mn20019 revision lecture (4)

8/3/2019 MN20019 Revision Lecture (4)

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Management Accounting

MN20019Lecture 11

Revision


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Lecture 1

Introduction to

Management Accounts


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Management vs Financial

Accounting

Nature of Reports

Level of Detail Regulations

Reporting Interval

Time Horizon Range and Quality of Information


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Management Accounting vs.

Financial AccountingFinancial

Accounting

Management Accounting

Legal Requirement Yes No

Users External & Internal Internal

Level of precision True & Fair Meet users needs i.e. As accurate aspossible

Rules GAAP No rules though some establishedtechniques

Reporting Past data Past & present make future decisions

Scope Whole organisation Segments/depts/products or anyrequirement

Frequency Annually As required

Format Stipulated in Cos act

No set format


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Strategic Decision Making Strategy:

An organisations overall plan or policy to achieve

its goals. Key questions: Where do we want to go?

How are we going to get there?

Theory of constraints: Indentify and remove constraints in system E.g. Limited by supply of raw materials or skilled

labour

i.e. bottlenecks


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Cost Classification The arrangement of cost items into logical

groups; by:

Function

e.g. Administration, production, etc

Nature

e.g. Raw materials, wages, etc

Aim of costing:

Determine the cost of producing a product


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Cost Components Production costs

Materials

Labour

Overheads

Non-production costs

Administration Selling

Distribution

Finance


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Lecture 2

Cost Behaviour, Cost

Estimation & CVP


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Total Cost Y = a + bx

Y = dependent variable (e.g. Total cost)

a = Y intercept (e.g. Fixed cost)b = is the slope of the line (e.g. Variable cost

per unit)

x = independent variable

(e.g. Output)

Therefore

TC = FC + (VC/unit * output)


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Cost Estimation

High/low methodUseful in analysis and planning

Determine fixed and variable cost

Use high/low method: 4 stepsSTEP1 - Analyse costs from previous periods - select highest and

lowest activity level and associated costs

STEP2 - Find the change in cost resulting from the change in output

STEP3 - Calculate the VC/unit.

STEP4 - Substitute back into formula of lineAssumption about costs:

Output costs: either fixed, variable or semi-

variable

Variable costs per unit are constant


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Cost Estimation

Least-squares method Mathematical regression line of best fit

Sum of squares of vertical deviations from that line isless than the sum of the squares of the verticaldeviations from any other line that may be drawn.

Y = a + bx

See Drury 7th p602 for example

!

y b x

a n n 2 2( )

!

n xy x y

bn x x


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Break-Even Point Calculation: Break-even: i.e. Contribution = fixed costs

Contribution/unit * Q = fixed costs

Fixed CostsContribution/unit

Breakeven Point (BEP) =

Output (units) Total costs

6,000 44,700

8,000 57,700

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Example:

A company has different output levels, and incurs different total

production costs at each level, as follows:

Required:

a) If the selling price is 8/unit, what is

the BEP (in units)?

b) What is the break-even revenue?


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Contribution to Sales (C/S) Ratio Alternative method to find BEP

i.e. The amount of contribution earned per of sales

A.k.a. The profit-volume (P/V) ratio Used to find break even revenue

Example (continued)

What is the C/S ratio?

What is the break-even revenue?

Fixed Costs

C/S RatioBreak-even Revenue =

13


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Margin of Safety Degree to which companies are profitable

A loss is made if sales volume is less than

BEP Margin of safety (as %) = budgeted sales

volume break-even sales volume

MoS (%) =

14

Budgeted sales volume - B/E sales volume

Budgeted sales volumex 100%


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Required Profit Levels Assess volume for required profit level

The required profit is like an additional fixed cost whichmust be covered before the company breaks even.

Example: using the same data as before

i.e. Fixed costs = 5,700 & contribution = 1.50/unit

Requirement: Whats the sales volume to make a profit of 10,000?

Answer: Volume = (FCs + required profit)/contribution

= (5,700+10,000)/1.50 = 10,467 units

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Lecture3

Limiting Factor Analysis &

Linear Programming


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Limiting Factor/Scarce Resource Companies create production and sales budgets

May be impacted by a limiting factor/scarce resource

A.k.a principal budget factor

Principal budget factors include:

Market demand

Materials

Manpower (labour)

Machine hours

Capital

The plans of the business must be built aroundthis factor.

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Can also be thought of as

restrictors of growth


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Single Constraint If produce more than one product

Find product mix which maximises profit given

this limited factor

i.e. Maximise contribution in following steps:

i) Determine limiting factor by producing to

maximum demand

ii) Rank products by contribution per unit of

limiting factor

iii) Prepare a production plan

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Multiple Constraints Methods discussed earlier (i.e. single

constraint) do not apply when:

More than one limiting factor exists

Products rank differently for these resources

Under these assumptions linear

programming provides solutions; using Graphs (for 2 products)

Computer programs (for more than 2

products) 20


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Shadow Prices Calculated from the graphical method

Relaxing (or constraining) one of the limiting

factors by a small amount. Usually one unit

Recalculate the optimal solution and associated

contribution

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Lecture 4

Income effects ofAbsorption Costing (AC)

and Marginal Costing (MC)


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Cost Cards Cost card can be drawn up for each

job/batch

Absorption Costing or Marginal costing

Profit calculated by:

Mark-up

i.e. % of total costs

Margin

i.e. % of selling price

Job Cost Card

Job XYZ

Direct Materials x

Direct Labour (hrs * /hr) xVariable Overheads (hrs * /hr) x

Prime Cost x

Fixed Overheads x

Total Cost x

Profit x

Selling price of job x


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Predetermined Overhead

Absorption Rates Businesses cost production throughout year

Therefore predetermine (estimate) absorption

rate Pre-determined OAR =

Note: activity levels refers to production activity

not sales

i.e. Activity levels are the long-term average

Production overheads

- Costs required to support the production process

Budgeted overhead

Budgeted activity level


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Absorption into production

At year end:

Due to:

Actual expenditure more/less than budgeted(expenditure variance)

Actual units produced (volume) were more/less

than budgeted (volume variance)

Overheads Actual levels Predetermined

absorbed (eg labour hrs) OAR= *

Overheads Actual levels Predetermined

absorbed (eg labour hrs) OAR= *

Overheads Actual

Absorbed Overheads


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Under and over absorption of

overheads


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Absorption Costing (AC) Principles of AC

Method whereby allproduction costs are

included in the cost of a cost unit i.e. Direct materials and labour, variable and fixed

production overheads

IAS 2 requires an element of fixed production

overheads to be absorbed into product costfor inventory valuation purposes

All production costs are charged to units ofproduction


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Marginal Costing (MC) Some businesses just want to know variable

costs of the units

Consider fixed costs as period costs (i.e. as sunkcosts)

Marginal costing (MC) includes only thevariable cost of a product or a service

i.e. Cost which could be avoided if the unit notproduced

In text book Variable costs = marginal costs


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Marginal Costing (cont.) Cost card:

Cost Card - marginal costing/unit

Direct Materials x

Direct Labour x

Variable Overhead x

Marginal Cost xFixed Overheads x

Full Production Cost x

Used to value

inventory

under MC

Used to value

inventory

under AC


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Lecture5

Cost Assignment


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Service Centre Cost Allocation:

Overview Businesses: determine total cost of making a

product for Profitability analysis

Selling price determination

Inventory valuation purposes

Cost card: Cost/Unit

Direct materials 4kg@2/kg 8

Direct labour 3 hours @ 7/hr 21

Direct expenses 4

Prime costs 33

Indirect costs (overheads) 10

Total cost4

3


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Production Overheads Overhead

Costs incurred in the course of production that

cantbe traced directly to the product or service. Overheads can be broken down into:

Indirect materials e.g. Oil, grease, paper towels

Indirect labour supervisors salary, CEO salary

Indirect expenses rent, rates, insurance,depreciation

Prime costs easy to determine and allocate

Overheads can be difficult!


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Steps Step 1

Allocation and apportionment of production

overheads to cost centres

Step 2

Reapportion service cost centre overheads

Step 3 Absorption of overheads into production


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Step 1 - ExampleAllocation and apportionment of production overheads to cost centres

Overhead allocation and apportionment

Mars Ltd has the following overheads in the year ended 31 December 20x5

Overheads:

Rent and rates 90,000

Insurance of machinery and equipment 40,000

Stores costs (wages and salaries) 75,000

Heating costs 57,000

262,000

Additional information:

Mixing Stirring Stores Canteen Total

Floor space (square ft) 9,000 3,000 1,000 2,000 15,000

NBV of machinery and equip. 2,000 1,000 600 400 4,000


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Step 2 (cont.) Service centre cost apportionment

Two methods:


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Step 2 (cont.) Direct Method: (simple but inaccurate)

All inter-service department work is ignored

Overheads reapportioned directly to production

cost centres Mainly used when:

Only one service centre, or

Service centres do not work for each other

The Reciprocal Method (repeat distribution) Recognises all inter-service department work

Carried out in two ways: Repeat distribution/continuous apportionment, or

Algebraic method


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Step 3 Absorption of

overheads into production

All production overheads now apportioned

Need to charge to COST UNITSpassingthrough process

i.e. Termed Absorption

OAR: Production overhead

Activity levelOAR =


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Activity Based Costing (ABC) Modern alternative to Absorption Costing (AC)

Traditional Absorption Costing (AC) Uses a single basis forabsorbing overheads into cost

units Companies choose best/most appropriate basis for

absorption

X


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ABC (cont.) Is an extension of AC

Considers what causes each type of

overhead (i.e. what the cost drivers are) Steps in ABC

Step 1: Group overheads into activities

Step 2: Identify cost drivers for each activity Step 3: Calculate cost per unit of cost driver

Step 4: Absorb activity costs into production

Based on usage of cost drivers


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Lecture 6

Measuring RelevantCosts and Revenues for

Decision Making


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Relevant Costs A future cashflow arising as a direct

consequence of a decision.


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Relevant Input Costs - Materials


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Relevant Input Costs - Labour


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Relevant Input Costs - Overheads In general:

Variable costs will be relevant costs

Fixed costs will be irrelevant to a decision

Note: there may be times when FCs are

relevant

General fixed overheads - not relevant! Often apportioned share of fixed costs

i.e. Unaffected by decision


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Short-term Decisions Based on

Relevant Costs1) Make or Buy?

Maximum price to outsource

Ignore sunk/unavoidable costs

2) Shutdown decisions Decisions involve the closure of divisions/products

(Adding/Dropping Segments)

Appear to be loss-making

Focus on relevant costs (and revenues) IFtheclosure is made, i.e. impact on whole organisation

3) Special Orders

Minimum price for one-off decisions

Its total relevant costs (price breaks even)


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Lecture 7

Capital InvestmentDecisions


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Investment Decision Making Decisions of a long-term nature Form part of the capital budget

Proposals generated by:

Environmental scanning In response to an identified problem

Evaluation techniques (or combination)a) Payback period

b) Accounting rate of return

c) Net present valued) Discounted payback

e) Internal Rate of Return

f) Modified Internal Rate of Return


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Capital Rationing - Summary


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Taxation and Investment Decisions Taxation legislation specifies that net cash

inflows of companies are subject to taxation,

and capitalallowances (writing downallowances) are available on capital

expenditure.

STEP 1 Calculate capital allowances

STEP 2 Calculate incremental taxes arisingfrom the project

STEP 3 Tax effect of balancing allowance


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Lecture 8

Budgeting


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Budgets Part of the overall process of planning and control

Budgets: assist in achieving objectives


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Budget PreparationSales Budget

(units, s)

Production

Budget(units)

Overheads

Budget(units, s)

Labour

Budget(hrs, s)

Materials Usage

Budget

(kgs, litres, etc)

Materials Usage

Budget

(kgs, litres, etc)

Operating budgets:

Budgeted Financial Statements


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Alternative Budget Systems

Fixed vs. Flexible Budgets

Incremental Budgeting vs. Zero-base Budgeting

Rolling budgets (Continuousbudgets)

Activity-based Budgeting


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Behavioural Aspects Participation in budgeting

In a top-down system, budgets imposed onindividuals by managers

In bottom-up system, budget holder invited tohave input at the budget setting stage

Advantages of top-down (imposed)

systems

Advantages of bottom-up budgeting

systems

Likely to be quicker More detailed local information used in

budget setting process

Avoid budgetary slack and budget bias Morale and motivation is improved

Utilise senior management awareness of total

resource availability

Increased likelihood of achievement

Avoids taking local management away from

day-to-day duties


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Beyond Budgeting Recently criticisms levelled at tradition budgeting:a) Time consuming and adds little value

b) Insufficient external focus

c) Too rigid and prevents rapid response

d) Protects rather than reduces costse) Stifles innovation

Beyond budgeting: 2 underlying concepts

i) Adaptive management processes ii) Decentralised management

Planning on a rolling basis Mangers empowered to make decisions (speeds upresponse times and exploits opportunities)

Focus on cash forecasts not cost control Responsibility drives motivation. Rewards are team

based

KPIs referenced to external benchmarks

such as competitors

Customer-orientated teams are established


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Lecture 9&10

Standard Costing andVariance Analysis


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Standards A standard

Represents what should happen than what has

happened

Prepared by management in advance Details expectations of the future

Standard cost is a predetermined estimated

unit cost

Calculated using expectations of:

a) Efficiencylevelsin the use of materials and labour

b) Expectedprice of materials, labour and expenses

c) Budgetedoverheadcosts and activity levels


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Uses of Standard Costs Two principal uses

Value inventory and cost production (MC &AC)

Acts as a control device (variance analysis) i.e. Difference between standard & actual results

Advantages of setting standards Disadvantages of setting standards

a) Facilitates budgetary control a) Difficult to forecast accurately

b) Leads to more accurate budgeting b) Time consumingc) Assists performance measurement c) Regular revisions required

d) Assist in target setting for staff d) Demotivating if wrong

e) Assists in price setting

f) Simplifies bookkeeping


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Variances Explain the difference between actual results

and expected results and provides

information for performance evaluation andcontrol purposes. i.e. Standard costs and revenues

Variances can be divided into three main

groups: i) Variable cost variances

ii) Fixed overhead variances

iii) Sales variances


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A General Model

for Variance Analysis

AQ(AP - SP) SP(AQ - SQ)

AQ = Actual Quantity SP = Standard Price

AP = Actual Price SQ = Standard Quantity

Price Variance Quantity Variance

Actual Quantity Actual Quantity Standard Quantity

Actual Price Standard Price Standard Price


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Material Variances: Price and Usage


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Labour: Rate, Idle Time & Efficiency


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Labour: Rate, Idle Time &

Efficiency


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Variable Overhead Variances:Expenditure & Efficiency variance


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Fixed overheads Variances

under MC and AC Marginal Costing:

Absorption Costing:

Fixed overhead expenditure variance

= Budgeted fixed overhead Actual fixed overhead


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Sales Variances: Price and Volume


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Budgeted net profit xxx

Sales variances

Sales margin price xxx

Sales margin volume xxx xxx

Direct cost varianceMaterial Price: xxx

Usage: xxx

Labour Rate xxx

Efficiency xxx

Manufacturing overhead variancesVariable overhead Expenditure xxx

Efficiency xxx

Fixed overhead expenditure xxx xxx

Actual profit xxx

Operating Statements

(Standard Marginal/Variable Costing System)


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Budgeted net profit xxx

Sales variances

Sales margin price xxx

Sales margin volume xxx xxx

Direct cost varianceMaterial Price: xxx

Usage: xxx

Labour Rate xxx

Efficiency xxx

Manufacturing overhead variancesVariable overhead Expenditure xxx

Efficiency xxx

Fixed overhead Expenditure xxx

Volume xxx xxx

Actual profit xxx

Operating Statements

(Standard Absorption Costing System)


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Interpretation of Variances Care taken when interpreting variances

Operational causes of variances (See pdf

file)

Interdependence of variances:

Identified for effective interpretation

When two variances are interdependent; One usually adverse

The other favourable


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Interdependence of Variables Eg:

Variance analysis Consider overall consequence


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Revisiony Exam paper 2010/2011

y Lecture slides (and other materials)/ seminar questions

y Use self-assessment questions as additional revision exercises (solutions at the back of

Drury 7th).


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Exam

Date: 27 January

Time: 16h30

Venue: ?

Format: Choose 4 from 5 (4*25 marks) No lecture on Jan 9th (Revision Week),

instead, email me ([email protected]) in

advance for a clinic slot between 13:00

17:00, Jan 11th, Wednesday. Note that the group project mark will be

released via email during the revision week.

mn20019 revision lecture (4)

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