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Management accounting


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F2 Management Accounting Text Kaplan Series Slides, By Raheem Sheikh FAST-NU

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Management accounting

  1. 1. BBAManagement Accounting (MA)
  2. 2. Chapter 1The nature and purpose of management accounting
  3. 3. The nature and purpose of management accounting• Data and information.• Planning, decision making and control.• Responsibility centres.• The role of management accounting.
  4. 4. 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).
  5. 5. Good informationThe ‘ACCURATE’ acronym: – A – Accurate – C – Complete – C – Cost-effective – U – Understandable – R – Relevant – A – Accessible – T – Timely – E – Easy-to-use!
  6. 6. Planning, decision making & control
  7. 7. Strategic, technical and operational planning
  8. 8. Responsibility CentresAn individual part of the business whose manager has personal responsibilityfor its performance. Cost Centre Profit Centre Responsibility Centre Investment Centre Revenue CentreManagers to plan & control areas of performance on which they are measured.
  9. 9. Responsibility Centres
  10. 10. Responsibility centres - Examples
  11. 11. Management Accounting vs. Financial Accounting
  12. 12. Management Accounting vs. Financial Accounting Management Accounting Financial AccountingInformation mainly Internal users, e.g. Managers External users e.g. Shareholders,produced for and employees creditors, lenders, banks, governmentPurpose of To aid planning, control and To record financial performance andinformation decision making 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-looking Mainly an historical record
  13. 13. Chapter 2Types of cost and cost behaviour
  14. 14. Classifying costs
  15. 15. Production CostsProduction costs are those incurred when raw materials are converted into finishedand part-finished goods.
  16. 16. Non-Production CostsNon- Production costs are costs not directly associated with the productionprocesses in a manufacturing organisation.
  17. 17. 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 CostIndirect costs : costs which can not be directly identified with a specific unit or costcentre Indirect costs = Indirect Materials + Indirect labour + Indirect expenses = Overheads
  18. 18. 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
  19. 19. 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. Warehouse costs(as more space is required, more warehouse must be purchased or rented).
  20. 20. Cost behaviour – Semi variable costsA cost with a fixed and a variable element, e.g. telephone charges with fixed linerental and charge per call
  21. 21. 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
  22. 22. Analysis of cost into fixed and variable elementsExample Output (units) Total costs ($) 200 7000 300 8000 400 9000a) Find the variable cost per unitb) Find the total fixed costc) Estimate the total cost if output is 350 unitsd) Estimate the total cost if output is 600 units
  23. 23. Hi-low method - Example
  24. 24. High Low method with changes in the variable cost per unit Example Output (units) Total costs ($) 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.
  25. 25. 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.
  26. 26. Cost Card
  27. 27. Chapter 3Business Mathematics
  28. 28. Expected ValuesThe weighted average of a probability distribution, used in simple decision-makingsituations. 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 with the highest EV.
  29. 29. Expected Values - Example
  30. 30. 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.
  31. 31. RegressionIf x is the independent variable and y the dependent variable, least squares regressionfinds the line of best fit through the scatter diagram. y = a + bxWhere a is the y value when x is 0, and b is the change in y when x increases by one unit.
  32. 32. 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)
  33. 33. Correlation Coefficientr 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.
  34. 34. Coefficient of determinationr² shows how much of the variation in the dependent variable is dependent on thevariation 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).
  35. 35. Chapter 4Ordering and Accounting for Inventory
  36. 36. Ordering, Receiving and issuing materials
  37. 37. Ordering, Receiving and issuing materials
  38. 38. Paperwork Document Completed by Sent to Information 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
  39. 39. Double entry
  40. 40. Double entry
  41. 41. Control Procedures
  42. 42. Chapter 5Order Quantities and Reorder Levels
  43. 43. Holding & Ordering CostsStock-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 placedMinimise total of holding, ordering and stock-out costs
  44. 44. 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 Total Annual Cost = PD + (Co X D/Q)+ (Ch X Q/2)
  45. 45. EOQA company uses components at the rate of 500 unitsper month, which are bought at a cost of $1.20 eachfrom the supplier. It cost $20 each time to place anorder, regardless of the quantity border.The total holding cost is 20% per annum of the value ofinventory held.Required:How many components company should order andwhat will be the total annual cost ?
  46. 46. EOQ with discount:A company uses components at the rate of 500 unitsper month, which are bought at a cost of $1.20 eachfrom the supplier. It cost $20 each time to place anorder, regardless of the quantity border.The supplier offers a 5% discount on the purchase pricefor order quantities of 2000 units. The current EOQ is1000 unitsThe total holding cost is 20% per annum of the value ofinventory held.Required:Should the discount be accepted?
  47. 47. Re-order levelsWhen inventory held reaches the reorder level then a replenishment reordershould be placed. Re-order level = usage X lead time (when demand in lead time is constant0Lead time-this is the time expected to elapse between placingan order and receiving an order for inventory.Reorder quantity-When reorder level is reached, the quantityof inventory to be ordered is known as the reorder or EOQDemand-this the rate at which inventory is being used up. It isalso known as inventory usage.
  48. 48. ExampleA company uses components M at the rate of1500 per week. The time between placing anorder and receiving the components is fiveweeks. The reorder quantity is 12000 units.Required:Calculate the reorder level.
  49. 49. Chapter 6Accounting for Labour
  50. 50. Direct or Indirect Costs? ‘Type’ of worker Indirect workers (Maintenance directly involved in making products staff, supervisors, CanteenDirect 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’, ‘atcustomer’s request’
  51. 51. 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)
  52. 52. 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)
  53. 53. Remuneration methods - examples
  54. 54. Labour Turnover
  55. 55. Labour TurnoverAt 1st January a company employed 3,641employees and at 31 December employeesnumbers were 3,735. During the year 624employees choose to leave the company.What was the labour turnover rate for theyear?
  56. 56. Labour Related Ratios
  57. 57. Labour Related Ratios
  58. 58. Chapter 7Accounting for Overheads
  59. 59. 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 Department production cost centres A B C D Step 3 : Overheads absorbed into units of A B production Cost Unit x
  60. 60. Overheads Allocation, Apportionmentand absorptionIntroductionA business needs to know the cost per unit of goods andservices 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 bea problem, because they can be measured. It is overheadsthat present the real difficulty-in particular fixed overheads.E.g. If the factory cost $100,000 p.a. to rent, then how muchshould be included in the cost of each unit?
  61. 61. Absorption of overheadsExample 1X Plc produce desks.Each desk uses 3kg of wood at a cost of $4 per kg, andtakes 4 hours to produce.Labour is paid at the rate of $2 per hour.Fixed costs of production are estimated to be $700,000p.a..The company expects to produce 50,000 desks P.a..Calculate the cost per desk.
  62. 62. First problem-more than one product producedin 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 andtakes 4 hours to produce.Each chair uses 3 kg of wood at a cost of $4 per kg, andtakes 1 hour to produce.Labour is paid at the rate of $2 per hour.Fixed cost of production are estimated to be $700,000p.a..The company expects to produce 30,000 desks and20,000 chairs p.a..Overheads are absorbed on labour hours basisCalculate cost per unit of desks and chairs
  63. 63. Second problem-more than one department in the factory.Example 3X plc produces desk and chairs in the same factory, The factory has twodepartments, 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 assemblysupervisor and $40,000 to finishing supervisor.The remaining overheads are to be split 40% to assembly and 60% tofinishing.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?
  64. 64. 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 CanteenCubic 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 threedepartments using a suitable basis.
  65. 65. Reapportionment of service cost centreoverheadsExample 5Reapportion the canteen cost in example 4to the production cost centers.
  66. 66. 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 distributionmethod
  67. 67. Example 7X plc produces one product-deskEach desk is budgeted to require 4 kg of wood at $3 per kg, 4 hours oflabour at $2 per hour, and variable production overheads of $5 perunit.Fixed production overheads are budgeted at $20,000 per month andaverage 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 costof $2000 per month.During the first two months X plc expects the following level ofactivity January FebruaryProduction 11,000 units 9,500 unitsSales 9,000 units 11,500 unitsa) Prepare a cost card using absorption costing?b) Set out budgeted profit statement for the month of Jan and Feb?
  68. 68. Marginal CostingVariable production costs are included in cost perunit(i.e. treated as a product cost).Many businesses only want to know the variable cost of the units theymake, as fixed costs treated as period cost. The variable cost is the extracost each time a unit is made, fixed cost being effectively incurred beforeany production is started.Fixed costs are deducted as a period cost in the profit statementVariable production cost of a unit is made up of $Direct material XDirect Labour XVariable production OH XMarginal Cost of a Unit XContributionIt is the difference between selling price and all variable costs, includingnon-production variable costs.
  69. 69. Example 8X plc produces one product-deskEach desk is budgeted to require 4 kg of wood at $3 per kg, 4 hours oflabour at $2 per hour, and variable production overheads of $5 perunit.Fixed production overheads are budgeted at $20,000 per month andaverage 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 costof $2000 per month.During the first two months X plc expects the following level ofactivity January FebruaryProduction 11,000 units 9,500 unitsSales 9,000 units 11,500 unitsa) Prepare a cost card using marginal costing?b) Set out profit statement for the month of Jan and Feb?
  70. 70. A company commenced business on 1st March making one productonly, 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 ofa budgeted normal output of 36,000 units per annum. The fixedproduction overhead incurred in March was $15,000 each month.Selling, distribution and admin expenses areFixed $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 unitsPrepare the absorption costing and marginal costing incomestatement for March.
  71. 71. 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
  72. 72. Re-apportionment
  73. 73. 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
  74. 74. 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
  75. 75. Chapter 8Marginal and Total Absorption Cost
  76. 76. Contribution Sales Revenue Per Unit Total Sales Revenue Variable costVariable Production & Non-production cost Total Variable Costs per unit CONTRIBUTION Per Unit Total Contribution Fixed CostsFixed Production & non production cost per Total Production cost unit PROFIT
  77. 77. Absorption & marginal costing and profits ABSORPTION COSTING MARGINAL COSTINGValuing units Total production cost Marginal (variable) production costValuing inventory Opening and closing stock valued at total OS and CS valued at marginal production cost costFixed production Carried forward from one period to the FC charged in full againstoverheads 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 neededunder-absorptionImpact of increase in Gives higher profit Gives lower profitinventory levelsImpact of decrease in Gives lower profit Gives higher profitinventory levelsInventory level constant Same profit under both systems
  78. 78. 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)
  79. 79. ReconciliationMARGINAL COSTING PROFIT Increase in inventory * Fixed OARASORPTION COSTING PROFIT
  80. 80. Absorption Vs Marginal
  81. 81. 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
  82. 82. CVP Analysis and Breakeven PointCost-volume-profit(CVP)/Breakeven analysis is thestudy of interrelationships between costs, volume andprofits at various level of activity.The management of an organization usually wished toknow the profit likely to be made if the aimed-forproduction and sales for the year are achieved.Management may also interested to know1) The breakeven point which is the activity level atwhich neither profit nor loss.2)The amount by which actual sales can fall belowanticipated sales, without a loss being incurred.
  83. 83. Breakeven PointThe breakeven point which is the activity levelat which neither profit nor loss.Breakeven Point = Total Fixed Cost(in terms of number of units sold) Contribution per unitBreakeven Point = Total Fixed Cost(in terms of sales revenue) C/S Ratio
  84. 84. ExampleThe 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 numberof units soldb) Calculate the breakeven point in terms of salesrevenue.
  85. 85. C/S ratio/PV ratio/Contribution margin ratioC/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 100,000Calculate the contribution to sales ratio.
  86. 86. Margin of safety and target profitsThe margin of safety is the difference in units between the budgetedsales volume and the breakeven sales volume. It is sometimeexpressed as a percentage of the budgeted sales volume.It may also be expressed as the difference between the budgeted salesrevenue and breakeven sales revenue expressed as a percentage of thebudgeted 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)
  87. 87. ExampleThe 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 budgetedsales.
  88. 88. Target profitSometime an organization might wish to knowhow many units of a product it needs to sell inorder to earn a certain level of profit or targetprofit.Sales volume to = (fixed cost+ required profit)achieve a target profit contribution per unit
  89. 89. ExampleArrow ltd manufactures product A and wishes toachieve a profit of $20,000, the following informationrelate 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 profitof $20,000.
  90. 90. Examplethe 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 ofbudgeted sales).
  91. 91. Breakeven ChartThe Breakeven point can also be determined graphically using abreakeven chart.The breakeven chart plots total costs and total revenues atdifferent levels of output.A breakeven chart has the following axisA horizontal axis showing the budgeted/actual sales/output (interms of units)A vertical axis showing $ for sales revenues and costs
  92. 92. 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.
  93. 93. Breakeven Chart
  94. 94. ExampleThe budgeted annual output of a factory is 120,000units. The fixed overheads amounts to $40,000 and thevariable costs are 50c per unit.The sales price is $1 per unit.RequiredConstruct a breakeven chart showing the currentbreakeven point and profit earned up to the presentmaximum capacity.
  95. 95. Contribution Breakeven ChartA variation on the traditional breakeven chart is thecontribution breakeven chart. The main differencebetween the two charts are as follows,a) The tradition breakeven chart shows the fixed costline whereas the contribution chart shows the variablecost line.b) Contribution can be read more easily from thecontribution breakeven chart than the traditionalbreakeven chart.
  96. 96. Contribution Breakeven Chart
  97. 97. P/ V Chart
  98. 98. Chapter 9Relevant Costs
  99. 99. Relevant Cash Flows INCREMENTALCASH FUTURE Relevant Cash flow
  100. 100. Relevant Cash Flows
  101. 101. Relevant Cash Flows - Materials
  102. 102. Relevant Cash Flows - Labour
  103. 103. Relevant Cash Flows - Labour
  104. 104. Other Relevant Costs•The Relevant cost of overheads is only that which varies as a direct result of thedecision 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).
  105. 105. Chapter 10Dealing with Limiting Factors
  106. 106. Single Limiting factorA limiting factor is a factor thatprevents a company achieving thelevel of activity it would like to.Scarce resources are whereone or more of themanufacturing inputsneeded to make a productare in short supply.
  107. 107. Multiple Limiting factorLinear Programming isthe technique used toestablish an optimum product mix when there are two more resource constraints.
  108. 108. Finding the solution – Method 1Draw an example contribution lineby making up a suitable value ofC, such that the sample line is easyto 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.
  109. 109. Finding the solution – Method 2Co-ordinates of each of thecorners of the feasibleregion are calculated usingsimultaneous 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.
  110. 110. Chapter 11Job. Batch and Process Costing
  111. 111. Job Costing Each job is uniqueProduce acost card for each job. PROFIT can be a mark-up Use the same on cost, or a margin (%). principles of costing
  112. 112. Batch Costing Each batch is different, but items identical. Determinetotal 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.
  113. 113. Process Costing - Features Production is continuous. Difficult to identify units of production. Closing WIPOutput of one Period 1 process = Part-finished By- products & = Lossesinput of next units joint products process Opening WIP Period 2
  114. 114. Process Costing – Losses & GainsNormal Abnormal AbnormalLosses 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
  115. 115. 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
  116. 116. WIP – Equivalent UnitsIf 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 Conversioncompleted evenly Cost valued costs = 50 between spread Weighted spreadcompleted completed over all average or over Eus EUs & part- units FIFO completed units.
  117. 117. WIP – Equivalent Units AVCO 2 Methods FIFOOpening 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
  118. 118. Losses part way through production
  119. 119. Joint and by-products
  120. 120. Joint and by-productsAccountingTreatment
  121. 121. Chapter 12Service and Operation Costing
  122. 122. Service & operation costingHETEROGENEITY INTANGIBILITY Output service industries is different from product of manufacturing. SIMULTANEOUS PERISHABILITY PRODUCTION & CONSUMPTION
  123. 123. Suitable Cost Units Based on their May be necessary More than onerelevance to the to use composite type of cost unitservice 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
  124. 124. Service Cost AnalysisLabour may be the only OH likely to be absorbed direct cost using labour hours
  125. 125. Chapter 13Budgeting
  126. 126. 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.
  127. 127. 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 BudgetingCommunication of targets Performance Evaluation Motivation Authorisation of expenditure
  128. 128. Components of the Budget
  129. 129. Importance of Budgeting Planning for the future Performance Motivation Evaluation Importance of Budgeting Co-ordinating Controlling Activities Cost Communication Authorisation of targets of expenditure
  130. 130. 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
  131. 131. Performance Evaluation• Budgets provide benchmarks against which to compare actual results and develop corrective measures.
  132. 132. 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.
  133. 133. Authorization of Expenditure• Budgets give managers “ pre approval " for execution of spending plans.
  134. 134. 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
  135. 135. 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.
  136. 136. Motivation• It gives a forward looking guidance to managers and employees
  137. 137. • Budgets dont guarantee success, but they certainly help to avoid failure.• Without a budget, an organization will be highly inefficient and ineffective.
  138. 138. 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 factorProduce and approve other budgets based on budget for limiting factor Review variances
  139. 139. Different types of budgets•The Master Budget includes the budgeted income statement, the cash budget andbudgeted statement of financial position (Balance Sheet).•A continuous budget is prepared for a year (or budget period) ahead, and is updatedregularly by adding a further accounting period (month, quarter) when the firstaccounting period has expired (= Rolling Budgets).
  140. 140. Functional budgets Sales BudgetOverheads Production Budget Budget Functional Budgets Raw Labour Material Budget Usage Budget Raw Material Purchases budget
  141. 141. Functional budgets
  142. 142. Functional budgets
  143. 143. ExampleThe XYZ company produces X, Y, Z. For the coming accounting periodbudgets are to be prepared using the following information.Budgeted SalesProduct X 2000 Units at $100 eachProduct 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 costof material $8 $4Inventories of finished goods X Y ZOpening 500u 800u 700uClosing 600u 1000u 800u
  144. 144. Inventories of raw material Wood (kg) Varnish (liters)Opening 21,000 10,000Closing 18,000 9,000Labour X Y ZStandard 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)
  145. 145. Example 1A company makes two products A and B. The productsare 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.
  146. 146. Example 2A ltd manufactures three products. The expected sales of eachproduct 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 leveland closing inventor is budgeted asProduct 1 200uProduct 2 300uProduct 3 300uPrepare the budget for the number of units to be produced ofProduct 1, 2 and 3.
  147. 147. Example 3C ltd manufactures three products. The expected production ofeach 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 themanufacture of the three products. Material requirement areshown 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
  148. 148. The closing inventory of material is expected to beMaterial M1 (kg) 2200Material M2 (kg) 1300 Material M3 (kg) 2000Material prices are expected to be 10% higher than this year andcurrent prices are $1.10/kg for material M1, $3.00/kg formaterial M2 and $2.50/kg fort material M3Prepare a budget of material usage, material purchase andvalue of M1, M2 and M3.
  149. 149. Example
  150. 150. Example - continued
  151. 151. Fixed, flexible & flexed budgets Fixed Flexible FlexedBudget 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
  152. 152. ExampleA ltd manufacture one product and when operating at 100%capacity can produce 5000 units per period. But in last fewperiods operating below capacityBelow is the flexible budget prepared at the start of the lastperiod 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
  153. 153. In the event, last period turned out to be even worsethan expected with 2500 units production only. Thefollowing cost incurredDirect material 4500Direct labour 22000Production overheads 28000Admin Expense 16500Total cost 71000RequiredUse the information given above to prepare thefollowinga)A flexed budget for 2,500 units.
  154. 154. Flexed Budgets and budget variancesVariances 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
  155. 155. Chapter 14Standard Costing
  156. 156. The purpose of standard costingStandard Costing is a control tool formanagement.Standard Costs are collected on astandard cost card. They may be basedon Absorption Costing or MarginalCosting.
  157. 157. Advantages & Disadvantages of Standard Costing
  158. 158. Types of standard Ideal What would be expected under perfect operating conditions AttainableWhat would be expected Basicunder 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
  159. 159. 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) x standardVolume standard contribution/unit profit / unitVarianceStandard Selling Price is not used. When volume changes, so do production costs, and the purpose ofthe variance is to show the impact on profit or on contributionFixed MC does not relate fixed o/h to cost Fixed o/h are related to cost units by usingoverhead 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.
  160. 160. Sales Price Variance Sales Price Variance(Budgeted Sales Price – Actual Sales Price) X Actual Quantity sold
  161. 161. 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
  162. 162. 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)
  163. 163. Variable Overhead variances Variable Overhead expenditure VarianceActual 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)
  164. 164. Fixed Overhead Variances Absorption Costing Fixed Production Overheads Total VarianceExpenditure Volume Variance Variance Efficiency Capacity Variance Variance
  165. 165. Fixed Overhead Variances Absorption Costing Under- or over-absorption of overheadsBudgeted 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
  166. 166. Fixed Overhead Variances Marginal Costing Fixed Production Overheads Total VarianceExpenditure Variance
  167. 167. Causes of Variances
  168. 168. Causes of Variances