s reports for the paper you will be taking tomorrow.
At the door of the exam room before you go in.
Read quickly through the full set of ExPress notes, focusing on areas you’ve highlighted, key workings, approaches to exam questions, etc.
Avoid looking at them in detail, especially if the notes are very big. It will scare you.
Leave at home. Leave at home.
ExPress Notes FIA MA1 Management Information
Page | 6 © 2013 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of reproduction. All examples presented in these course materials are for information and educational purposes only and should not be applied to a specific real life situation without prior advice. Given the nature of information presented in these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any information presented in these materials as to its application to any specific cases.
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Our ExPress notes fit into our portfolio of materials as follows:
Notes
Notes
Notes
Provide a base understanding of the most important areas of the syllabus only.
Provide a comprehensive coverage of the syllabus and accompany our face to face professional exam courses
Provide detailed coverage of particular technical areas and are used on our Professional Development and Executive Programmes.
To maximise your chances of success in the exam we recommend you visit www.theexpgroup.com where you will be able to access additional free resources to help you in your studies.
START About The ExP Group
Born with a desire to be the leading supplier of business training services, the ExP Group delivers courses through either one of its permanent centres or onsite at a variety of locations around the world. Our clients range from multinational household corporate names, through local companies to individuals furthering themselves through studying for one of the various professional exams or professional development courses.
As well as courses for ACCA and other professional qualifications, our portfolio of expertise covers all areas of financial training ranging from introductory financial awareness courses for non-financial staff to high level corporate finance and banking courses for senior executives.
Our expert team has worked with many different audiences around the world ranging from graduate recruits through to senior board level positions.
Full details about us can be found at www.theexpgroup.com and for any specific enquiries please contact us at [email protected].
ExPress Notes FIA MA1 Management Information
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Chapter 1
The Nature and Purpose of Cost and Management Information
KEY KNOWLEDGE Business organisation and accounting systems
The business organisation and its structure Taken in its most general sense, an organization is a social arrangement which aims for collective goals; in the case of a business, this usually involves the maximization of wealth of the shareholders (owners) of the business. An organisation controls its own performance and is distinct from its environment. Benefits of an organisation include:
• shared expertise • pooling of resources
ExPress Notes FIA MA1 Management Information
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Policies, procedures and best practices A policies and procedures manual contains a description of the practices and rules governing an organisation’s operations. In setting standards for the performance of work, it ensures consistency across the organisation. Additional benefits of such a manual, normally distributed to all employees, include the mitgation of risk to the business (and to staff) as well as compliance with external regulatory rquirements. By setting standards with reference to “best practices” – i.e. the best that the industry can demonstrate at any given moment -- the organisation is recognizing that it can only survive by doing at least as well as its competitors. Effective control over transactions Effective control over transactions means that they are initiated, executed and recorded according to pre-set policies and procedures, so that the organisation is not exposed to an unacceptable level of risk of loss. Controls exist to prevent and detect errors and fraud; for example, internal controls are processes put in place by management to help prevent things from going wrong. It is management’s responsibility for having an adequate internal control policy in place. Double-entry book-keeping Double-entry bookkeeping involves the recording of transactions in such a way that two entries are recorded, one called a debit and the other a credit. Debits mean Credits mean An increase in assets A decrease in assets A decrease in liabilities An increase in liabilities In this system, debits must equal credits.
ExPress Notes FIA MA1 Management Information
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Ledgers and prime entry records All accounting transactions are recorded in a document called a General Ledgers.
Books of prime entry are the bridge between the raw data (e.g. receipt for cash purchase of some building materials) and the accounting system. They may be written up by the accountant, or by a semi-trained member of staff within the client’s business.
The most commonly used books of original entry are:
Book of original entry:
Used to record data on: Data typically used to feed:
Cash in book Cash received into the business bank account.
All sorts of things! Anything that may generate cash for the business.
Cash payments book
Cash paid from the business bank account. All sorts of things! Anything that results in cash being paid out of the business.
Petty cash book Cash in and out of the balance of cash held in notes and coins by the business (normally small). This is often controlled using the imprest system (see later).
Typically, small expenses (eg Friday cakes for staff!) and sundry income.
Sales day book Sales on credit. Note that sales immediately settled in cash will be recorded in either the cash book (if paid directly into the bank account) or petty cash book (if received in notes and coins).
Sales revenue.
Purchases day book
Purchases of inventory for resale on credit. Note that purchases settled immediately in cash will be recorded immediately in the cash payments book or petty cash book.
Purchases of inventory for resale.
Journal book Anything not covered by any of the other books of original entry.
Often, this is the book maintained by the accountant, in which “period 13” adjustments like depreciation and bad debts are recorded.
Books of original entry may be recorded in paper form, or using a spreadsheet.
ExPress Notes FIA MA1 Management Information
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Integrated and interlocking accounting systems An integrated system is one in which the cost and financial accounts are maintained in the same books; In an interlocking system, cost and financial accounts are kept separately (so that a reconciliation of the two must be made) Computerised accounting systems Computerised systems are common and can be cheap. They still require rigorous systems for data capture at the point when transactions happen, as the maxim “garbage in, garbage out” very much applies! Input to a computerised system will not look like a book of original entry, but will require the same data. Software may be more user friendly, for example asking “how much cash was spent?” and “what was this for?”, whilst then offering a drop down menu of choices. The software will still prepare records using the same methodology as the manual recording systems above.
Advantages of using a computerised system include:
• Back ups can be made easily • Makes producing periodic frequent accounts much less laborious than a manual
system • Can be user-friendly • Analyses sales taxes more easily than manual systems (see later) • Can be used to quickly produce lots of reports such as VAT returns and interim
management accounts.
Disadvantages of a computerised system include:
• Cost • May not be tailored very well to the business own needs • Still requires effective data capture and maintenance of the underlying records.
ExPress Notes FIA MA1 Management Information
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KEY KNOWLEDGE Management information
The purpose of management information
Planning: has to do with the formulation of objectives within the organization, both in the short- and long-term;
Decision-making: refers to conclusions drawn once all relevant information has been analysed. Implementation of decisions taken (i.e. the decision to take action) follows;
Control: Post-implementation, actual results are analysed in order to determine whether planning and decisions taken need to be revised or to implement corrective actions.
The control step acts as a feedback loop into the previous processes. Remember, look at theses systems dynamically: we learn from experience and need to take corrective steps and to improve processes continuously!
An important focus of management accounting is suggested by its original name, cost accounting. Knowing the costs of individual products is vital to running a business!
Comparison of cost and management accounting with external financial reporting
Principal differences between financial accounting and management accounting:
It particular, it should be noted that management accounting is:
• Aimed at internal users (as opposed to financial accounting, which is aimed at external stakeholders)
ExPress Notes FIA MA1 Management Information
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• Focused on present and future performance (as opposed to financial accounting, which reports past performance)
• Not required by law and not regulated by accounting frameworks (as opposed to financial accounting, which is a legal requirement and is regulated by accounting frameworks)
• Focused on specific areas or activities (as opposed to financial accounting, which provides a holistic view of company’s performance)
• Employs non-financial indicators as well financial, while financial accounting uses only financial measures.
Since the management accounting system is based on (or derived from) a company’s financial accounting system, the two are usually combined (or integrated) for reasons of cost and efficiency, i.e. to avoid duplications. Distinction between data and information
Management information systems convert raw data (facts and figures) into meaningful information which can then be used by management for a variety of analyses and ultimately decisions regarding the business. Good quality information enhances the quality of decision- making. Features of useful management information.[K]
Using a well known mnemonic, information should be ACCURATE:
Accurate Complete Cost-beneficial Understandable Relevant Adaptable Timely Easy to use
Sources and categories of information: Financial and Non-financial
In addition to financial information which can be extracted from the financial accounting records, managers rely for their decision-making on a host of information that is derived
ExPress Notes FIA MA1 Management Information
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from non-financial sources. These can range from industry data (overall size, market shares of different competitors) to customer opinions about the products and services offered.
Internal examples of non-financial information
Non-financial information can embrace a host of operational statistics which are relevant to managerial decision-making: examples include the rate of staff turnover; the time it takes to cook a hamburger (in a restaurant business); the rate of defects in a production process; the set-up time necessary between different production batch runs; or measurements of service/product quality.
Limitations of cost and management accounting information
The key to management accounting is to measure the “right” things, i.e. activities and processes that are relevant to the success of the business. Due to limitations of staff and time, it is necessary to identify and prioritize what is to be measured. Not all companies are successful in doing this and therefore squander resources measuring the wrong things! The role of information technology
Information technology has had a dramatic and far-reaching impact on the structure and conduct of business. IT has also been frequently poorly employed at great cost to companies. When implemented well, IT has made it possible for companies to exploit the benefits of increased accuracy of information and faster decision-making. Suitable formats for the presentation of management information according to purpose
Managerial accounting is a free-style form of accounting in which format and structure of information are not prescribed externally, but conform to the requirements of the users (management and staff).
ExPress Notes FIA MA1 Management Information
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Chapter 2
Source Documents and Coding
KEY KNOWLEDGE Source documents
When a business transaction happens, it is essential that the source data is captured immediately. This does not necessarily mean immediately writing up the books, but it does involve some record being made of the transaction happening.
Materials The ordering, receiving and issuing of materials from inventory must be controlled according to procedures and documented at all stages with forms appropriate to the purpose.
The controls and procedures are designed to monitor inventory movements so as to minimise discrepancies and losses and theft.
Every company which buys, processes and sells materials will have established procedures for ordering, receiving and issuing (such materials) which are generically similar. Some may have highly automated systems in place, while others record the steps manually.
ExPress Notes FIA MA1 Management Information
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The key documents one should be familiar with are: Purchase requisition form: This is an internal form that provides the authorization for materials to be ordered from a supplier (external). Purchase order (PO): The buyer issues a PO to the seller, indicating the
• Description • Quantity • Price
of the product ordered. The PO is a legal offer. Its acceptance by the seller creates a contractual commercial relationship for the intended transaction. Goods Received Note (GRN): This is completed by the buyer upon delivery to verify whether the order has been properly fulfilled. It will contain:
• Order No. • Description • Quantity ordered • Quantity delivered
Materials issuance (or requisition) form: This is the form necessary to authorize the release of materials from inventory into the production process at the company. Labor Labor is evidenced by work contracts. The payroll function is responsible for ensuring prompt payment of salaries and wages to employees. Documents relating to the recording of sales Sales order Records an order from a customer Goods despatched note Records that an order from a customer has been sent out Invoice A request for payment by a supplier
ExPress Notes FIA MA1 Management Information
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Credit note Acknowledgement from a supplier that the customer has overpaid and is entitled either to a refund or free goods/ services in the future Debit note To cancel a credit note that previously existed, eg if goods were ordered, paid for and then returned there would initially be a credit note. The refund made would be accompanied with a debit note Remittance advice Normally included with an invoice. A document that is included with the payment (eg if paid by cheque) with details that will allow the recipient of the funds to match the payment to the customer’s account Receipt Issued by the supplier for goods, to acknowledge payment of a debt
KEY KNOWLEDGE Coding system
Transactions in a business are more easily processed by use of a coding system. This involves assigning to a particular transation a code, i.e. a kind of symbolic label, which identifies the nature of the transaction in a systematic and unambiguous way. In doing so, this allows transactions to be grouped together in information systems, processed, added up and analyzed in a manner that permits checking and reconciliation (against original records).
The characteristics of a coding system shares some of the features of good information: it must be standardized, logical, objective, brief (i.e. capable of being summarized), verifiable, comprehensive and yet flexible (allowing development to cover all relevant situations in a relevant manner).
There are different methods by which data can be coded; these include: • sequential, • hierarchical, • block, • faceted, and • mnemonic
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Chapter 3
Cost Classification and Measurement
KEY KNOWLEDGE Cost Classification
There are a variety of ways in which one can classify costs:
Production vs. Non-Production
Production costs: These are costs (both direct and indirect, also variable and fixed) which relate to the production of goods; this is also referred to as manufacturing or factory cost. It is these costs, accumulated, which provide the value at which goods are placed in inventory (prior to sale) and form the “cost of goods” value when sold.
ExPress Notes FIA MA1 Management Information
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Non-production costs: These are expenses that are incurred independent of production and include administrative, selling, distribution and finance costs. These costs can have the character of “period” costs, as they relate to the period of time in which they occur.
Direct vs. Indirect
Direct costs: are costs that can be directly attributable to a product.
Indirect costs: these are costs that cannot be directly attributable to a product.
Fixed vs. variable
Fixed costs: are costs that remain constant regardless of the volume of production. A variety of indirect costs are fixed.
Variable costs: vary in proportion with the volume produced. Direct costs are by their nature variable in behaviour.
Other types of costs
Mixed costs: these are costs that contain a fixed and a variable element.
Step costs: costs that remain fixed within a defined range of production, but at a certain level of output increase in a significant way to a new (fixed) level.
Direct and indirect labour Direct labour refers to work which is directly involved in the manufacture of a product. Indirect labour (e.g. the supervisor’s salary, or that of a security guard) forms part of overhead costs. It is important to note that the basic pay portion of direct labour costs is included in the prime cost of a product. Overtime premiums, bonuses, employers’ contributions, sick pay and idle time costs relating to direct workers are all accounted for as overheads (indirect costs). One exception: Overtime performed as a result of a client request is recorded as a direct labour cost. Profit statements in Absorption and Marginal costing
Example
ExPress Notes FIA MA1 Management Information
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Below is data on a manufacturing company. Selling price (per unit): 120 Cost card (per unit): Direct materials 45 Direct labour 18 Variable production O/Hs Total variable costs 72
9
There is a variable selling cost of $2 per unit Year 1 Year 2 (units) (units) Budget (normal) production 1,100 1,100 Actual Production 1,000 1,100 Actual Sales 950 1,150 Actual fixed production O/Hs $16,500 $16,500 Actual SGA costs $ 7,000 $ 7,000
Based on the above data, a profit and loss statement for the Years 1 and 2 is prepared.
Assume that the beginning inventory is zero.
Profit/Loss (Marginal costing)
Year 1 Year 2 $ $ Sales (950/1,150 units) 114,000 138,000 Less: Variable cost of sales Opening inventory 0 3,600 Production costs:
o Variable (1,000 x $72) 72,000 (1,100 X $72) 79,200 Less: closing inventory (50 x $72) (3,600) (68,400) (82,800)
0
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Less: Variable selling costs (950 x $2) (1,150 x $2)
(1,900)
(2,300)
Contribution 43,700 52,900 Less: Fixed production O/Hs (16,500) (16,500) Less: SGA costs (7,000)
(7,000)
Profit 20,200 29,400
Inventory is valued at variable production costs.
Absorption Costing
This method argues that focusing on marginal costs is potentially misleading in the longer run because fixed production costs have also to be covered. Accounting conventions require that fixed production costs be reflected in each unit produced.
Revised cost card (Absorption costing)
Cost card (per unit): Direct materials 45 Direct labour 18 Variable production O/Hs 9 Fixed production O/Hs Total production costs 87
15
Year 1 Year 2 Profit/Loss (Absorption costing) $ $
Sales (950/1,150 units) 114,000 138,000 Less: Variable cost of sales Opening inventory 0 4,350 Production costs:
o Variable (1,000 x $72) 72,000 (1,100 X $72) 79,200
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o Fixed
(1,000 x $15) 15,000 (1,100 X $15) 16,500
Less: closing inventory (50 x $87) (4,350) 0 Over/(under) absorption 1,500 0
(84,150)
Gross Profit 29,850 37,950 (100,050)
Less: Variable selling costs (950 x $2) 1,900 (1,150 x $2) 2,300 Less: SGA costs 7,000 (8,900) 7,000 Profit 20,950 28,650
(9,300)
Inventory is valued at the full production costs.
KEY KNOWLEDGE Summary of Absorption and Marginal costing systems
Summary of Absorption costing and Marginal costing formats
Absorption Costing Marginal Costing
Revenue
Less: Cost of Sales
Variable/Fixed Variable production/ production costs non-production costs Gross profit Contribution
Less: Expenses
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Variable/Fixed Fixed production/ non-production costs non-production costs Net Profit
Reconciliation of the two methods
The different profit figures calculated under Absorption costing and Marginal costing can be reconciled thus:
The difference in profit = Net change in inventory (no. of units) X the fixed cost per unit
It follows that:
• If the level of inventory increases in a given period, then profits (for that period) under the Absorption costing system will be greater than under Marginal costing; and
• If the level of inventory decreases, then profits under the Absorption costing system will be smaller than under Marginal costing
• If the inventory level does not change, then the profit calculated under both methods will be equal.
KEY KNOWLEDGE Cost concepts and terms
Cost units: The units are the discreet items to be measured, such as packs of nails (batches) or a student.
Cost centres: Responsible for current expenses only
Revenue centres: Responsible for revenues, but not current expenses other than marketing expenses
Profit centres: Responsible for revenues and current expenses
Investment centres: Responsible for revenues, current expenses and capital expenditure
In order to competently manage his/her area of responsibility, a manager needs to have relevant information (and authority) pertaining to their job function.
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Performance measures Different measures of performance apply to the types of centre: Cost centres: Controlling costs in absolute (monetary) terms or in relation to overall business volumes achieved (revenue);
Revenue centres: Sales targets achieved (on a risk-adjusted basis);
Profit centres: Profits achieved; Profit margins (and in the case of banks, for example, profitability on a risk-adjusted basis);
Investment centres: Return on Capital Employed (ROCE); Residual Income (RI); Asset turnover (in relation to sales)
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Chapter 4
Recording Costs
KEY KNOWLEDGE Accounting for materials
Material costs can be broken down into
• Raw materials • Semi-finished goods • Finished goods
Accounting entries Materials Inventory
Debit (Dr) entries Credit (Cr) entries
= =
Increase in Decrease in
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inventory inventory
Material requirements In budgeting for the amount of materials to be purchased, a business must take into consideration the volume of sales expected, the level of finished goods required (which together determine the volume of production required) and the level of raw material required (closing balance). Methods of inventory valuation:
• FIFO (first-in-first-out); • LIFO (last-in-first-out); • Periodic; and • Weighted average
Accounting for labour costs
Labour Account Debit (Dr) entries Credit (Cr) entries
= = Labour costs incurred Transfer to P&L
Note: The transfer to the P&L takes place via the Work-In-Progress (WIP) account for direct labour costs and the production overheads account in the case of indirect labour costs. Remuneration methods There are two basic forms of remuneration:
• Time-based, and
• Output–based (e.g. piecework)
Effective incentive schemes are designed to ensure that the interests and behaviour of individual employees and groups of employees are in-line (i.e. consistent) with the company’s objectives.
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Accounting for other expenses a) Explain the process of charging indirect costs to cost centres and cost units and illustrate the process of cost apportionment for indirect costs (excluding reciprocal service) .[s] b) Explain and illustrate the process of cost absorption for indirect costs .[s] Direct and Indirect costs Traditionally, accountants maintain that costs have to be charged to whatever is being costed – the goal is ultimately to link costs to the units of product themselves:
Direct costs are not a problem as they are directly attributable to the product.
Indirect costs – in this context referred to as “overheads” -- are more difficult to link to products (e.g. a supervisor’s salary or a security guard).
KEY KNOWLEDGE Absorption costing at work
This is one method which seeks to make the link between overheads and (product) cost units. The diagram below provides a useful roadmap.
Total Production Costs
Direct Costs Indirect costs (overheads)
2. Allocate/Apportion to Cost Centres
Production A Production B Service C
1. Allocate
3. Reapportion from Service to Production Production A Production B
4. Absorb
Cost Unit
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The focus (above) is production. Overhead costs that are not incurred at the time of production do not find their way into inventory.
It is useful to think of production costs as being those that end up as part of the inventory (valuation) while other (non-production) costs are incurred outside, and normally after the product leaves inventory.
Allocation and Apportionment
Allocate, Apportion and Re-apportion indirect production costs (shown on the right side of the diagram) to cost units.
Our focus is on the first category (production); the other overhead costs are not incurred at the time of production and do not find their way into inventory. Always think of the costs going into inventory and those that occur after the product leaves inventory!
EXERCISE
A company producing refrigerators and toasters has identified the following overhead costs relating to production:
$ Rent 8,000 Indirect materials 1,500 Power 3,000 Equipment insurance 2,500 15,000 The company has 3 cost centres, 2 production workshops (A & B) and 1 warehouse (C, service centre).
1. Suggest the basis on which the costs shown above might be charged to the various cost centres.
Basis A B C
Rent 8,000 sq.m. 4000 2500 1500 Indirect materials 1,500 Specific 600 700 200 Power 3,000 kWh 1500 1000 500 Equipment 2,500 Book 1000 1400 100
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insurance value 15,000 sq.m. 7100 5600 2300
As a manager with cost centre responsibility, what could be your concerns with respect to the bases selected above?
2. Re-apportion the service centre costs to the production workshops.
Assumption: C is used by A (65%) and B (35%):
A B C
Costs apportioned to A, B, C: 7,100 5,600 2,300
Costs re-apportioned from C: 1,500 800 (2,300)
Total overheads: 8,600 6,400
3. Absorb the overheads into the units produced.
Assumption: The company absorbs overhead costs on the basis of direct labour hours
Total labour Overheads Overhead Absorption Hrs $ Rate (OAR) $ Workshop A 1,400 8,600 6.14 Workshop B 950 6,400 6.74 Each workshop uses its OAR to keep track of overhead costs as it produces. Alternatively, the company can use a “blanket” or company-wide OAR, calculated as: Total overhead costs = 15,000 Total labour hours 2,350
= 6.38
The company’s cost cards for toasters and refrigerators could look as follows:
Refrigerator (cost per unit) $
Direct materials (15kg @ $2/kg) 30.00 Direct labour (1.75hrs @ $15/hr) 26.25 Variable OHs 5.00 Fixed OHs (1.75hrs @ $6.38/hr) 11.17
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Total 72.42
Toaster (cost per unit) $
Direct materials (1kg @ $3/kg) 3.00 Direct labour (0.30hrs @ $15/hr) 4.50 Variable OHs 2.00 Fixed OHs (0.30hrs @ $6.38/hr) Total 11.41
1.91
Summary – Absorption costing
• Method of measuring the cost of products or services by including a fixed overhead “fair” share into the product manufacturing/service provision cost
• Results in reporting higher ending inventories and higher operating profits (as fixed factory overheads are taken to inventory cost instead of being expensed as incurred)
It addresses the problem of allocating factory overheads per product lines
• Step 1: Identify total factory overheads to be absorbed
• Step 2: Take the total quantity recorded for the absorption base
o The absorption base should be highly correlated with incurrence of overhead
o Most common absorption bases selected: direct labour hours, machine hours, units of output
• Step 3: Compute overhead absorption rate (OAR) as Step 1 / Step 2 ($/unit of absorption base)
• Step 4: Obtain unit overhead cost per product line, by multiplying the OAR with the absorption base quantity recorded per unit
• Step 5: For each product, multiply Step 4 by total output to determine factory overhead to absorb in the production cost.
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KEY KNOWLEDGE Job costing / Batch costing
This refers to the calculation of costs associated with a specific job or customer order. This is appropriate in situations where each product or service is distinct, and possibly unique, in its delivery. Batch costing is similar to job costing; the distinction lies in the identification of costs with specific batches, which are numbered (separately identified) for this purpose.
KEY KNOWLEDGE Process costing
Process costing is a technique that applies to the mass production of a large number of identical products, moving through a series of processing stages. The accumulated costs of production can be averaged over the number of items produced.
Illustration 1
Process B
units $
units $
Input units 1,000
20,000 Output to 1,000
30,000 from Process A
Process C
Additional:
Materials
5,000
Labour
3,000 Overheads 2,000
1,000 30,000
1,000 30,000
Avg.cost/unit: 30
The average cost is determined by the following formula:
Average cost per unit = No. of units of input – Normal loss
Total cost of inputs – Scrap value of rejected units
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The total cost of inputs refers to labour, materials and overhead costs of production. If losses occur along the way that necessitate the scrapping of defective units, then to the extent that these items fetch a scrap value, then that (scrap) value will reduce the total costs. Similarly, an accounting is made of the number of units introduced into a process with the expectation that a normal loss will be incurred. The number of good units emerging from a process will therefore be the number of units entering it, minus the expected number lost in processing. Illustration 2 Normal loss
10% of input
1,000 = 900 + 100
good NL
Avg. cost / unit 33.3
Conclusion: Average cost per unit = No. of units of input – Normal loss
Total cost of inputs
Process B
units $
units $
Input units 1,000
20,000 Output to 900
30,000 from Process A
Process C
Additional:
Materials
5,000 Normal loss 100 0
Labour
3,000 Overheads 2,000
1,000 30,000
1,000 30,000
Illustration 3 Scrap value
scrap/unit 5
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Avg cost/unit 32.78
Conclusion: Average cost per unit = No. of units of input – Normal loss
Total cost of inputs – Scrap value of normal loss units
Process B
units $
units $
Input units 1,000
20,000 Output to 900
29,500 from Process A
Process C
Additional:
Materials
5,000 Normal loss 100 500
Labour
3,000 Overheads 2,000
1,000 30,000
1,000 30,000
Equivalent units (EU) This refers to the way in which partially-completed output (“work-in-progress” or WIP) is expressed. If an unfinished unit of product contains 35% of the labour and materials costs of a complete unit, then the unit has a degree of completion of 35% in terms of value. It is therefore considered to have an EU of 35%, which is normally expressed in monetary terms. Illustration 5
Closing WIP
Assume 200 units are 100% complete with respect to materials, but 40% with respect to the conversion costs (labour + overheads)
Materials EU Conv. EU Total
Finished units 800 100% 800 100% 800 WIP units 200 100% 200 40% 80 Total units
(EU)
1000
880 Value
25,000
5000
Value/unit
25.00
5.68
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Finished units
20000
4545 24545 WIP units
5000
455 5455
25000
5000
Process B
units $
units $
Input units 1,000
20,000 Finished output 800
24,545
from Process A
to Process C Additional:
Materials
5,000 Closing WIP 200 5,455 Labour
3,000
Overheads 2,000
1,000 30,000
1,000 30,000
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Chapter 5
Providing Information
KEY KNOWLEDGE Information for comparison
The purpose of making comparisons Information is only really meaningful if it is looked at in relevant contexts and allows comparisons to be made. For example, a company with sales growth of 10% is impressive if the overall market has grown only 5%. If the growth of the market is 20%, then 10% looks modest. In analysing a company’s performance, one can use different bases of comparison:
1) Company performance with that of its competitors during the same period of time; 2) Company performance during the current period with a previous period (year,
quarter or month); 3) Company actual performance compared to its budget for the period.
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Budgeting: definition and purpose
A budget is a quantitative plan addressing the future. It is used to:
KEY KNOWLEDGE Forecasting/Budgeting
The process by which a budget is prepared can be a highly structured and even complex. It is based on the company’s strategy, a clear understanding of the company’s opportunities and capabilities, and identification of any limiting factors.
Master budget
The result of combining the budgets defined above, while ensuring consistency in assumptions made, is the company’s master budget, which sits atop a hierarchy of budgets.
Master budget
Operating Financial budgets budgets
b) Motivate Employees
b) Evaluate Performance
b) Control Activities
a) Communicate Objectives
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The master budget process features:
• Annual frequency, preferably revised on a regular basis (rolling budget) • Based on organization’s objectives, expressed in financial, quantitative and
qualitative measures
Operating budgets
These are budgets that quantify the revenues and costs relating to a company’s activities at a disaggregated level, meaning that there is direct input from department and functional levels. They require both volume (e.g. units of output, quantities, hours, etc.) and price specifications. Operating budgets are modelled on what will emerge as the company’s income statement.
Examples include:
• Sales budget
• Production budget
• Direct material usage
• Direct material purchases
• Direct labour budget
• Factory overhead budget
• Selling & distribution budget
• Administrative expenses budget
The “disaggregation” of budgets referred to above allows the practice of “responsibility” accounting. The operating budget sequence:
1. Sales budget 2. Production budget 3. Ending inventory budget 4. Direct materials budget, Direct labour budget, Factory overhead budget
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5. Cost of Sales budget 6. R&D budget, Marketing budget, Distribution budget, Customer service budget, Admin
budget 7. Pro-forma income statement
Financial budgets
The operating budgets, which cover future periods, feed into the company’s financial budgets, based on the balance sheet. These provide a “snap shot” view of the company’s assets and liabilities frozen at a moment in time.
The financial budget sequence
• Capital budget • Cash budget • Pro-forma balance-sheet and pro-forma statement of cash-flows
Principal budget factor
When a budget is prepared, management must identify any factors that will prevent the company from surpassing a certain level of activity. A bank, for example, may be constrained from developing an extensive branch network owing to the scarcity of suitably-skilled professional staff; or production may be constrained by the built capacity of the plant or by the level of demand for a company’s products. In each of these cases, there is a limiting factor at work.
Fixed vs. flexible budgets
Traditional budgets tended to be rigid, i.e. they were not subject to modification during the period to which they referred.
EXAMPLE
A producer of office equipment has a budget for the coming year:
Output: 1,000 units
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Costs: Materials 75,000 Labour 200,000 Fixed O/Hs Total 375,000
100,000
After 3 months, the company observes that sales are running ca. 20% higher than originally projected and it has therefore increased its production by a similar amount. In order to look back at what its budget would have been had the actual (higher) level of activity been anticipated, management can prepare a “flexed” budget; this is effectively a re-calibration of the original budget. It allows management to re-focus their efforts without losing time tracking “artificial” spending excesses according to the original budget.
Output: 1,200 units Costs: Materials 90,000 Labour 225,000 Fixed O/Hs Total 415,000
100,000
Prepare a flexed budget for an output level of 1,075 units.
Based on the data (below), the
• variable cost of labour is $125 per unit, and the • fixed cost of labour is $75,000
Output: 1000 1200
Mats 75,000 90,000
Labour 200,000 225,000
Fix 100,000 100,000
Total 375,000 415,000
The cost of labour at output of 1,075 units is $209,375. Variance analysis
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In the previous example, if 1,000 units are (originally) budgeted, actual output is 1,075 units, and actual labor costs are $205,000, then the following variances may be calculated with respect to labor costs:
(a) Original budget/labor costs: $200,000 Actual labor costs: $205,000 Difference: $ 5,000 (adverse)
(b) Flexed budget/labor costs: $209,375 Actual labor costs: $205,000 Difference: $ 4,375 (favorable)
Causes of variances
Material price
Favourable: Unanticipated discounts received, better purchasing/negotiation, cheaper (substandard) materials
Adverse: Price inflation, poor purchasing, better quality materials
Material usage Favourable: Better quality materials, more efficient processing Adverse: Substandard material, waste, poor quality control, theft Labour rate Favourable: Low pay rates, cheap workers Adverse: Wage inflation Labour efficiency Favourable: More efficient production, motivated/better trained workers, better materials and/or equipment
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Adverse: Poorly trained workers, deficient work organization, materials or equipment Exception reports
When transactions and processes run according to expectations, there is normally no need for management attention and intervention. This is beneficial when large numbers are involved (number of bottles filled in a bottling plant; number of credit card invoices issued in a month). In such cases, management needs to highlight exceptions to normal operations (defective bottles, or bottles dropped; number and amount of invoices not paid on time) so that corrective actions can be undertaken. Investigating variances
Variances need to be investigated when:
1. They involve a large amount of financial loss to the firm (materiality); 2. The cost of investigation does not exceed the amount that can be saved.
KEY KNOWLEDGE Reporting management information
Methods of analysing, presenting and communicating information
Information can be conveyed in a variety of ways:
• Formal reports, with tables and appendices attached; normally an “executive summary” is provided at the beginning for busy managers with short attention spans;
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• Means of transmission: The use of e-mail is increasingly dominating other ways of communication because it is efficient; printing reports, memos and letters may be considered wasteful, particularly if the item is not read;
• (On-line) databases: allowing managers to access and view information at their
discretion; this method requires that databases are organised in a purpose-driven manner and faithfully kept up to date with relevant information;
• Powerpoint presentations (favored by general managers);
• Informal: Oral reports, provided on an adhoc basis, usually to those who need to
know.
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Chapter 6
The Spreadsheet System
KEY KNOWLEDGE Use of spreadsheets
The use of spreadsheets is a basic skill that all accountants and business analysts should possess. A spreadsheet is a computer program that is organised in a tabular format. The vertical and horizontal arrangement of cells allows the input and processing of large amounts of data in a systematic way. Spreadsheets contain sophisticated formulae which can be used to operate on the data. Instead of merely adding up columns of numbers, spreadsheet formulae can handle discounting (i.e. net present value) calculations. Apart from processing a large volume of data quickly, spreadsheets permit analysis to be performed with great efficiency. Thus, if an assumption is modified, then the spreadsheet can automatically adjust all affected values (known as “what-if” analysis), meaning that the management acccountant can focus on interpeting the output.