Chapter 1The nature and purpose of management accounting
The nature and purpose of management 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!
Responsibility CentresAn part of the business whose manager has personal responsibilityfor its performance. Cost Centre Profit Centre Responsibility Centre Investment Centre Revenue Centre Managers to plan & control areas of performance on which they are measured.
Management Accounting vs. Financial Accounting
Management Accounting vs. Financial Accounting Management Accounting Financial AccountingInformation mainly Internal users, e.g. External users e.g.produced for Managers and employees Shareholders, creditors, lenders, banks, governmentPurpose of To aid planning, control To record financial performanceinformation and decision making and position in a periodLegal requirements No Yes (limited companies)Formats No set format – managers Limited companies must produce decide on content & financial accounts presentationNature of Financial & non-financial Mostly financialinformationTime period Historical & forward- Mainly an historical record looking
Production CostsProduction costs are those incurred when raw materialsare converted into finished and part-finished goods.
Non-Production CostsNon- Production costs are costs not directly associated with theproduction processes in a manufacturing organisation.
Direct and Indirect costsDirect costs : costs which can be directly identified with aspecific unit or cost centre Total of direct costs = Direct Materials + Direct labour + Direct expenses = Prime CostIndirect costs : costs which can not be directly identifiedwith a specific unit or cost centre Indirect costs =Indirect Materials + Indirect labour + Indirect expenses = Overheads
Cost Behaviour – variable cost The 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 bychanges 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.
Cost behaviour – Semi variable costsA cost with a fixed and a variable element, e.g.telephone charges with fixedline 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 = Change in Cost / Change in level of activity Step 3 : Find fixed cost by substitution Fixed cost per unit = Total cost – (Variable Cost per unit * Number of units)
Cost Objects, Units & Centres A Cost object : any activity for which a separate measurement of cost is undertaken, e.g. A productCost centre : aproduction or service Cost unit : a unitlocation, function, of product oractivity or item of service in relationequipment for which to which costs arecosts can be ascertained e.g. Aascertained e.g. Award in a hospital. hotel room.
Expected ValuesThe weighted average of a probability distribution, usedin simple decision-making situations. EV = ∑pxWhere p = probability of outcome occurring x = outcome.When using Expected Values :•Only accept projects if EV is positive•With mutually exclusive options, accept the one withthe highest EV.
Expected Values - LimitationsExpected 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.
RegressionIf x is the independent variable and y the dependent variable,least squares regression finds the line of best fit through thescatter diagram. y = a + bxWhere a is the y value when x is 0, and b is the change in ywhen x increases by one unit.
RegressionIn 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 (Given)
Correlation Coefficientr measures the strength of a linear relationship between twovariables. -1 < r < 1 • If r = 1 perfect positive correlation •If r = 0, no correlation •If r = -1, perfect negative correlation. (Given)Correlation does not prove cause and effect – it merely suggests it.
Coefficient of determinationr² shows how much of the variation in the dependentvariable is dependent on the variation of the independentvariable.E.g. If r = 0.95, r² = 0.90 or 90%This means that 90% of the variation in y (costs) isexplained by the variation in x (level of output).
Chapter 4Ordering and Accounting for Inventory
Paperwork Document Completed Sent to Information by includedPurchase Requisition form Production department Purchasing department Goods required Manager’s authorisationPurchase order form Purchasing Department Supplier Goods required Accounting (copy) Goods receiving department (copy)Delivery note Supplier Goods Receiving Department Check of goods delivered against order formGoods Received Note Goods receiving department Purchasing department Verification of goods received to enable paymentMaterials requisition note Production department Stores Authorisation to release goods Update stores recordMaterials returned notes Production Department Stores Details of goods returned to stores Update stores recordMaterials Transfer notes Production Department A Production Department B Goods transferred between departments Update stores records
Holding & Ordering Costs Stock-out costs : Holding costs: Ordering costs :running out of inventory holding inventory placing orders Fixed costs • Cost of storage Administrative Loss of sales space, insurance costs Variable costs Loss of customers • Interest on capital Delivery and goodwill tied up in stock Order costs vary Reduced profits with number of orders placed Minimise total of holding, ordering and stock-out costs
Economic Order QuantityThe EOQ minimises the total of holding, ordering & stock-out costs EOQ = √ 2C0D Ch Where : D = demand p.a. C0 = Cost of placing one order Ch = cost of holding one unit per year Annual ordering costs = C0D/Q Annual holding cost = Ch*Q/2
Economic Batch QuantityThe number of manufactured items to produce in a batch,to minimise total costs EBQ = √ 2C0D Ch(1-D/R) Where : D = demand p.a. C0 = Cost of setting up batch Ch = cost of holding one unit per year R = Annual replenishment (annual production) rate Annual setup costs = C0D/Q Annual holding cost = Ch*Q/2 (1-D/R)
Re-order levelsThe pre-determined level of inventory at which order isplaced, to avoid stock-outs. Re-order level = usage per day * lead time in daysWhen lead time and demand in lead time is not constant : Re-order level = maximum usage*maximum lead time Maximum Inventory level = Re-order level + re-order quantity – (minimum usage*minimum lead time) Minimum Inventory level (buffer stock) = Re-order level – (average usage *average lead time) Average inventory = (Re-order quantity / 2) + minimum inventory
Direct or Indirect Costs? ‘Type’ of worker Indirect workers Directly involved in making products (Maintenance staff, supervisors, CanteenDirect Labour cost Indirect Labour cost •Basic Pay •General O/T Indirect Labour cost premiums•Overtime Premium •Bonus payments‘on specific job’, ‘atcustomer’s request’ •Idle time •Sick pay ALL COSTS •Time spent on indirect jobs Dr Bank – Labour Costs Incurred Cr WIP – Direct Labour Costs Cr Production Overheads – Indirect Labour Costs
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)
Absorption costingStep1 : O/H allocated or apportioned to cost centres using suitable OVERHEADS bases Step 2 : Service cost Production Production Service Servicecentres reapportioned to Department Department Department Departmentproduction cost centres A B C D Step 3 : Overheads absorbed into units of A B production Cost Unit x
Absorption costingStep1 : 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 activity
Over- or under-absorption of overheads Overheads Absorbed = Actual labour hours * OAR per labour hour Actual Overheads Incurred Overhead under- or over-absorbed Actual overheads Actual activity leveldifferent from budget different from budget
Ledger Accounting• In • Debited to Production one of the Overheads non- production Account OH accounts Indirect Non- Production production Costs Overheads Over- or Absorbed under- Production absorption Overheads overheads• Transferred to • Credited to the income production statement at the overheads end of the account period
Contribution Sales Revenue Per Unit Total Sales Revenue Variable costVariable Production & Non-production Total Variable Costs cost per unit CONTRIBUTION Per Unit Total Contribution Fixed CostsFixed Production & non production cost Total Production cost per unit PROFIT
Absorption & marginal costing and profits ABSORPTION COSTING MARGINAL COSTINGValuing units Total production cost Marginal (variable) production costValuing inventory Opening and closing stock valued at OS and CS valued at total production cost marginal costFixed production Carried forward from one period to FC charged in full againstoverheads the next as part of the closing / profit in the period in which opening stock valuation. Only hit they are incurred profit when units are sold.Adjusting for over- or Yes – in the income statement None neededunder-absorptionImpact of increase in Gives higher profit Gives lower profitinventory levelsImpact of decrease in Gives lower profit Gives higher profitinventory levelsInventory level Same profit under both systemsconstant
Profit Statements Sales Revenue Sales Revenue Units Sold Price Units Sold * Price * Cost of sales Cost of sales Units sold Full prod. cost/unit Units sold Marginal cost/unit * * Over/Under absorptionVariable non-production costs incurred Gross Profit Contribution Variable non-production costs Fixed costs Production Non-Production Fixed non-production costs Net Profit / (Loss) Net Profit / (Loss)
Other Relevant Costs•The Relevant cost of overheads is only that whichvaries 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).
Single Limiting factorA limiting factor is afactor that prevents acompany achieving thelevel of activity it wouldlike to.Scarce resources arewhere one or more of themanufacturing inputsneeded to make a productare in short supply.
Multiple Limiting factor LinearProgramming is the technique used to establish an optimum product mixwhen there are two more resource constraints.
Finding the solution – Method 1Draw an example contributionline by making up a suitable valueof C, such that the sample line iseasy 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 2Co-ordinates of each ofthe corners of thefeasible region arecalculated usingsimultaneousequations. 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.
Job Costing Each job is uniqueProduce a cost card foreach job. PROFIT can be a Use the same principles of mark-up on cost, costing or a margin (%).
Batch Costing Each batch is different, but items identical.Determinetotal cost of batch. Cost per unit : PROFIT can be a Total Cost of mark-up on cost, batch / Number of units in a batch. or a margin (%).
Process Costing - Features Production is continuous. Difficult to identify units of production. Closing WIPOutput of one Period 1 process = By- products Part-finished = Losses & jointinput of next units Opening WIP products process Period 2
Process Costing – Losses & GainsNormal Abnormal AbnormalLosses losses Gains Actual Losses Actual Losses EXPECTED to > Normal < Normal occur losses losses Abnormal Do not pick up Pickup a share gains debit the a share of of process process process costs costs account Sometimes Valued like a Benefit credits sold for scrap – unit of good the income credit process output statement account. Written off in Remember to income Credit the statement scrap account Cost reduced by scrap proceeds
Steps for answering questions Draw process account Value Good Enter output & Abnormal inputs and Loss or Gain value(£) Calculate Enter NormalAverage Cost Loss units & per unit scrap value Balance ‘units’ Enter Good column with Abnormal Output – Loss or Gain Units only
WIP – Equivalent UnitsIf incomplete units at the beginning or the end ofthe period, the concept of Equivalent Units (EU) is used. Process costs can 100 half be spread Material Conversion WIP valuedcompleted evenly Cost costs Weighted = 50 between spread over spread over average orcompleted completed all units Eus FIFO EUs & part- completed units.
WIP – Equivalent Units AVCO 2 Methods FIFO Opening Opening WIPInventory Values Units are are added to completed first. current costs to Process Costs in provide overall the period allocatedaverage cost per between : unit •Opening WIP units •Units started & completed in period •Closing WIP Units
Service & operation costingHETEROGENEITY INTANGIBILITY Output service industries is different from product of manufacturing. SIMULTANEOUSPERISHABILITY PRODUCTION & CONSUMPTION
Suitable Cost Units May be Based on their necessary to use More than onerelevance to the composite cost type of cost unitservice provided units 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 AnalysisLabour may be the only OH likely to be absorbed direct cost using labour hours
Purpose A quantitative expression of a plan of action prepared in advance. It sets out the costs and revenues that are expected in future periods. Planning Co-ordinating Activities Controlling Costs BudgetsCommunication of targets Performance Evaluation Motivation Authorisation of expenditure
Preparing Budgets Define long-term objectives of the businessForm budget committee to communicate budget policy, set and approve budgets. Produce budget manual Identify principal budget factor Produce budget for principal budget factorProduce and approve other budgets based on budget for limiting factor Review variances
Different types of budgets•The Master Budget includes the budgeted incomestatement, the cash budget and budgeted statement offinancial position (Balance Sheet).•A continuous budget is prepared for a year (or budgetperiod) ahead, and is updated regularly by adding a furtheraccounting period (month, quarter) when the first accountingperiod has expired (= Rolling Budgets).
Functional budgets Sales BudgetOverheads Production Budget Budget Functional Budgets Raw Labour Material Budget Usage Budget Raw Material Purchases budget
Fixed, flexible & flexed budgets Fixed Flexible FlexedBudget Compares budget Prepared at the budget start of the Changes as the Original Budget period, for volume of activity with actual different possible changes results levels of activity Remains Useful for unchanged even Best, Most Likely, budgetary control though level of Worst purposes activity changes Cost behaviour Does not assist of the different in variance items in the analysis original budget Hi-low method
Flexed Budgets and budget variancesVariances are differences arising between the originalbudget and actual results. Volume Variance Expenditure Variance Fixed Budget Flexed Budget Actual results Original Original Actual expenditure expenditure expenditure levels for levels for levels for budgeted actual activity actual activity activity level level level Total Variance
The purpose of standard costingStandard Costing is acontrol tool for management.Standard Costs arecollected on a standard costcard. They may be based onAbsorption Costing orMarginal Costing.
Advantages & Disadvantages of Standard Costing
Types of standard Ideal What would be expected under perfect operating conditions Attainable Basic What would be Types of Standards A standard left expected under unchanged fromnormal operating period to period conditions CurrentA standard adjusted for specific issues relating to the current period
Variance Calculations Are we working with a marginal or absorption costing system? Marginal Costing Absorption CostingSales (Budgeted Sales – Actual Sales) x (Budgeted Sales – Actual Sales) xVolume standard contribution/unit standard profit / unitVarianceStandard Selling Price is not used. When volume changes, so do production costs, and thepurpose of the variance is to show the impact on profit or on contributionFixed MC does not relate fixed o/h to Fixed o/h are related to cost units byoverhead cost units – fixed overhead is a using absorption rates.variances period cost. No fixed overheads volume variance. The Fixed overhead total variance is equal to the over- or under-absorption of The fixed overhead expenditure overheads. variance is the difference between actual expenditure & budgeted The FO Volume variance can be further expenditure. It is the total subdivided into efficiency & capacity variance. 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 variances Variable 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 Absorption CostingFixed Production Overheads Total Variance Expenditure Volume Variance Variance Efficiency Capacity Variance Variance
Fixed Overhead Variances Absorption CostingUnder- or over-absorption of overheadsBudgeted FOH (Actual Production in standard hours x OAR) – – Budgeted FOH Actual FOH (Actual hours (Actual Hours taken – standard worked – hours for output budgeted hours achieved) x OAR worked) x OAR
Fixed Overhead Variances Marginal CostingFixed Production Overheads Total Variance Expenditure Variance