Management accounting

BBA

Management Accounting (MA)

http://www.fb.com/softmover


Chapter 1

The nature and purpose of management accounting



The nature and purpose ofmanagement accounting

• Data and information.• Planning, decision making and control.• Responsibility centres.• The role of management accounting.



Data and information

• Data and information are different.– Data consists of numbers, letters, symbols, raw

facts, events and transactions which have been recorded but not yet processed into a form suitable for use.

– Information is data which has been processed in such a way that it is meaningful to the person who receives it (for making decisions).



Good informationThe ‘ACCURATE’ acronym:– A – Accurate– C – Complete– C – Cost-effective– U – Understandable– R – Relevant– A – Accessible– T – Timely– E – Easy-to-use!



Planning, decision making& control

Strategic, technical and operational planning

Responsibility CentresAn individual part of the business whose manager has personal responsibility for its performance.

Managers to plan & control areas of performance on which they are measured.

Responsibility Centre

Cost Centre

Profit Centre InvestmentCentre

Revenue Centre

Responsibility Centres



Responsibility centres - Examples

Management Accounting vs. Financial Accounting

Management Accounting vs. Financial Accounting

Management Accounting Financial Accounting

Information mainly produced for

Internal users, e.g. Managers and employees

External users e.g. Shareholders, creditors, lenders, banks, government

Purpose of information

To aid planning, control and decision making

To record financial performance and position in a period

Legal requirements No Yes (limited companies)

Formats No set format – managers decide on content & presentation

Limited companies must produce financial accounts

Nature of information

Financial & non-financial Mostly financial

Time period Historical & forward-looking Mainly an historical record

Chapter 2

Types of cost and cost behaviour



Classifying costs

Production Costs

Production costs are those incurred when raw materials are converted into finished and part-finished goods.

Non-Production Costs

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

Direct and Indirect costsDirect costs : costs which can be directly identified with a specific unit or cost centre

Total of direct costs = Direct Materials + Direct labour + Direct expenses =

Prime Cost

Indirect costs : costs which can not be directly identified with a specific unit or cost centre

Indirect costs = Indirect Materials + Indirect labour + Indirect expenses =

Overheads



Cost Behaviour – variable costThe way in which costs vary at different levels of activity

• A cost that varies with the level of activity, e.g. Material cost

Cost behaviour – Fixed CostsA cost that, within certain output and sales revenue limits, is unaffected by changes in the level of activity.

Stepped Fixed Costs : A fixed cost which is only fixed within a certain level of activity. Once the upper level is reached, a new level of fixed costs becomes relevant. Warehouse costs(as more space is required, more warehouse must be purchased or rented).

Cost behaviour – Semi variable costsA cost with a fixed and a variable element, e.g. telephone charges with fixed line rental and charge per call

Cost behaviour – Hi-low methodCosts are analysed into variable & fixed elements using

the hi-low method.

Step1 : Select high and low activity levels and their associated costs.

Step 2 :Variable Cost per unit

= cost at high level of activity-cost at low level of activity / High level of activity-low level of activity

Step 3 : Find fixed cost by substitution using either the high or low activity level

Fixed cost=Total cost at activity level– Total variable Cost



Analysis of cost into fixed and variable elements

Example Output (units) Total costs ($) 200 7000 300 8000 400 9000a) Find the variable cost per unitb) Find the total fixed costc) Estimate the total cost if output is 350 unitsd) Estimate the total cost if output is 600 units

Hi-low method - Example

High Low method with changes in the variable cost per unit

Example Output (units) Total costs ($) 200 7000 300 8000 400 8600For output volume above 350 units the variable cost per unit falls by 10%.( this fall applies to all units –not just the excess above 350)a) Estimate the cost of producing 450 units of

product ABC in 2009.

Cost Objects, Units & CentresA Cost object : any activity for which a

separate measurement of cost is undertaken, e.g. A

product

Cost unit : a unit of product or

service in relation to which costs

are ascertained e.g. A hotel

room.

Cost centre : a production or service

location, function, activity or item of

equipment for which costs can be

ascertained e.g. A ward in a hospital.



Cost Card

Chapter 3

Business Mathematics

Expected ValuesThe weighted average of a probability distribution, used in simple decision-making situations.

EV = ∑px

Where p = probability of outcome occurringx = outcome.

When using Expected Values :

•Only accept projects if EV is positive

•With mutually exclusive options, accept the one with the highest EV.

Expected Values - Example



Expected Values - Limitations

Expected values :

• Use past data and estimates, which may be inaccurate

• Are not always suitable for one-off decisions as they are long-term average. The expected value might never occur for any single result

• Do not take into account the time value of money

• Do not take into account the decision maker’s attitude to risk.

Regression

If x is the independent variable and y the dependent variable, least squares regression finds the line of best fit through the scatter diagram.

y = a + bx

Where a is the y value when x is 0, and b is the change in y when x increases by one unit.

Regression

(Given)

In the context of cost estimation :

y represents the total costx represents the production volume in unitsa represents the total fixed costsb represents the variable cost per unit

Correlation Coefficient

(Given)

r measures the strength of a linear relationship between two variables.

• If r = 1 perfect positive correlation•If r = 0, no correlation•If r = -1, perfect negative correlation.

-1 < r < 1

Correlation does not prove cause and effect – it merely suggests it.http://www.fb.com/softmover


Coefficient of determination

r² shows how much of the variation in the dependent variable is dependent on the variation of the independent variable.

E.g. If r = 0.95, r² = 0.90 or 90%

This means that 90% of the variation in y (costs) is explained by the variation in x (level of output).

Chapter 4

Ordering and Accounting for Inventory

Ordering, Receiving and issuing materials

Ordering, Receiving and issuing materials



PaperworkDocument Completed by Sent to Information

included

Purchase Requisition form Production department Purchasing department Goods requiredManager’s authorisation

Purchase order form Purchasing Department SupplierAccounting (copy)Goods receiving department (copy)

Goods required

Delivery note Supplier Goods Receiving Department Check of goods delivered against order form

Goods Received Note Goods receiving department Purchasing department Verification of goods received to enable payment

Materials requisition note Production department Stores Authorisation to release goodsUpdate stores record

Materials returned notes Production Department Stores Details of goods returned to storesUpdate stores record

Materials Transfer notes Production Department A Production Department B Goods transferred between departmentsUpdate stores records

Double entry

Double entry

Control Procedures



Chapter 5

Order Quantities and Reorder Levels

Holding & Ordering Costs

Stock-out costs : running out of inventory

Loss of sales

Loss of customers and goodwill

Reduced profits

Minimise total of holding, ordering and stock-out costs

Economic Order QuantityThe EOQ minimises the total of holding, ordering & stock-out costs

2C0D

ChEOQ =

Where : D = demand p.a.

C0 = Cost of placing one orderCh = cost of holding one unit per year

Total Annual Cost = PD + (Co X D/Q)+ (Ch X Q/2)

√

EOQ

EOQA company uses components at the rate of 500 units per month, which are bought at a cost of $1.20 each from the supplier. It cost $20 each time to place an order, regardless of the quantity border.The total holding cost is 20% per annum of the value of inventory held.Required:How many components company should order and what will be the total annual cost ?



EOQ with discount: A company uses components at the rate of 500 units per month, which are bought at a cost of $1.20 each from the supplier. It cost $20 each time to place an order, regardless of the quantity border.The supplier offers a 5% discount on the purchase price for order quantities of 2000 units. The current EOQ is 1000 units The total holding cost is 20% per annum of the value of inventory held.Required:Should the discount be accepted?

Re-order levelsWhen inventory held reaches the reorder level then a replenishment reorder should be placed.

Re-order level = usage X lead time(when demand in lead time is constant0

Lead time-this is the time expected to elapse between placing an order and receiving an order for inventory.Reorder quantity-When reorder level is reached, the quantity of inventory to be ordered is known as the reorder or EOQDemand-this the rate at which inventory is being used up. It is also known as inventory usage.

ExampleA company uses components M at the rate of 1500 per week. The time between placing an order and receiving the components is five weeks. The reorder quantity is 12000 units.Required:Calculate the reorder level.

Chapter 6

Accounting for Labour



Direct or Indirect Costs?‘Type’ of worker

directly involved in making productsIndirect workers (Maintenance

staff, supervisors, Canteen

Direct Labour cost Make up part of prime cost of a

product, Basic Pay

• Overtime Premium ‘on specific job’, ‘at customer’s request’

Indirect Labour cost General O/T premiums• Bonus payments

• Idle time• Sick pay

• Time spent on indirect jobs

Indirect Labour cost

ALL COSTS

Direct and Indirect Labour Vienna is a direct labour employee who works a standard 35

hours per week and is paid a basic rate of $12 per hour. Overtime is paid at time and a third. In week 8 she worked 42 hours and received a $50 bonus.

• Please find Basic pay for standard hours (DLC)• Basic pay for overtime hours (DLC)• Overtime premium (IDLC)• Bonus (IDLC)

Remuneration Methods• Time Based Schemes

• Total Wages = (hours worked * basic pay/hour) + (o/t hrs worked * o/t premium/hour)

•Higher quality if workers are happy to spend longer on units to get them right; However, no incentive to improve productivity.

• Piecework Schemes• Total Wages =

Number of units completed * agreed rate per unit.

•May involve a guaranteed minimum wage;•May use a higher rate per unit once productivity target achieved•Higher productivity at the expense of quality?

• Other Schemes e.g. Flat salary + bonus

• Bonus Schemes (individuals or groups)

Remuneration methods - examples



Labour Turnover

Labour TurnoverAt 1st January a company employed 3,641 employees and at 31 December employees numbers were 3,735. During the year 624 employees choose to leave the company.

What was the labour turnover rate for the year?

Labour Related Ratios

Labour Related Ratios



Chapter 7

Accounting for Overheads

Absorption costing

OVERHEADS

Production Departme

nt A

A

Production Departme

nt B

B

Service Departm

ent C

Service Departm

ent D

Cost Unit x

Step1 : O/H allocated or apportioned to cost

centres using suitable bases

Step 2 : Service cost centres reapportioned to production cost centres

Step 3 : Overheads absorbed into units of

production



Overheads Allocation, Apportionment and absorption Introduction A business needs to know the cost per unit of goods and services that they produce for many reasons.E.g.1)to value stock2)to fix a selling price3)to analyse profitabilityIn principle, the unit cost of material and labour should not be a problem, because they can be measured. It is overheads that present the real difficulty-in particular fixed overheads.E.g. If the factory cost $100,000 p.a. to rent, then how much should be included in the cost of each unit?



Absorption of overheadsExample 1X Plc produce desks.Each desk uses 3kg of wood at a cost of $4 per kg, and takes 4 hours to produce.Labour is paid at the rate of $2 per hour.Fixed costs of production are estimated to be $700,000 p.a..The company expects to produce 50,000 desks P.a..

Calculate the cost per desk.



First problem-more than one product produced in the same factoryExample 2X plc produce desk and chairs in the same factory.Each desk uses 3 kg of wood at a cost of $4 per kg and takes 4 hours to produce.Each chair uses 3 kg of wood at a cost of $4 per kg, and takes 1 hour to produce.Labour is paid at the rate of $2 per hour.Fixed cost of production are estimated to be $700,000 p.a..The company expects to produce 30,000 desks and 20,000 chairs p.a..Overheads are absorbed on labour hours basis

Calculate cost per unit of desks and chairshttp://www.fb.com/softmover


Second problem-more than one department in the factory.Example 3X plc produces desk and chairs in the same factory, The factory has two departments, assembly and finishingEach desk take 3kg of wood at $4 per kg and takes 4 hours to produce-3 hours in assembly and 1 hour in finishing.Each chair uses 2kg of wood at $4 per kg and takes 1 hour to produce-1/2 hour in assembly and ½ in finishing, All labor is paid at the rate of $2 per hour.Fixed cost of production are estimated to be $700,000 pa, of this total , $100,000 is the salary of the supervisors-$60,000 to assembly supervisor and $40,000 to finishing supervisor.The remaining overheads are to be split 40% to assembly and 60% to finishing.The company expect to produce 30,000 desks and 20,000 chairs.Overheads are absorbed on labour hour basis. Calculate the cost per unit for desks and for chairs?



Overheads allocation, apportionment and absorptionExample 4X plc, production overheads costs for the periodFactory rent 20,000Factory heat 5,000Processing Dep-Supervisor 15,000Packing Dep-Supervisor 10,000Depreciation of equipment 7,000Factory Canteen expense 18,000Welfare cost of factory employees 5,000 80,000 Processing Dep Packing Dep Canteen Cubic space 50,000 m 25,000 5,000NBV equipment $300,000 $300,000 $100,000No. of employees 50 40 10Allocate and apportion production overheads costs amongst the three departments using a suitable basis.



Reapportionment of service cost centre overheadsExample 5Reapportion the canteen cost in example 4 to the production cost centers.



Example 6Allocate and apportion overheads Production Dep Service Dep X Y Stores Maintenance $ $ $ $Allocated and apportioned 70,000 30,000 20,000 15,000overheadsEstimated work done by the service centers for other DepStores 50% 30% - 20%Maintenance 45% 40% 15%

-

Reapportion service department costs to department using repeated distribution method



Example 7X plc produces one product-deskEach desk is budgeted to require 4 kg of wood at $3 per kg, 4 hours of labour at $2 per hour, and variable production overheads of $5 per unit.Fixed production overheads are budgeted at $20,000 per month and average production is estimated to be 10,000 units per month.The selling price is fixed at $35 per unit.There is also a variable selling cost of $1 per unit and fixed selling cost of $2000 per month.During the first two months X plc expects the following level of activity January FebruaryProduction 11,000 units 9,500 unitsSales 9,000 units 11,500 units

a) Prepare a cost card using absorption costing?b) Set out budgeted profit statement for the month of Jan and Feb? http://www.fb.com/softmover


Marginal CostingVariable production costs are included in cost per unit(i.e. treated as a product cost). Many businesses only want to know the variable cost of the units they make, as fixed costs treated as period cost. The variable cost is the extra cost each time a unit is made, fixed cost being effectively incurred before any production is started. Fixed costs are deducted as a period cost in the profit statement Variable production cost of a unit is made up of $Direct material XDirect Labour XVariable production OH XMarginal Cost of a Unit X

ContributionIt is the difference between selling price and all variable costs, including non-production variable costs. http://www.fb.com/softmover


Example 8X plc produces one product-deskEach desk is budgeted to require 4 kg of wood at $3 per kg, 4 hours of labour at $2 per hour, and variable production overheads of $5 per unit.Fixed production overheads are budgeted at $20,000 per month and average production is estimated to be 10,000 units per month.The selling price is fixed at $35 per unit.There is also a variable selling cost of $1 per unit and fixed selling cost of $2000 per month.During the first two months X plc expects the following level of activity January FebruaryProduction 11,000 units 9,500 unitsSales 9,000 units 11,500 units

a) Prepare a cost card using marginal costing?b) Set out profit statement for the month of Jan and Feb?



A company commenced business on 1st March making one product only, the cost card of which is as follows $Direct labour 5Direct material 8Variable production overheads 2Fixed production overheads 5 20Fixed production overheads figure has been calculated on the basis of a budgeted normal output of 36,000 units per annum. The fixed production overhead incurred in March was $15,000 each month.Selling, distribution and admin expenses are Fixed $10,000 per monthVariable 15% of the sales valueThe selling price per unit is $35 and units produced and sold were:Production in March 2000 unitsSales in March 1500 units Prepare the absorption costing and marginal costing income statement for March.



Absorption costing

Step1 : Allocation is the charging of overheads directly to specific departments where they can be identified directly with a cost centre or cost unit.

Apportionment is the sharing of overheads which relate to one department between those departments on a fair basis.

Step 2 : Service department costs need to be reapportioned to the production departments, using a suitable basis linked to usage of the service.

Step 3 : Costs within production cost centres are charged to a cost unit, using Overhead absorption rates (OAR) based on :

• Labour or machine hours• % of direct labour cost

• ....

OAR =

Budgeted overheads / Budgeted level of activityhttp://www.fb.com/softmover


Re-apportionment



Over- or under-absorption of overheadsOverheads Absorbed

= Actual labour hours * OAR per labour hour

Actual Overheads Incurred

Overhead under- or over-absorbed

Actual overheads different from budget

Actual activity level different from budget



Ledger Accounting

• In Production Overheads Account

• Debited to one of the non-

production OH accounts

• Credited to the production overheads

account

• Transferred to income statement at the end of the period

Indirect Production

Costs

Non-production Overheads

Absorbed Production Overheads

Over- or under-

absorption overheads



Chapter 8

Marginal and Total Absorption Cost



Contribution



Absorption & marginal costing and profitsABSORPTION COSTING MARGINAL COSTING

Valuing units Total production cost Marginal (variable) production cost

Valuing inventory Opening and closing stock valued at total production cost

OS and CS valued at marginal cost

Fixed production overheads

Carried forward from one period to the next as part of the closing / opening stock valuation. Only hit profit when units are sold.

FC charged in full against profit in the period in which they are incurred

Adjusting for over- or under-absorption

Yes – in the income statement None needed

Impact of increase in inventory levels

Gives higher profit Gives lower profit

Impact of decrease in inventory levels

Gives lower profit Gives higher profit

Inventory level constant Same profit under both systems



Profit Statements*

*

*

*



ReconciliationMARGINAL COSTING PROFIT

Increase in inventory * Fixed OAR

ASORPTION COSTING PROFIT



Absorption Vs Marginal



DefinitionsC/S ratio = Contribution per unit / Selling Price

B.E.P. = Fixed Costs / Contribution per unit

Margin of Safety

Budgeted Sales – Breakeven Point Sales(Budgeted – BEP sales) / Budgeted Sales %

Target profit =(Fixed Costs + Required profit) / Contribution per unit

CVP Analysis



CVP Analysis and Breakeven PointCost-volume-profit(CVP)/Breakeven analysis is the study of interrelationships between costs, volume and profits at various level of activity.The management of an organization usually wished to know the profit likely to be made if the aimed-for production and sales for the year are achieved. Management may also interested to know1) The breakeven point which is the activity level at which neither profit nor loss.2)The amount by which actual sales can fall below anticipated sales, without a loss being incurred.



Breakeven PointThe breakeven point which is the activity level at which neither profit nor loss.

Breakeven Point = Total Fixed Cost (in terms of number of units sold) Contribution per unit

Breakeven Point = Total Fixed Cost (in terms of sales revenue) C/S Ratio



Example The following information relates to product X $Selling price per unit 20Variable cost per unit 12Fixed cost 100,000Required:

a) Calculate the breakeven point in terms of number of units soldb) Calculate the breakeven point in terms of sales revenue.



C/S ratio/PV ratio/Contribution margin ratio

C/S ratio= Contribution PU = Total Contribution Selling price PU Total sales revenueExampleThe following information relate to product B. $Selling price per unit 20Variable cost per unit 12Fixed cost 100,000

Calculate the contribution to sales ratio.



Margin of safety and target profitsThe margin of safety is the difference in units between the budgeted sales volume and the breakeven sales volume. It is sometime expressed as a percentage of the budgeted sales volume.It may also be expressed as the difference between the budgeted sales revenue and breakeven sales revenue expressed as a percentage of the budgeted sales revenue.

Margin of safety = Budgeted Sales – Breakeven point sales (in terms of no. of units)

Margin of safety = Budgeted Sales – Breakeven sales Budgeted Sales (as a % of budgeted sales)



Example The following information relates to product X $Selling price per unit 20Variable cost per unit 12Fixed cost 100,000Budgeted sales for the period are 16,000 units.

Required:a) Calculate the margin of safety in terms of units.

b) Calculate the margin of safety as a % of budgeted sales.



Target profitSometime an organization might wish to know how many units of a product it needs to sell in order to earn a certain level of profit or target profit.

Sales volume to = (fixed cost+ required profit)achieve a target profit contribution per unit



Example Arrow ltd manufactures product A and wishes to achieve a profit of $20,000, the following information relate to product A $Selling price per unit 20Variable cost per unit 12Fixed cost 100,000Budgeted sales for the period are 16,000 units.

Required:Calculate the sales volume required to achieve a profit of $20,000.



Example the following information relate to product A $Selling price per unit 100Variable cost per unit 56Fixed cost 220,000Budgeted sales are 7,500 units.Required:a)Calculate the C/S ratio.b) Calculate the breakeven point in terms of units sold.c) Calculate the breakeven point in terms of sales revenue.d) Calculate the unit sales required to achieve the target profit of $550,000.e) Calculate the margin of safety (expressed as a percentage of budgeted sales).



Breakeven ChartThe Breakeven point can also be determined graphically using a breakeven chart.

The breakeven chart plots total costs and total revenues at different levels of output.

A breakeven chart has the following axis A horizontal axis showing the budgeted/actual sales/output (in terms of units)A vertical axis showing $ for sales revenues and costs



Drawing a breakeven chartThe breakeven chart is constructed as follows 1) Plot the fixed cost line as a straight line parallel to the horizontal axis. 2) Plot the sales revenue line from the origin. 3) the total cost line is represented by fixed cost plus variable costs. 4) Note the point at which the breakeven point and margin of safety occurs. 5) Breakeven point is the point where sales revenue is equal to the total costs. 6) Margin of safety is the difference between the breakeven point and the budgeted or actual sales.



Breakeven Chart



ExampleThe budgeted annual output of a factory is 120,000 units. The fixed overheads amounts to $40,000 and the variable costs are 50c per unit.The sales price is $1 per unit.

RequiredConstruct a breakeven chart showing the current breakeven point and profit earned up to the present maximum capacity.



Contribution Breakeven ChartA variation on the traditional breakeven chart is the contribution breakeven chart. The main difference between the two charts are as follows,a) The tradition breakeven chart shows the fixed cost line whereas the contribution chart shows the variable cost line.b) Contribution can be read more easily from the contribution breakeven chart than the traditional breakeven chart.



Contribution Breakeven Chart



P/ V Chart



Chapter 9

Relevant Costs



Relevant Cash Flows

Relevant Cash flow

CASHINCREMENT

AL FUTURE



Relevant Cash Flows



Relevant Cash Flows - Materials



Relevant Cash Flows - Labour



Relevant Cash Flows - Labour



Other Relevant Costs•The Relevant cost of overheads is only that which varies as a direct result of the decision taken.

•Fixed Assets• Relevant costs are treated as if related to materials

• If P+M is to be replaced, then relevant cost = current replacement cost• If P+M not to be replaced, then relevant cost is higher of :

• Sales proceeds (if sold)• Net cash inflows arising from use of the asset (if not sold).



Chapter 10

Dealing with Limiting Factors



Single Limiting factorA limiting factor is a factor that prevents a company achieving the level of activity it would like to.

Scarce resources are where one or more of the manufacturing inputs needed to make a product are in short supply.



Multiple Limiting factorLinear Programming is the technique used to establish an optimum

product mix when there are two more

resource constraints.



Finding the solution – Method 1

Draw an example contribution line by making up a suitable value of C, such that the sample line is easy to draw on the graph.

To solve a maximisation problem, whilst keeping its slope constant, slide the line out, away from the origin.

Find the last point where this is still feasible.

Solve simultaneously the equations of the 2 lines that cross at the optimal point identified on the graph.



Finding the solution – Method 2

Co-ordinates of each of the corners of the feasible region are calculated using simultaneous equations.

For each corner calculate the value of the objective function.

Select the corner with the highest or lowest value, depending on whether you are minimising / maximising.



Chapter 11

Job. Batch and Process Costing



Job Costing

Use the same principles of

costing

Produce a cost card for each

job.

Each job is unique

PROFIT can be a mark-up on cost, or a margin (%).



Batch Costing

Cost per unit : Total Cost of

batch / Number of units in a

batch.

Determine total cost of batch.

Each batch is different, but items identical.

PROFIT can be a mark-up on cost, or a margin (%).



Process Costing - Features

Production is continuous.Difficult to identify units of

production.Output of one

process = input of next

process

Closing WIP Period 1 =

Opening WIP Period 2

Losses Part-finished units

By- products & joint

products

FIND A COST PER UNIT VALUE CLOSING STOCK



Process Costing – Losses & GainsEXPECTED to occur

Do not pick up a share of process costs

Sometimes sold for scrap – credit process account.

Normal Losses

Actual Losses > Normal losses

Pickup a share of process costs

Valued like a unit of good output

Written off in income statement

Cost reduced by scrap proceeds

Abnormal losses

Actual Losses < Normal losses

Abnormal gains debit the process account

Benefit credits the income statement

Remember to Credit the scrap account

Abnormal Gains



Steps for answering questionsDraw process

account

Enter inputs and value(£)

Enter Normal Loss units & scrap value

Enter Good Output – Units only

Balance ‘units’ column with Abnormal Loss or

Gain

Calculate Average Cost per unit

Value Good output & Abnormal Loss or Gain



WIP – Equivalent Units

If incomplete units at the beginning or the end of the period, the concept of Equivalent Units (EU) is

used.

100 half complete

d = 50 complete

d EUs

Process costs can be spread

evenly between

completed & part-completed

units.

Material Cost

spread over all

units

Conversion costs spread

over Eus

WIP valued

Weighted average or FIFO



WIP – Equivalent Units

AVCO FIFO2 Methods

Opening Inventory Values are added to current

costs to provide overall average cost per unit

Opening WIP Units are completed first.

Process Costs in the period allocated

between : • Opening WIP units• Units started &

completed in period• Closing WIP Units



Losses part way through production



Joint and by-products



Joint and by-products

Accounting Treatment



Chapter 12

Service and Operation Costing



Service & operation costingHETEROGENEITY

INTANGIBILITY

PERISHABILITY

SIMULTANEOUS PRODUCTION & CONSUMPTION

Output service industries is different

from product of manufacturing.



Suitable Cost UnitsBased on

their relevance to the service provided

May be necessary to

use composite cost units

More than one type of cost

unit

Service Possible Cost Unit

Hotel Cost per guest per night

Transport Cost per passenger mile

College Cost per student

Hospital Cost per patient day / cost per procedure



Service Cost Analysis

Labour may be the only direct cost

OH likely to be absorbed using labour hours



Chapter 13

Budgeting



Budgets and Budgeting

• A quantitative expression of a plan of action prepared in advance. It sets out the costs and revenues that are expected in future periods.

• Budgeting is a process to construct a Quantitative model of how our business might perform financially if certain strategies, events and plans are carried out.



PurposeA quantitative expression of a plan of action prepared in advance. It sets out the costs and revenues that are expected in future periods.

Purpose of Budgeting

Co-ordinating Activities

Planning for the future

Controlling Costs

Performance Evaluation

Authorisation of expenditureMotivation

Communication of targets

Components of the Budget

Importance of Budgeting

Planning for The Future

• It can provide the basis for detailed sales targets.

• It can provide staffing plans.• It can be a document to buy and maintain

inventory levels• it can be use to set production Plans• It can be used for cash investment/borrowing,

capital expenditures (for plant assets, etc.), and on and on

Performance Evaluation

• Budgets provide benchmarks against which to compare actual results and develop corrective measures.

Controlling Costs

• It can be used to control costs because standards are set in advance for each expenditure and managers are aware about the limits.

Authorization of Expenditure

• Budgets give managers “ pre approval " for execution of spending plans.

Communication of Targets

• A budget document is a best way to communicate targets to the departments of organization

• Like: sales, Purchase, Finance, manufacturing, Store and so on

Co-ordinating Activities

• A comprehensive budget usually involves all segments of a business. As a result, representatives from each unit are typically included throughout the process.

Motivation

• It gives a forward looking guidance to managers and employees

• Budgets don't guarantee success, but they certainly help to avoid failure.

• Without a budget, an organization will be highly inefficient and ineffective.

Preparing BudgetsDefine long-term objectives of the business

Form budget committee to communicate budget policy, set and approve budgets.

Produce budget manual

Identify principal budget factor

Produce budget for principal budget factor

Produce and approve other budgets based on budget for limiting factor

Review variances

Different types of budgets

•The Master Budget includes the budgeted income statement, the cash budget and budgeted statement of financial position (Balance Sheet).

•A continuous budget is prepared for a year (or budget period) ahead, and is updated regularly by adding a further accounting period (month, quarter) when the first accounting period has expired (= Rolling Budgets).

Functional budgets

Functional Budgets

Sales Budget

Production Budget

Raw Material Usage Budget

Raw Material Purchases

budget

Labour Budget

Overheads Budget

Functional budgets

Functional budgets

ExampleThe XYZ company produces X, Y, Z. For the coming accounting period budgets are to be prepared using the following information.Budgeted SalesProduct X 2000 Units at $100 each Product Y 4000 units at $130 eachProduct Z 3000 units at $150 eachStandard usage of raw material Wood (kg pu) Varnish (liters pu) Product X 5 2 Product Y 3 2 Product Z 2 1Standard cost of material $8 $4Inventories of finished goods X Y ZOpening 500u 800u 700uClosing 600u 1000u 800u

Inventories of raw material Wood (kg) Varnish (liters)Opening 21,000 10,000Closing 18,000 9,000Labour X Y Z Standard hours pu 4 6 8Labour is paid at the rate of $3 per hour.Prepare the following budgets1)Sales Budget (quantity and value)2)Production Budget (units)3) Material Usage Budget(quantities)4) Material purchase budget(quantities and values)5)Labour budget(hours and values)

Example 1 A company makes two products A and B. The products are sold in the ratio of 1:1.Plannaed planning prices are $100 and $200per unit. The company need to earn $900,000revenueb in the coming year.

Prepare sales budget for the coming year.

Example 2A ltd manufactures three products. The expected sales of each product are shown below. Product 1 Product 2 Product 3Sales in units 3000 4500 3000Opening inventory is expected to beProduct 1 500uProduct 2 700uProduct 3 500uManagement have stated their desire to reduce inventory level and closing inventor is budgeted as Product 1 200uProduct 2 300uProduct 3 300uPrepare the budget for the number of units to be produced of Product 1, 2 and 3.

Example 3C ltd manufactures three products. The expected production of each product is shown below. Product 1 Product 2 Product 3Budgeted production in units 2700 4100 2800The three type of material are used in varying amount in the manufacture of the three products. Material requirement are shown below Product 1 Product 2 Product 3Material M1 (kg) 2 3 4Material M2 (kg) 3 3 4Material M3 (kg) 6 2 4The opening inventory of material is expected to beMaterial M1 (kg) 4300Material M2 (kg) 3700 Material M3 (kg) 4400

The closing inventory of material is expected to beMaterial M1 (kg) 2200 Material M2 (kg) 1300 Material M3 (kg) 2000Material prices are expected to be 10% higher than this year and current prices are $1.10/kg for material M1, $3.00/kg for material M2 and $2.50/kg fort material M3

Prepare a budget of material usage, material purchase and value of M1, M2 and M3.

Example

Example - continued

Fixed, flexible & flexed budgetsCompares Original Budget with actual results

Remains unchanged even though level of activity changes

Does not assist in variance analysis

Fixed Budge

t

Prepared at the start of the period, for different possible levels of activity

Flexible

budget

Changes as the volume of activity changes

Useful for budgetary control purposes

Cost behaviour of the different items in the original budget

Hi-low method

Flexed budge

t

ExampleA ltd manufacture one product and when operating at 100% capacity can produce 5000 units per period. But in last few periods operating below capacity Below is the flexible budget prepared at the start of the last period for three activity levelsLevel of activity 70% 80% 90% $ $ $Direct material 7000 8000 9000Direct labour 28000 32000 36000Production overheads 34000 36000 38000Admin and selling Overheads 15000 15000 15000Total cost 84000 91000 98000

In the event, last period turned out to be even worse than expected with 2500 units production only. The following cost incurredDirect material 4500Direct labour 22000Production overheads 28000Admin Expense 16500Total cost 71000RequiredUse the information given above to prepare the followinga)A flexed budget for 2,500 units.

Flexed Budgets and budget variancesVariances are differences arising between the original budget and actual results.

Fixed Budget

Original expenditure levels for budgeted

activity level

Flexed Budget

Original expenditure levels for actual

activity level

Actual results

Actual expenditure levels for actual

activity level

Volume Variance Expenditure Variance

Total Variance

Chapter 14

Standard Costing

The purpose of standard costing

Standard Costing is a control tool for management.

Standard Costs are collected on a standard cost card. They may be based on Absorption Costing or Marginal Costing.

Advantages & Disadvantages of Standard Costing

Types of standard

Types of Standards

IdealWhat would be expected under perfect operating conditions

Basic A standard left

unchanged from period to period

Current A standard adjusted for specific issues relating to the current period

AttainableWhat would be expected under normal operating

conditions



Variance CalculationsAre we working with a marginal or absorption costing system?

Marginal Costing Absorption Costing

Sales Volume Variance

(Budgeted Sales – Actual Sales) x standard contribution/unit

(Budgeted Sales – Actual Sales) x standard profit / unit

Standard Selling Price is not used. When volume changes, so do production costs, and the purpose of the variance is to show the impact on profit or on contribution

Fixed overhead variances

MC does not relate fixed o/h to cost units – fixed overhead is a period cost. No fixed overheads volume variance.

The fixed overhead expenditure variance is the difference between actual expenditure & budgeted expenditure. It is the total variance.

Fixed o/h are related to cost units by using absorption rates.

The Fixed overhead total variance is equal to the over- or under-absorption of overheads.

The FO Volume variance can be further subdivided into efficiency & capacity variances.

Sales Price Variance

Sales Price Variance

(Budgeted Sales Price – Actual Sales Price)

X Actual Quantity sold

Direct Materials Variances

Materials Price Variance

Actual units purchased X Standard Price-

Actual units purchased X Actual Price

Material UsageVariance

(Actual production X Standard usage per unit) @ standard cost per kg/litre -

(Actual production X Actual usage per unit) @ standard cost per kg/litre

Direct Labour Variances

Labour rate (price) Variance

Actual hours paid X Standard Rate-

Actual hours paid X Actual Rate

Labour efficiency Variance

(Actual Production in Standard hours X Standard hourly rate)

- (Actual hours worked X Standard hourly rate)

Variable Overhead variancesVariable Overhead expenditure Variance

Actual o/h cost incurred –(actual hrs worked X variable OAR per hour)

Variable overhead efficiency Variance

(Actual hours worked X variable OAR)-

(Actual production in standard hrs X variable OAR per hour)

Fixed Overhead Variances

Fixed Production Overheads Total Variance

Absorption Costing

Expenditure Variance

Volume Variance

Efficiency Variance

Capacity Variance


Under- or over-absorption of overheads

Absorption Costing

Budgeted FOH –

Actual FOH

(Actual Production in standard hours x OAR) –

Budgeted FOH

(Actual hours taken – standard hours

for output achieved) x OAR

(Actual Hours worked – budgeted

hours worked) x OAR


Fixed Production Overheads Total Variance

Marginal Costing

Expenditure Variance

Causes of Variances

Causes of Variances



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