Management accounting

BBA

Management Accounting (MA)

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Chapter 1

The 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 information
The ‘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 Centres
An individual part of the business whose manager has personal responsibility
for its performance.
Cost Centre

Profit Centre Responsibility Centre Investment
Centre

Revenue Centre

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

Responsibility Centres


Responsibility centres - Examples

Management Accounting vs. Financial
Accounting

Management Accounting vs. Financial
Accounting
Management Accounting Financial Accounting

Information mainly Internal users, e.g. Managers External users e.g. Shareholders,
produced for and employees creditors, lenders, banks,
government
Purpose of To aid planning, control and To record financial performance and
information decision making position in a period
Legal requirements No Yes (limited companies)
Formats No set format – managers Limited companies must produce
decide on content & financial accounts
presentation
Nature of Financial & non-financial Mostly financial
information
Time period Historical & forward-looking Mainly an historical record

Chapter 2

Types of cost and cost behaviour


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 costs
Direct 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 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 Costs
A 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 costs
A cost with a fixed and a variable element, e.g. telephone charges with fixed line
rental and charge per call

Cost behaviour – Hi-low method
Costs 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 9000
a) Find the variable cost per unit
b) Find the total fixed cost
c) Estimate the total cost if output is 350 units
d) Estimate the total cost if output is 600 units

High Low method with changes in the variable cost per unit

Example
Output (units) Total costs ($)
200 7000
300 8000
400 8600
For 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 & Centres

A Cost object : any
activity for which a
separate measurement
of cost is
undertaken, e.g. A
product

Cost centre : a Cost unit : a unit
production or service of product or
location, function, activi service in relation
ty or item of equipment
for which costs can be to which costs are
ascertained e.g. A ward ascertained e.g. A
in a hospital.
hotel room.


Chapter 3

Business Mathematics

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

EV = ∑px

Where 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 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
In the context of cost estimation :

y represents the total cost
x represents the production volume in units
a represents the total fixed costs
b represents the variable cost per unit

(Given)

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

-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 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


Paperwork
Document Completed by Sent to Information
included
Purchase Requisition form Production department Purchasing department Goods required
Manager’s authorisation

Purchase 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 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 goods
Update stores record

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

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

Control Procedures


Chapter 5

Order Quantities and Reorder Levels

Holding & Ordering Costs
Stock-out costs : running Holding costs: holding Ordering costs :
out of inventory inventory placing orders

Fixed costs
Loss of sales • Cost of storage Administrative costs
space, insurance

Variable costs
Loss of customers • Interest on capital Delivery
and goodwill tied up in stock

Order costs vary with
Reduced profits number of orders
placed

Minimise total of holding, ordering and stock-out costs

Economic Order Quantity
The 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
Total Annual Cost = PD + (Co X D/Q)+ (Ch X Q/2)

EOQ
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 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 levels
When 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 EOQ
Demand-this the rate at which inventory is being used up. It is
also known as inventory usage.

Example
A 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

Indirect workers (Maintenance
directly involved in making products staff, supervisors, Canteen

Direct Labour cost Indirect Labour cost
Make up part of General O/T premiums
prime cost of a •Bonus payments
Indirect Labour cost
product, •Idle time
Basic Pay •Sick pay

•Overtime Premium
•Time spent on indirect
jobs
ALL COSTS
‘on specific job’, ‘at
customer’s request’

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
At 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


Chapter 7

Accounting for Overheads

Absorption costing
Step1 : O/H allocated or
apportioned to cost
centres using suitable OVERHEADS
bases

Step 2 : Service cost Production Production Service Service
centres reapportioned to Department Department Department Department
production cost centres A B C D

Step 3 : Overheads
absorbed into units of A B
production

Cost Unit x


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 stock
2)to fix a selling price
3)to analyse profitability
In 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 overheads
Example 1
X 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 factory
Example 2
X 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.
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 chairs

Second problem-more than one department in the factory.
Example 3
X plc produces desk and chairs in the same factory, The factory has two
departments, assembly and finishing
Each 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 absorption
Example 4
X plc, production overheads costs for the period
Factory rent 20,000
Factory heat 5,000
Processing Dep-Supervisor 15,000
Packing Dep-Supervisor 10,000
Depreciation of equipment 7,000
Factory Canteen expense 18,000
Welfare cost of factory employees 5,000
80,000
Processing Dep Packing Dep Canteen
Cubic space 50,000 m 25,000 5,000
NBV equipment $300,000 $300,000 $100,000
No. of employees 50 40 10
Allocate and apportion production overheads costs amongst the three
departments using a suitable basis.


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


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

Reapportion service department costs to department using repeated distribution
method


Example 7
X plc produces one product-desk
Each 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 February
Production 11,000 units 9,500 units
Sales 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?

Marginal Costing
Variable 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 X
Direct Labour X
Variable production OH X
Marginal Cost of a Unit X
Contribution
It is the difference between selling price and all variable costs, including
non-production variable costs.

Example 8
X plc produces one product-desk
Each 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 February
Production 11,000 units 9,500 units
Sales 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 5
Direct material 8
Variable production overheads 2
Fixed production overheads 5
20
Fixed 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 month
Variable 15% of the sales value
The selling price per unit is $35 and units produced and sold were:
Production in March 2000 units
Sales 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 activity

Re-apportionment


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 level
different from budget different from budget

Ledger Accounting
• In • Debited to one
Production of the non-
Overheads production OH
accounts
Account
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 period account


Chapter 8

Marginal and Total Absorption Cost


Contribution
Sales Revenue
Per Unit Total Sales Revenue

Variable cost
Variable Production & Non-production cost
Total Variable Costs
per unit

CONTRIBUTION
Per Unit Total Contribution

Fixed Costs
Fixed Production & non production cost per
Total Production cost
unit

PROFIT


Absorption & marginal costing and
profits
ABSORPTION COSTING MARGINAL COSTING
Valuing units Total production cost Marginal (variable)
production cost
Valuing inventory Opening and closing stock valued at total OS and CS valued at marginal
production cost cost
Fixed production Carried forward from one period to the FC charged in full against
overheads next as part of the closing / opening profit in the period in which
stock valuation. Only hit profit when they are incurred
units are sold.
Adjusting for over- or Yes – in the income statement None needed
under-absorption
Impact of increase in Gives higher profit Gives lower profit
inventory levels
Impact of decrease in Gives lower profit Gives higher profit
inventory levels
Inventory level constant Same profit under both systems


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 absorption
Variable 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)


Reconciliation
MARGINAL COSTING PROFIT

Increase in inventory * Fixed OAR

ASORPTION COSTING PROFIT


Absorption Vs Marginal


Definitions
C/S ratio B.E.P.
= =
Fixed Costs / Contribution
Contribution per unit / per unit
Selling Price

CVP Analysis

Margin of Safety Target profit
• Budgeted Sales – Breakeven Point =
Sales (Fixed Costs + Required
• (Budgeted – BEP sales) / Budgeted profit) / Contribution per
Sales % unit


CVP Analysis and Breakeven Point
Cost-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 know
1) 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 Point
The 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 20
Variable cost per unit 12
Fixed cost 100,000
Required:

a) Calculate the breakeven point in terms of number
of units sold
b) 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 revenue
Example
The following information relate to product B.
$
Fixed cost 100,000

Calculate the contribution to sales ratio.


Margin of safety and target profits
The 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
$
Fixed cost 100,000
Budgeted 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 profit
Sometime 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
$
Fixed cost 100,000
Budgeted 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
$
Fixed cost 220,000
Budgeted 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 Chart
The 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 chart
The 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


Example
The 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.

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


Contribution Breakeven Chart
A 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

INCREMENTAL

CASH FUTURE

Relevant
Cash
flow


Relevant Cash Flows


Relevant Cash Flows - Materials


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 factor
A 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 factor
Linear 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

Each job is
unique

Produce a
cost card
for each
job.
PROFIT can be a mark-up
Use the same on cost, or a margin (%).
principles of
costing


Batch Costing

Each batch is
different, but
items
identical.

Determine
total cost of
batch.
PROFIT can be a mark-up
Cost per unit : Total on cost, or a margin (%).
Cost of batch /
Number of units in
a batch.


Process Costing - Features
Production is continuous.
Difficult to identify units of production.
Closing WIP
Output of one Period 1
process = Part-finished By- products &
= Losses
input of next units joint products
process Opening WIP
Period 2


Process Costing – Losses & Gains
Normal Abnormal Abnormal
Losses losses Gains
EXPECTED to Actual Losses > Actual Losses <
occur Normal losses Normal losses

Do not pick up a Abnormal gains
Pickup a share
share of process debit the
of process costs
costs process account

Sometimes sold Valued like a Benefit credits
for scrap – credit unit of good the income
process account. output statement

Written off in Remember to
income Credit the scrap
statement account

Cost reduced by
scrap proceeds

Steps for answering questions
Draw
process
account
Value Good Enter
output &
Abnormal Loss inputs and
or Gain value(£)

Calculate Enter Normal
Average Cost Loss units &
per unit scrap value

Balance ‘units’ Enter Good
column with
Abnormal Loss
Output –
or Gain Units only

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

Process
costs can
100 half be spread Material WIP
Conversion
completed evenly Cost valued
costs
= 50 between spread Weighted
spread
completed completed over all average or
over Eus
EUs & part- units FIFO
completed
units.

WIP – Equivalent Units

AVCO 2 Methods FIFO

Opening Inventory Values Opening WIP Units are
are added to current completed first.
costs to provide overall
average cost per unit

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 costing

HETEROGENEITY INTANGIBILITY

Output service
industries is different
from product of
manufacturing.
SIMULTANEOUS
PERISHABILITY PRODUCTION &
CONSUMPTION


Suitable Cost Units
Based on their May be necessary
More than one
relevance to the to use composite
type of cost unit
service provided cost 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 Analysis

Labour may be the only OH likely to be absorbed
direct cost 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.


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 for the future

Co-ordinating Activities Controlling Costs

Purpose of
Budgeting
Communication of targets Performance
Evaluation

Motivation
Authorisation of expenditure

Importance of Budgeting
Planning for
the future

Performance
Motivation Evaluation

Importance
of Budgeting
Co-ordinating Controlling
Activities Cost

Communication
Authorisation
of targets
of
expenditure

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 Budgets
Define 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
Sales
Budget

Overheads Production
Budget Budget

Functional
Budgets

Raw
Labour Material
Budget Usage
Budget
Raw
Material
Purchases
budget

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

Inventories of raw material
Wood (kg) Varnish (liters)
Opening 21,000 10,000
Closing 18,000 9,000
Labour
X Y Z
Standard hours pu 4 6 8
Prepare the following budgets
1)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 2
A ltd manufactures three products. The expected sales of each
product are shown below.
Product 1 Product 2 Product 3
Sales in units 3000 4500 3000
Opening inventory is expected to be
Product 1 500u
Product 2 700u
Product 3 500u
Management have stated their desire to reduce inventory level
and closing inventor is budgeted as
Product 1 200u
Product 2 300u
Product 3 300u
Prepare the budget for the number of units to be produced of
Product 1, 2 and 3.

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

The closing inventory of material is expected to be
Material 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.

Fixed, flexible & flexed budgets
Fixed Flexible Flexed
Budget budget Prepared at the budget
Compares Original start of the Changes as the
Budget with actual period, for volume of activity
results different possible changes
levels of activity

Remains
Useful for
unchanged even
budgetary control
though level of
purposes
activity changes

Cost behaviour of
Does not assist in the different items
variance analysis in the original
budget

Hi-low method

Example
A 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 levels
Level of activity 70% 80% 90%
$ $ $
Direct material 7000 8000 9000
Direct labour 28000 32000 36000
Production overheads 34000 36000 38000
Admin and selling Overheads 15000 15000 15000
Total 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 incurred
Direct material 4500
Direct labour 22000
Production overheads 28000
Admin Expense 16500
Total cost 71000
Required
Use the information given above to prepare the
following
a)A flexed budget for 2,500 units.

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

Volume Variance Expenditure Variance

Fixed Budget Flexed Budget Actual results

Original expenditure Original expenditure Actual expenditure
levels for budgeted levels for actual levels for actual
activity level activity level activity level

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
Ideal
What would be expected under perfect operating conditions

Attainable
What would be expected Basic
under normal operating A standard left
Types of Standards unchanged from period
conditions
to period

Current
A 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 Costing
Sales (Budgeted Sales – Actual Sales) x (Budgeted Sales – Actual Sales) x standard
Volume standard contribution/unit profit / unit
Variance
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 MC does not relate fixed o/h to cost Fixed o/h are related to cost units by using
overhead units – fixed overhead is a period absorption rates.
variances cost. No fixed overheads volume
variance. The Fixed overhead total variance is equal to
the over- or under-absorption of overheads.
The fixed overhead expenditure
variance is the difference between The FO Volume variance can be further
actual expenditure & budgeted subdivided into efficiency & capacity
expenditure. It is the total 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 Costing

Fixed Production Overheads Total Variance

Expenditure Volume
Variance Variance

Efficiency Capacity
Variance Variance

Absorption Costing

Under- or over-absorption of overheads

Budgeted FOH (Actual Production in
– standard hours x OAR) –
Actual FOH Budgeted FOH

(Actual hours taken (Actual Hours
– standard hours worked – budgeted
for output hours worked) x
achieved) x OAR OAR

Marginal Costing

Fixed Production Overheads Total Variance

Expenditure
Variance

Causes of Variances


Management accounting

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