amaf lr1 slides.2011 mw

8/3/2019 Amaf Lr1 Slides.2011 Mw

1/47

Advanced Management

Accounting

Weeks 1 to 6


2/47

Advanced Management Accounting

INTRODUCTION AND REVISION

INTRODUCTION

Welcome to Advanced Managerial Accounting and Finance

2011 Qualifying examination statistics

Relevance of this course

Nature of the course

Answering test and exam questions:

Point Form

Report formats where applicable

CONTEXTUALISATION!!!

MULTI DISCIPLINED integrated questions

Deeper level of thinking, surface issues are not sufficient to pass.


3/47



INTRODUCTION For example, consider the following:

The following table indicates operating results for an exporter:

Are variable and fixed costs under control for the exporter??

What is the key driver of the results for the exporter??

ITEM 2010 2011 2012

VOLUME 10 000 11000 11 500

R/$ R7 R8 R10

SALES R70000 R88 000 R120000

VAR. COSTS R35 000 R44 000 R55 000

FIXED COSTS R50000 R56 500 R58 000


4/47



REVISION

Chap 2 Cost terms and concepts

Direct & indirect

Period & product

Fixed & variable

Relevant & irrelevant

Avoidable & unavoidable

Sunk

Opportunity Incremental & marginal

Chap 3 Cost assignment

Allocation of costs to products, overhead apportionment


5/47



REVISION

Chap 4 Job costing

Accounting entries to account for costs

Calculating the cost of the job

Chap 5 Process costing

Valuing WIP and Finished goods in a process costing

environment


6/47


WEEK 1: STRATEGIC MANAGEMENT ACCOUNTING

New section to advanced managerial accounting therefore

important.

What is it? Big picture view of a company relative to its

environment Differentiate between STRATEGY and TACTICS

TACTICS: Short to medium term actions designed to achieve

the objectives set out in a strategy. Usually internal, and the

work that you are familiar with in Managerial Accounting and

Finance: Setting capital budgets

Determining WACC

Relevant costing for repeat orders etc.


7/47



STRATEGY: Long term objectives set up by a company withreference to its external environment given its internalcharacteristics. These items are similar to the vision andmission of a company:

We want to capture the largest market share in our industry We want to grow our share price by 5% every year for the next

generation

Your strategy determines your tactics. Your tactics shouldNEVER determine your strategy.

Given our discussion above, what is strategic managementaccounting?

It is management accounting concerned with how thecompany fits into and grows in relation to its externalenvironment


8/47



Before a company can set objectives for growth and adaptation

to its environment, it needs to understand its environment and

itself:

ENVIRONMENT: PEST ANALYSIS

ITSELF: SWOT ANALYSIS

Now the company can set objectives for itself armed with the

understanding it obtained above:

GOALS MUST BE: S.M.A.R.T

GOALS MUST BE: Based and evaluated on BALANCEDSCORECARD principles (similar to King III triple bottom line

reporting).

Critical to environmental analysis are the principles developed

by Micheal Porter:


9/47



External environment (beyond company control):

PORTERS FIVE FORCES used to determine how competitive an

industry is:

BARGAINING POWER OF SUPPLIERS

BARGAINING POWER OF CUSTOMERS

THREAT OF NEW COMPETITORS IN INDUSTRY

THREAT OF SUBSITUTE PRODUCTS

DEGREE OF COMPETITION IN INDUSTRY

Internal environment (can be controlled by company):

PORTERS THEORY ON COMPETITIVE ADVANTAGE

What is it?

How is it obtained?


10/47



Internal environment (can be controlled by company): PORTERS VALUE CHAIN ANALYSIS

Used to see where a company creates value and where value

is destroyed.

Dont only focus on manufacturing, but also on other

activities in the business (HR, marketing, accounting etc)

Split the analysis into:

PRIMARY ACTIVITIES: MANUFACTURING/SERVICE

INPUT OR INBOUND LOGISTICS

PROCESSIN

G/SE

RVICE

DELI

VE

RY OUTPUT OR OUTBOUND LOGISTICS/SERVICE

DELIVERY

SUPPORT ACTIVITIES:

HR, MARKETING, ACCOUNTING, LEGAL,

INFRA

STR

UCTUR

E


11/47


WEEK 2: ABC AND JOINT/BY PRODUCTS

ACTIVITY BASED COSTING

Traditional vs. ABC systems (pg 223)

ABC is..an absorption costing system that provides more accurateproduct costs by allocating indirect costs (e.g. overheads) toproducts by means of a variety ofcause-effect cost drivers.

Stages in implementation of ABC (4 steps)

Need for ABC: The % indirect cost is significant and increasing. Highly complex environments Numerous product lines on a continuous basis. Resources are shared by many products.

D 10.24, 10.26; Discuss theory on tut Qs


12/47




ABC profitability analysis: ABC product costs are not directlysuitable for decision making, but more readily revealpotential unprofitable products. Three contribution levels

should be analysed:

unit level contribution for each product (i.e. sales minus cost ofunit level activities),

batch level contribution (i.e. unit level contribution minus batch

related costs),

product sustaining contribution (i.e. batch level contributionminus product sustaining costs).

Resource consumption model : PTO


13/47





14/47



ACTIVITY BASED COSTING Resource consumption models:

ABC systems measure the cost ofusingresources and not the cost ofsupplying resources:Cost of resources = Cost of resources + Cost of unusedSupplied used capacity

Periodic financial statements measure the cost of resources supplied(i.e.15 000 orders at a cost of 300000 in Example 10.2 Pg 234).

ABC systems measure the cost of resources used (i.e. 13 000 orders at

a cost of20 per order in Example 10.2).

The difference between the cost of resources supplied and the cost ofresources used represents the cost of unused capacity (i.e. 2000orders at 20 per order=40000)


15/47



Example 10.2 Pg 234

(1) Resources supplied

10 staff at 30000 per year = 300000 annual activity cost

Cost driver = Number of orders processed

Annual quantity of cost driver

supplied:(1 500 orders per employee) = 15 000 purchase orders

Estimated cost driver rate = 20 per purchase order

(300000/15 000 orders)

(2) Resources used

Estimated annual number of

orders to be processed = 13 000

Estimated cost of resources

used assigned to parts/

materials = 260000 (13 000*20)

(3) Cost of unused capacity

Resources supplied (15 000)

Resources used (13 000)

at 20 per order = 40000 (2000*20)


16/47



ACTIVITY BASED COSTING Selecting the cost driver denominator level

The correct denominator activity level to use is the level of capacitysupplied (practical capacity)and not the anticipated usage.

Using anticipated usage in Example 10.2 would result in a cost driverrate of 23.08 (300000/13 000) so that the cost of unused capacitywill be hidden in the cost driver rate rather than being separatelyreported.

Using anticipated usage would result in high cost driver rates inperiods of low sales demand.

The ABC data base Ideally maintained at estimatedstandard costs and periodically

reviewed.

In addition a cost and profitability audit of a firms products, customersand sales outlets should be periodically undertaken.


17/47



JOINT AND BY PRODUCTS Joint products two or more products produced through the

same process and separated in processing each having asufficiently high saleable value to merit recognition as a mainproduct.

By- product output of some value produced incidentallywhile manufacturing the main product.

Valuing joint products:

Common costs incurred up to the split off point.

These common costs need to be allocated between the jointproducts.

Four methods suggested

Physical measures method (Eg. 6.1)

Sales value at split off point method (Eg. 6.1)

Net realisable value method. (Eg. 6.2)

Constant gross profit method. (Eg. 6.2)


18/47



JOINT AND BY PRODUCTS Joint costs are irrelevant for decision making. Further processing decision

illustrated in Eg. 6.3.

By-product valuation - Net realisable value deducted from the joint cost ofproduction of the main product\s. (Eg. 6.4)

Tut Q Alloc joint costs discuss (b.)


19/47


WEEK 3: ABSORPTION AND VARIABLE COSTING

Covered in 3rd year\intermediate

See learning objectives page 141

Understand the differences in net profits where sales volumesdiffer from production volumes

Understand the types of denominators that one could to absorboverheads:

Maximum

Practical

Normal

Budgeted Revise examples and ensure able to produce information in the

required formats, and reconcile profits.

Make sure that you can discuss the arguments for and against thedifferent types of costing systems.


20/47



Arguments in support of variable costing

More useful incremental/relevant information for decision-making (e.g.buy or make).

Separates fixed and variable costs facilitating cost estimation at differentactivity levels.

Eliminates profit manipulation by means of increasedinventory/production levels (deferring fixed costs). This strategy can alsobe discouraged by fixed inventory or stock turnover level requirements.

Excludes capitalising fixed overheads in unsaleable/obsolete/surplusinventory.

Arguments in support of absorption costing

Considers fixed production costs as essential for production and inclusionin products/inventory costs.

Emphasises the recovery of fixed costs in sales revenue in the long run. Consistent with IAS2 used by financial markets to appraise an entitys

performance and share price. The same reporting standards should beused to evaluate/reward managerial performance internally.


21/47



UKZN EXAMPLE

Assume UKZN Limited manufactures and sells 66 centimetre television sets. Actual data for20X8 was:

Opening stock 2000 units

Sales 24 000 units

Production 26 000 units

Selling price per unit R90

Variable costs per unit:

Direct materials R20

Direct labour R10

Direct overheads R6

Selling costs R4

Fixed costs for the year:

Production overhead Actual R324 000(Budgeted R300000)

Selling costs R110000

Administration costs R80000

The company determined its fixed production overhead rate on the basis of its budgetedproduction volume of25 000 units for the next year.


22/47



ABSORPTION COSTING

Sales

Cost of sales

(24 000 x R90) 2160000

1152000

Opening stock

ProductionLess: closing stock

(2 000 x R48)

(26 000 xR48

)(4 000 x R48)

96 000

12

48000

(192 000)

Normal gross profit

Over/(under) absorption

1008 000

(12000)

Actual gross profit

Less: Selling /admin costs

996 000

286 000

Selling costs fixed

variable

Administration costs

(24 000 x R4)

110000

96 000

80000

Net profit 710 000


23/47



VARIABLE COSTING

Sales

Less: variable cost of sales

(24 000 x R90) 2160000

864 000

Opening stockProduction

Less: closing stock

(2 000 xR36

)(26 000 x R36)

(4 000 x R36)

72 000

936 000

(144 000)

Variable selling costs

CONTRIBUTION

(24 000 x R4) 96 000

1200000

Less: fixed costsSelling costs

Administration costs

Production

51

4000

110000

80000

324 000

Net Profit 686 000


24/47


WEEK 3: COST VOLUME PROFIT ANALYSIS

Objective ofCVP

Long run or short run?

NP = (Unit sales x SPpu)-(Unit sales x VCpu) FCor

NP = Unit sales x (SPpu-VCpu) FC

Relevant range Basic formulas: examples pg 170 -173

Break even sales volume and value

Sales volume\value required to make a given level of profit.

Profit from a given level of sales

Selling price required to show a given profit on a given level of sales.

Profit volume ratio (contribution margin)

Margin of safety.

Cash break even Calculated using FC excluding depreciation.

Graphs Break even chart\ profit volume graph.

Assumptions?


25/47



MULTI PRODUCT ANALYSISExample:

Assume two products (A and B) are sold in fixed proportions of 2A:3B,contribution per product is R15 (A) and R25 (B) and total fixed costsR787 500. The multi-product breakeven can be calculated as follows:

Total contribution per sales mix Total contribution for A (2x15 =R30) and B (3x25=R75) is R105

(R30+R75) and Breakeven is 787500/105 = 7500 sales mixes or 15 000 A (7500x2) and

22 500 B (7500x3) Note that the total contribution is R787 500 [(15 000A x R15)+(22500

x R25)

Weighted average contribution per sales mix Weighted average contribution: A R6 (2/5 x R15) plus B R15 (3/5 x

R25) = WA R21 (R6+R15) Breakeven is 787500/21 = 37500 units with 2/5ths or 15 000 of A and

3/5ths or 22 500 ofB Again, total contribution is R787 500 [(15 000A x R15)+(22500 x R25)

Work through See eg. 8.2 Pg 178

Tut Q 8.11 Drury students manual is a multi product example


26/47



Use of computers and CVP: Sensitivity analysis

Scenario analysis

Monte Carlo Simulation

Semi variable costs Apply the high low analysis to split costs into fixed and variable

elements and work from there.


27/47


WEEK 3: LEARNING CURVES AND REGRESSION ANALYSIS

LEARNING CURVES The more often you do something the better you become at

it.

Learning rate and Learning tempo.

Doubling of production, the learning rate kicks in on an

average time per product basis. Average production time per unit is not the same as

cumulative production time.

Learning curve formula: Y=a b(to the power of r)

Example of 80% learning curve: If1 product requires 1 labour hour at R10/hour, how much will we

spend on labour if 4 products are made?

Production doubles twice, once at 2 units and then at 4 units.

Average labour time at 4 products produced per unit = R10 x .8 x. 8 =R6.40

Total expense = R6.40 x 4 = R25.60


28/47


WEEK 3: LEARNING CURVES AND REGRESSION ANALYSIS

REGRESSION ANALYSIS Mathematical means to determine the relationship between

costs and cost drivers in order to predict future cost levels.

Y= a +bx

Detailed regression calculations not required. However, you must understand what the following are and

what they represent:

Co-efficient of variation

Co-efficient of correlation

Graphing the cost relationships on scatter graphs.

Comparison of cost drivers.


29/47


WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING

RELEVANT COSTING: BASICS Defined as future, incremental (differential) cash flows.

Differential additional costs resulting from the decision

Avoidable costs that would be avoided as a result of thedecision

Opportunity costs benefit foregone by choosing anopportunity over the next best alternative. (cost of the next

best alternative)

Non-relevant costs sunk costs, committed costs


30/47



Materials current replacement cost unless alreadypurchased and would not be replaced. In this case use thehigher of resale value and\or opportunity cost.

Using machines repairs, hiring, fall in resale value

Testing any cost against the future differential rule shouldmake the above obvious.

Scarce resources where scarce resources are being divertedto the opportunity, there is an opportunity cost equal to thecontribution currently being earned per unit of the scarceresource.


31/47



Special pricing (Eg. 9.1)

Product mix with limiting factors (Eg. 9.2)

Replacement of equipment (Eg. 9.3)

Outsourcing and make-or-buy (Eg. 9.4)

Discontinuation decisions (Eg. 9.5)


32/47



RELEVANT COSTING: THEORY OF CONSTRAINTS Definition: .a set of concepts ..which aim to identify the

binding constraints in a production system and which strivefor evenness of production flow. . No inventories shouldbe held except prior to the binding constraint.

Managing constraints Glodratts 5 steps:

1. Identify the bottlenecks

2. Exploit (achieving higher throughput in the short term)

3. Subordinate (all operations subordinated to B\C)4. Elevate (i.e. take steps to inc. throughput from B\C)

5. Return to step 1. (Once bottleneck is eliminated attentionmoves to next B\C)


33/47



RELEVANT COSTING: THROUGHPUT ACCOUNTING Key terms

Throughput contribution = sales revenue direct material cost

Other operational cost (Conversion cost) = all operating costexcept direct material

Investment cost = inventory, equipment, building cost

TA is an accounting system, based on TOC and JIT whichmeasures the throughput contribution per factory hour (timeperiod).

Similar to marginal costing, but used to make longer termdecisions. Main difference is that TA treats all labour as fixedin the short term.


34/47



RELEVANT COSTING: THROUGHPUT ACCOUNTING TA ratio

Return (Throughput contribution) per time period/ cost pertime period

Based on throughput contribution of bottleneck resource. A

profitable product would have a ratio greater than 1

Return per factory hour (time period) (Sales price material costs) / time on key resource

Cost per factory hour (time period) Total factory cost / Total time available on key resource

See example 9A.1 page 211


35/47



LINEAR PROGRAMMING

Used in relevant costing typically when there are multiple

resource constraints and/or multiple products.

Solved graphically and mathematically, although practical use

is limited due to Excel and other software packages.

Essentially you create linear equations for each resource

input you use and you create an objective function equation.

Consider the following:

Product A requires 5 labour hours, product B requires 3 labour

hours. Product A requires 10 kgs of materials and product B

requires 5 kgs of materials. Only 1000 labour hours are

available and only 1000 kgs of materials are available.


36/47



LINEAR PROGRAMMING Consider the following:

Product A has a contribution of R20 per product and product B

has a contribution of R15 per product.

Determine the constraint equations and the objective functionequation:

Note: A and B represent number of products of A and B, and y

represents the maximum contribution given the constraints.

Labour constraint: 1000 = 5A + 3B

Material constraint: 1000 = 10A + 5B

Objective: y = 20A + 15B

The equations above would be plotted on a graph and a

maximum contribution subject to the constraints would be

derived.


37/47


WEEK 5: PRICING AND PROFITABILITY ANALYSIS

Cost plus pricing Price taker vs price setter Long-run vs. short-run price decisions

Whether price taker or price setter, in short-run decisions a

price should be set so that incremental revenue exceedsincremental cost.

Must meet the following conditions: Sufficient capacity must be available to meet the order. The bid price should not effect future selling prices and the

customer should not expect repeat business at short-termincremental cost. The order will utilize unused capacity for only a short period and

capacity will be released for use on more profitableopportunities.


38/47



A price setting firm facing long-run pricing decisions

Three scenarios considered:

1. Pricing customized products using cost-plus pricing.

2. Pricing non-customized products using cost-plus pricing ordemand estimates. (see example 11.2 Pg 252)(next OH)

3. Pricing non-customized products using target costing.

In the long-term a firm can adjust the supply of resources that

are committed to it - therefore a product or service should bepriced to cover all of the resources that are committed to it.This is effectively a full-cost plus (excluding only facilitysustaining costs) pricing policy.


39/47


Non-customized products

PRICING DECISIONS AND PROFITABILITY ANALYSIS

Example 11.2(a)

Sales volume 100 120 140 160 180 200

Total cost 10000 10 800 11200 11 600 12 600 13 000

Required profit contribution 2000 2000 2000 2000 2000 2000

Required sales revenues 12000 12 800 13 200 13 600 14 600 15 000

Required SP to achievetarget profit contribution 120.00 106.67 94.29 85.00 81.11 75.00

Unit cost 100.00 90.00 80.00 72.50 70.00 65.00

Example 11.2(b)

Potential selling price 100 90 80 70 60

Estimated sales volume

at the potential selling price 120 140 180 190 200Estimated total sales revenue 12000 12 600 14 400 13 300 12000

Estimated total cost 10 800 11200 12 600 12 800 13 000

Estimated profit (loss)

contribution 1200 1 400 1 800 500 (1000)Management and Cost Accounting, 7th edition.

2008 Colin Drury


40/47



A price taker firm facing long-run product-mix decisions

In the long-term a firm can adjust the supply of resources thatare committed to it Therefore the sales revenue from aproduct or service should be sufficient to cover all of the

resources that are committed to it.

Periodic profitability analysis is required to ensure that onlyprofitable products/services are marketed, that is that youproduct mix optimises your profits.

Profitability analysis should be used as an attention-directingmechanism.

Ideally ABC hierarchical profitability analysis should be used(see figure 11.1 page 255).


41/47



Cost + pricing arguments for & against

Criticisms of cost-plus pricing:

Ignores demand

Does not necessarily ensure that total sales revenue will exceed totalcost.

Can lead to wrong decisions if budgeted activity is used to unitize costs. Circular reasoning Volume estimates are required to estimate unit

fixed costs and ultimately price.

Reasons for using cost-plus pricing:

May encourage price stability

Demand can be taken into account by adjusting the target mark-ups.

Simplicity

Difficulty in applying sophisticated procedures where a firm marketshundreds of products/services.

Used as a guidance to setting the price but other factors are also takeninto account.

Applied to only the relatively minor revenue items.


42/47


WEEK 6: RISK AND UNCERTAINTY

Very important concepts both in Managerial Accounting andin Managerial Finance

What elements in managerial accounting are subject to risk

and uncertainty?

Returns on projects (in the forms of cash flows) Costs to be incurred in projects (again cash flows)

Refer to the examples discussed on pages 271 and 272

Probability:

likelihood of an outcome Probability must be exhaustive.

Probability can be:

Mutually exclusive (shown in simple probability distributions)


43/47



Probability: Probability can be:

Conditional (decision trees)

Subjective (you input your experience and judgement into aprobability calculation)

Objective (you use historical data and research to form aprobability)

Which do you consider to be the better measure?

Probability distributions are tables that show you values foroutcomes of certain events together with the probabilities thatthese outcomes will occur.

Expected Value:

Expected value or the expected cost is simply the probability ofan event occurring multiplied by the events expectedoutcome.


44/47



Measures of risk: Standard deviation

What is it?

Historical versus Probabilistic

Problems?

Coefficient of variation

What is it?

Historical versus Probabilistic

Problems?

Remember the risk and return measures are on

measures based on average units. Up to this point we considered simple probability.

However this is not realistic since probabilities areconditional on the choices management makes.


45/47



Decision trees (see figure 12.1)Example

A company is considering whether to develop and market a new product.

Development costs are estimated to be 180 000, and there is a 0.75 probability

that the development effort will be successful and a 0.25 probability that the

development effort will be unsuccessful. If the development is successful, the

product will be marketed, and it is estimated that:

(i) If the product is very successful, profits will be 540000.

(ii) If the product is moderately successful, profits will be 100000.

(iii) If the product is a failure, there will be a loss of 400000.

Each of the above profit and loss calculations is after taking into account thedevelopment costs of 180000. The estimated probabilities of each of the

above events are as follows:

(i) Very successful 0.4

(ii) Moderately successful 0.3

(iii) Failure 0.3


46/47



Decision tree for example on previous slide


47/47



Expected Value of Perfect Information Enables one to calculate how much expected profits will be

increased by if information to remove uncertainty was available

Example:Low Demand High Demand EV

Machine A: R100000x .5 + R160000x .5 = R130000

Machine B: R10000 x .5 + R200000x .5 = R105 000

Equal probability of high and low demand.What is the expected value?

What is the value of perfect information?

Asks the question how much would EV increase by, if advanceinformation about demand was available?

amaf lr1 slides.2011 mw

Documents