ACCA

Paper MA

Management Accounting
Revision Cards

For Exams until August 2020

British Library Cataloguing-in-Publication Data
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ISBN 978-1-78480-703-0

Second Edition 2019

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How to boost your chances of passing your exam using these Revision Cards

These Revision Cards should form an integral part of your exam preparation and be used
in conjunction with the Study Manual, which you should have used to gain the knowledge
needed. You should also use the Question Bank to get used to the types of question asked
in the exam, apply your knowledge, improve your exam technique and get in prime shape
for this exam.

Revision Cards contain knowledge in text form as well as diagrams and tables to help you
remember key details you need for the exam. In order to get the most from them you need
first to try to think what you’d expect to see in a chapter, without peeking. If you could
recite the full chapter straight away you’d be in a great position if that subject came up in
the exam! The serious point is that you need the knowledge in your head, which you can
take into the exam, rather than on paper, which you can’t. 
After you have thought what you know already, then look at these Revision Cards
to prompt you on what you didn’t remember and to get confidence from the
parts you do remember. Use our overview in the Study Manual as one way to help
you remember and tie the parts of the paper together – useful if you are asked a
question that deals with more than one part of the syllabus. You learn by repetition
and the above process helps you repeat knowledge. If you still have difficulties
putting the knowledge into practice then go back again to these Revision Cards until
you can recall quickly and accurately.

Finally, after question practice from the Question Bank, think what you have been
asked in the question requirements and look back to these Revision Cards to make
sure you link the knowledge together and make notes to consolidate for next time
you try a similar question.

Good luck with the exam; remember that boosting your knowledge levels,
practice on exam standard questions and making sure you have a plan for the
exam (knowing what you can do in the time available) are key to your success.
 Contents
Page
Introduction to the Paper 7
Chapter 1 The Nature and Purpose of Management Accounting 9
Chapter 2 Cost Classification, Behaviour and Purpose 25
Chapter 3 Cost Accounting Techniques (Materials) 47
Chapter 4 Cost Accounting Techniques (Labour) 71
Chapter 5 Cost Accounting Techniques (Overheads) 85
Chapter 6 Marginal and Absorption Costing 93
Chapter 7 Alternative Cost Management Techniques 101
Chapter 8 Job, Batch and Service Costing 107
Chapter 9 Process Costing 115
Chapter 10 Process Costing with WIP 131
Chapter 11 Budgeting 135
Chapter 12 Statistical Techniques 1 145
Chapter 13 Statistical Techniques 2 167
Chapter 14 Investment Appraisal Techniques 179
Chapter 15 Standard Costing and Variance Analysis 193
Chapter 16 Performance Measurement 219
6
Introduction to the Paper

7
 Introduction to the Paper

The aim of the paper is to develop knowledge and understanding of management accounting
techniques to support management in planning, controlling and monitoring performance in a
variety of business contexts. Think about what you know from the following areas before you get
into more detail:
1. Explain the nature, source and purpose of management information
2. Explain and analyse data analysis and statistical techniques
3. Explain and apply cost accounting techniques
4. Prepare budgets for planning and control
5. Compare actual costs with standard costs and analyse any variances
6. Explain and apply performance measurements and monitor business performance

8
 Chapter 1
The Nature and Purpose of
Management Accounting

9
 Types of accounting Chapter 1

There are three different types of accounting that we will see at the knowledge level:
• Financial accounting
• Management Accounting
• Cost accounting

10
Financial accounting Chapter 1

Financial Accounting focuses on the recording of transactions and balances in the accounting
records and financial statements of a business.
Financial Accounting is historic, and is mainly aimed at external parties of the business such as
shareholders, bankers, etc.

11
 Management accounting Chapter 1

Management information and management accounts however will allow the managers of the
business to fulfil the following functions:
• Planning
• Control
• Decision making

12
Cost accounting Chapter 1

Cost accounting provides management with detailed information about:

• The relevant expenses and sales prices/revenues associated with particular activities,
departments and processes. This allows management to assess profitability.
• Inventory valuations, in order to value stocks appropriately for Financial Reporting purposes.

13
 Comparison between financial and management Chapter 1
accounting

Financial Accounting Management Accounting

Purpose Record historic transactions • assist in controlling the business
operations
• planning how the business will
develop
• making decisions between
alternatives
Audience External parties – particularly Internal management and owners of
shareholders, lenders and regulators the organisation
Legal • prepare financial statements • No legal requirement to prepare
requirements (in accordance with legal • No set format for presentation
requirements)
• prepare accounts for tax
authorities

14
Comparison between financial and management Chapter 1
accounting (cont.)

Financial Accounting Management Accounting

Format Must conform to accounting and Presented in such a format as to be
legal requirements easily understood by managers
Perspective Historic performance (i.e. Both future perspective (for
backwards looking only) planning and decision-making) and
historic perspective (for control)
Nature of Almost entirely financial Both financial and non-financial
Information
Frequency of Usually once a year As often as necessary – daily,
Preparation weekly preparation or monthly,
depending upon the needs of
managers.

15
 Data versus information Chapter 1

Data is raw facts that have not been processed into a meaningful form that is of use to
management. For example data could be numbers, symbols, letters, words, transactions etc but
not presented in a manner that is understood by management.
Information is data that has been processed into a form that is understandable and hence of use
to management.

Data + Meaning = Information

16
Attributes of good information Chapter 1

Accurate The information should not contain errors or miscategorisations

Cost efficient The benefit derived from the information should outweigh the cost of producing
and processing it
Complete All the information needed by the manager should be provided
User-focused The information should be provided in the manner required by the user
Relevant The information needs to be focused on the decision being taken
Authoritative The information should be produced from a reliable data source
Timely The information must be produced in advance of the time when it is needed
Ease of use The information needs to be accessed and understood quickly and efficiently

17
 Decision making levels Chapter 1

Decision making takes place on varying levels and the management accounting system and
information will need to give enough information for important decisions to be made.
Operational level
Day-to-day running of the business, lower level managers.
Tactical or Functional level
Medium term future of the business, focused on particular business units or departments.
Strategic level
Senior management, long-term decisions over the future of the whole business.

18
Cost, revenue, profit and investment centres Chapter 1

A Responsibility centre is a production or service location, a function, an activity or an item of

equipment for which costs, revenue and/or capital investment levels can be ascertained (either a
cost, profit, revenue or investment centre)
A Cost centre is a responsibility centre for which only revenue costs can be identified and controlled
A Revenue centre is a responsibility centre for which only revenue income can be identified
and controlled
A Profit centre is a responsibility centre for which both revenue costs and revenue income can
be identified and controlled
An Investment centre is a responsibility centre with control over all of its revenue costs, revenue
income and capital investment levels

19
 Sources of Information Chapter 1

Internal information
Wage rates
Production rates
Sales price and volume statistics
External information
Government statistics
Professional and trade statistics

20
Sampling Chapter 1

A number of sampling techniques can be used which enables conclusions about a whole population.
Random – each item in the population has an equal chance of selection
Systematic – population is ordered samples are selected systematically e.g. every 10th item
Stratified – population is divided into different categories and samples are chosen randomly
from each category.

21
 The economic environment Chapter 1

The macroeconomic environment

• Growth
• Control of inflation
• Full employment
• External balance
Fiscal policy
Fiscal policy is the decisions the government takes regarding taxation and public expenditure. A
government can spend more than it receives in taxation, the difference being referred to as the
‘budget deficit’.
Monetary policy
Monetary policy is the decisions that the government makes regarding the rate of interest and
the supply of money to the economy.

22
Big data Chapter 1

Refers to the accumulation of large amounts of both historical and current data.
The characteristics of big data are described by the ‘3Vs:
• Variety
• Volume
• Velocity
Sometimes ‘veracity’ is also added.
Once the data has been accumulated it can be searched (or ‘mined’) to try to discover trends,
patterns and associations that can help the organisation’s decision-making and marketing

23
24
 Chapter 2
Cost Classification, Behaviour and
Purpose

25
 Cost units Chapter 2

A cost unit is a unit of production or service for which costs can be ascertained.
To arrive at a cost unit figure the relevant costs associated with that product/service must
be ascertained.

26
Cost centres Chapter 2

Costs will often first need to be accumulated in a cost centre. A cost centre is a process,
department or activity where costs can be accumulated.

27
 Production costs Chapter 2

Production costs relate to costs that incurred in the manufacture of goods or the delivery of a
service. They are incurred as a result of manufacture and therefore should be included in cost of
sales (in the Income Statement) and should also be included as part of the inventory valuation (in
the Balance Sheet assets).
Inventory valuation should only include costs incurred to bring the cost unit to its current
location and condition. If a business has products within its inventory, then only production costs
incurred to date should be charged to those cost units.

28
Types of production costs Chapter 2

Production costs are likely to have a number of component parts:

• Labour
• Materials
• Expenses
• Production overheads

29
 Production costs and Direct costs Chapter 2

Production costs which are clearly attributable to the manufacture of a good or service are direct
costs or prime costs. These costs consist of:
• direct materials
• direct labour
• direct expenses

30
Indirect costs or Overheads Chapter 2

Indirect costs or overheads are costs incurred by the business which are not easily identifiable
with individual cost units
The business needs to identify whether these overheads relate to production or whether they
relate to the general administration and running of the business (non-production).

31
 Production overheads Chapter 2

Production overheads relate to production costs incurred in the manufacture of a good or service
that are not ‘easily’ attributable to each cost/unit. Such costs could be:
• production machine depreciation and maintenance
• factory heat, light and insurance
• factory supervisor’s salary
• stores department expenses
• goods inwards costs
• oil and grease for machinery.
Production overheads should be included in the inventory valuation because they are expenses
incurred in the actual manufacture of the goods/services

32
Inventory valuation example Chapter 2

Input Quantities Cost $

Input Quantities Cost ($)
Direct Material – wood 6 metres @ $6.50 $39.00
Direct Labour – craftsmen 5 hours @ $14/hour $70.00
Direct Expenses – royalty $2 per table $2.00
Prime Cost $111.00
Production overheads 5 hours @ $12.80/hour $64.00
Inventory valuation per table $175.00

33
 Non-production costs Chapter 2

Non-production costs are incurred by the organisation in order to operate as a successful entity.
However these costs are not directly related to production and are therefore EXCLUDED from the
inventory valuation
The main types are:
• Distribution costs
• Selling costs
• Finance costs
• Administration costs

34
Fixed versus variable costs Chapter 2

Cost Related activity Likely cost behaviour

Direct materials Production levels Cost increases in proportion to
output (variable)
Machine depreciation Production Unchanged as output increases
(fixed)
Sales staff remuneration Sales levels Basic salary unchanged as sales
levels increase (fixed) Commission
earned increases in proportion to
sales (variable)

35
 Total fixed costs Chapter 2

Any cost that does not change with activity levels is likely to be a fixed cost.
Graphically, for a hospital paying a doctor a salary per annum of $50,000:

Total Cost
($)

$50K

0
Activity level

36
Fixed cost per unit Chapter 2

Fixed costs, although fixed in total, do reduce on a per unit basis as production rises. Consider
the doctor’s salary cost per operation:

Cost per
operation
($)

$250

$100

0 200 500 No. operations

Many businesses therefore try to ‘utilise’ resources such as staff or machinery extensively in
order to obtain as low a cost per unit as possible.

37
 Fixed costs Chapter 2

Examples of fixed costs:

• Depreciation
• Property rental
• Rates
• Property insurance
• Fixed salaries
• Machinery rental

38
Variable costs Chapter 2

Any cost that changes with activity level is likely to be a variable cost:

Total Cost
($)

$150

$60

0 20 50 No. customer
treatments

39
 Variable cost per unit Chapter 2

The variable cost per unit is constant as production volumes change:

Cost per
treatment
($)

$3

0
No. customer treatments

40
Stepped fixed costs Chapter 2

Some fixed costs are only fixed only over a particular range of activity. Outside this range an extra
fixed cost may be incurred or indeed saved. These costs are known as stepped fixed costs.

Total Cost
($)
$95k

$50k

0 750 Number of operations

One doctor can carry out a maximum of 750 operations per year. For activity levels above this, a
second doctor must be hired at a salary of $45,000. The total cost has thus increased to $95,000.

41
 Changes in variable cost/unit Chapter 2

Variable costs per unit may alter in particular circumstances. Some examples:
• Hourly paid staff working overtime in a period of high demand – direct labour per hour
would increase above a certain levels of activity (see a) below)
• Staff/machinery becoming more efficient at high levels of output (learning effects) may lead
to the direct labour and variable production overhead per unit falling.
• A business may get bulk discounts for ordering large quantities of material from suppliers –
this could occur when output is above a certain level (see b) below)

42
Changes in variable cost/unit Chapter 2

Graphically:

(a)
Total Cost
($)

(b)

0 Key activity level

43
 Semi-variable costs Chapter 2

Some costs have a part-fixed and part variable element:

• Utility costs (e.g. electricity, water, telephone) which have a fixed charge for a period plus a
variable cost based on the consumption of the utility
• Sales staff paid partly by a fixed annual salary and partly on a bonus based on sales levels

44
Semi-variable costs Chapter 2

Graphically:

Total Cost
($)

$175,000

$100,000

0 500 units Activity level

45
 High/low method of cost estimation Chapter 2

The high/low method is a simple method of estimating the fixed and variable cost elements of a
straight line cost function.
If given a series of cost data, it is important to identify the highest and lowest levels of activity
(usually production output) and measure the change in cost between these levels.
Step 1 – estimate the variable cost per unit:
change in cost
V/C unit =
change in units
Step 2 – estimate the total fixed costs:
FC = total cost – (VC/unit × output)
Step 3 – cost function can be used to predict future costs
TC = fixed cost + (VC/unit × output)

46
 Chapter 3
Cost Accounting Techniques
(Materials)

47
 Accounting for materials Chapter 3

There are different types of stocks (formally known as ‘inventory’) that a business may carry:
• raw materials
• work-in-progress
• finished goods and goods for resale
Too little inventory and the business will lose customer goodwill and sales revenue if they suffer
from lack of availability when stick is demanded (stock outs).
Too much inventory and the business will have spent a lot of cash in making products that have
yet to be sold. Additionally extra storage costs will be incurred as well as the risk of inventory
deterioration and obsolescence.

48
Purchasing department Chapter 3

A purchase order is sent to the supplier by the purchasing department. This will detail what
goods are required, how many units are required, order value ($), required delivery date
A delivery note (advice note) is received from the supplier together with the goods. The goods
are inspected for quality, quantity and importantly to the relevant purchase order to ensure the
delivery is complete and bona fide.
A materials requisition note will be raised subsequently by the production department to
request that the stores department supplies goods to the shop floor for inclusion in production.
These requests will often relate to specific job orders by the business’s customers.
A GRN (goods received note) is raised to record the delivery details for the goods entering
into inventory.
A purchase invoice is sent to the company from the supplier to request payment for the goods.

49
 Perpetual inventory systems Chapter 3

Equals
Quantities of each stock Physical stock quantities
line per stock ledger of each stock line

If not equal …

Examples of reasons for discrepancies:

Theft
Physical stock counting errors
Mis-postings of deliveries/sales to stock ledger
Timing differences between physical deliviries/saes and
updating stock ledger
Damage to physical stocks

50
Inventory counts Chapter 3

Year-end (or other periodic) stocktake – occurs when all inventory lines are counted and valued,
usually at the year-end date. This method is relatively cheap but does not allow the business to
keep an ongoing check on its inventory line quantities and the condition of that inventory.
Continuous stocktake – where all lines are counted at least once a year but at different points
in time. This allows the business to keep a more ongoing record of inventory quantities. This is
particularly important in checking the accuracy of the perpetual inventory system.

51
 Inventory holding costs Chapter 3

The typical holding costs incurred include:

• Cost of capital (or cash) tied up in the inventory that has been bought. This is often known as
the opportunity cost of capital, since if we had not held stocks then the business would have
had the opportunity to do something else with the money spent on overdraft interest.
• Warehousing/storage/insurance costs.
• Deterioration costs. The more inventory held, the higher the chance (and costs) of goods
becoming obsolete, damaged or unsuitable for sale.

52
Inventory ordering costs Chapter 3

Typically this will include:

• Shipping or courier costs to deliver the goods.
• Clerical or administrative costs.
Given that we assume that the amount demanded each year is known, then the larger the order
size, the less orders need to be placed per annum and the lower the annual holding costs becomes.

53
 Stockout costs Chapter 3

A stockout occurs when a unit is demanded by a customer yet cannot be supplied.

The ‘penalty’ costs involved with running out of inventory would be:
• Lost sales revenue from not being able to fulfil a current sales opportunity.
• Loss of customer goodwill and future sales if the dissatisfied customer subsequently goes to
another supplier.
• Emergency ordering costs to replenish inventory. It is often expensive to have the required
items couriered to you at short notice by a supplier.
• Idle-time of the production workforce who cannot continue with manufacture without the
key component that is missing

54
Economic order quantity (EOQ) model Chapter 3

The aim of this model is to calculate the optimal order size that the business should place in
order to minimise the annual costs of ordering and holding inventory.
Two important assumptions:
• There is no chance of a stock out occurring.
• Annual demand is known with certainty, as is the unit purchase cost.
The two costs that are relevant to the EOQ calculation are:
• Total annual holding costs and
• Total annual ordering costs

55
 Annual holding costs Chapter 3

Q
Annual stock holding costs are: × Ch
2
Where:
Q = the order of quantity
Ch = cost of holding one item for a year

56
Annual ordering costs Chapter 3

D
Annual ordering costs are: × Co
Q
Where:
Co = cost of placing each order
D = annual demand
Q = the order quantity

57
 Economic Order Quantity (EOQ) Chapter 3

2CoD
EOQ =
Ch
Where Co = cost of placing each order
D = annual demand
Ch = cost of holding one item for a year

58
Bulk discounts Chapter 3

The quantity where a discount can be obtained may not be the EOQ, but the discount given
may make the higher order quantity worthwhile. This is because it may become slightly cheaper
per unit to hold larger quantities if less capital is tied up in each unit (the purchase price being
slightly cheaper).

59
 Economic Batch Quantity (EBQ) Chapter 3

The format given in the exam is:

2CoD
 D
Ch  1 - 
 R
Where
R = the production rate in the relative time period
D = demand or usage in the relevant time period
Co = production set-up costs per batch
Ch = cost of holding one item for a year

60
Re-order levels Chapter 3

In reality there is always likely to be:

• A delay between placing an order with the supplier and the receipt of goods from a supplier
– a lead time.
• Demand for goods in the lead time; and
• Variation/uncertainty over the length of the lead time and/or the quantity demanded in
the lead time.
It is quite possible that a stockout may occur if we do not place an order soon enough.
To be completely ‘safe’ and avoid stockouts we could place an order with a supplier when large
amounts of inventory are on hand. This however would eliminate the risk of stockouts, but lead
to large amounts of stock over time being held.
Therefore we wish to re-order such that we hold as little inventory as possible, yet have enough
inventory to extinguish the risk of stockouts.

61
 Inventory re-order management Chapter 3

Two bin system

This is a simple approach to inventory management where goods are held in two ‘bins’ or areas.
Inventory is only issued from one bin. When this bin becomes empty, an order is placed for the
re-order quantity.
During the lead time, issues of inventory are made from the second bin. The bins need to be
of sufficient size to cope with demand in the lead time. The bins are refilled when the delivery
arrives and the process starts again.
Just-in-time (JIT) inventory management
This technique is in reality a complex production philosophy which requires very flexible
suppliers who are located nearby in order to very rapidly deliver inventory as and when required.
Essentially our business does not want to carry any inventory at all and will expect to be able to
re-order components etc from suppliers at very short notice with immediate delivery.

62
Raw material control account Chapter 3

An example of the raw material control account:

Raw material account

$ $
Bal b/f 2,000 WIP (RM issues) 23,500
Raw material purchases 25,000
Bal c/d 3,500
27,000 27,000
Bal b/d 3,500

63
 Work In Progress (WIP) control account Chapter 3

An example of the work-in-progress control account:

WIP control account

$ $
Bal b/f 4,500 Finished goods 91,000
Raw material issues 78,500
Direct labour 15,000
Royalty expenses 1,000
Bal c/d 8,000
99,000 99,000
Bal b/d 8,000

64
Inventory Valuation Chapter 3

Imagine a small company buys one new set of cutting tools every month. It currently has three
sets of tools in stock as follows:
Set Purchased Purchased Cost
Set Purchased Purchase Cost
1 15.1.2010 £200.00
2 18.2.2010 £210.00
3 21.3.2010 £223.00

If the first set of tools is issued on 24/3/2010, what should it be valued at?
There are four main methods of doing this:
1. LIFO
2. FIFO
3. Weighted average
4. Periodic weighted average.

65
 Inventory Valuation – FIFO Chapter 3

Each issue is charged at the earliest price of the stock being held from which the issue could
have been made.
If the set of tools issued above is valued as if it were the first one purchased it would be given a
value of £200.00.

66
Inventory Valuation – LIFO Chapter 3

Each issue is charged at the latest price of the stock being held from which the issue could
have been made.
If the set of tools issued above is valued as if it were the last one purchased then it would be
given a value of £223.00.

67
 Inventory Valuation – Weighted Average Chapter 3

Each issue is charged at a weighted average price of the stock being held at that time.
value in any given year × 100
Index number =
n base year
value in
The weighted average purchase cost for current stock can be used to value the toolkit issued ie
(£200.00 + £210.00 + £223.00)/3 = £211.00.
Under the weighted average method, a new average is calculated after each receipt.

68
Inventory Valuation – Periodic Weighted Average Chapter 3

This method can only be applied at the end of an accounting period. .

The price of items during a period is calculated as follows:
Cost of all receipts in the period + Cost of open
ning stock
Number of units received in period + nummber of units of opening stock
This average is then used to value all issues during the period.

69
70
 Chapter 4
Cost Accounting Techniques (Labour)

71
 Recording Labour Costs Chapter 4

Personnel records will show full details of each individual worker.

Time sheets/jobbing cards/piecework records keep a record of how much work an individual
has performed on particular projects, jobs or processes within the business.
Attendance records/clock cards/computerised swipe cards keep a record of times that
employees arrive at and depart from work as well as breaks taken. They are not able to identify
what jobs an employee has worked on within their working hours.

72
Payment Systems Chapter 4

• Time-based payment systems – e.g. where employees are paid an hourly rate of pay and may
be paid an overtime premium for work over and above a prescribed number of hours (or
outside normal hours of employment)
• Piecework payment systems – where employees are paid based on the amount of work done
(or output achieved).
• Individual/group incentive schemes – where employees are paid a bonus on them as
individuals or the group in which they work achieving certain objectives.
Typical objectives may relate to exceptional levels of performance (e.g. sales achieved) or
productivity (how efficiently output was achieved).

73
 Time-based payment systems Chapter 4

Basic pay
Basic pay is based on the number of hours worked typically:
Labour wages = hours worked × hourly rate of pay
Overtime premiums
Many employees are entitled to claim overtime premiums (for working beyond or outside their
agreed basic hours – e.g. a night shift or weekend work). Overtime is usually paid at a premium
over and above the basic rate of pay.

74
Piecework payment systems Chapter 4

However many workers paid on a piecemeal basis will also have a guaranteed minimum wage to
protect them against loss of earnings if production is low because of factors outside their control
(e.g. machine breakdown).
Piecework systems base the pay on the levels of production achieved and are based on the
following calculation:
Labour wages = number of units produced × rate of pay per unit

75
 Other schemes Chapter 4

Bonus systems
Bonuses can be paid in reality for achieving particular targets, for example profit levels, sales
levels, productivity, customer satisfaction etc.
Differential piecework schemes
To encourage efficiency, a business may have different piecework bases for different levels of
production achieved.

76
Practical bonus and incentive schemes Chapter 4

Group bonus schemes – groups of employees (for example in a department or working a

production line) qualify for bonuses based on the productivity or performance of the group
as a whole. This is necessary where it is not possible to accurately measure the output or
contribution of an individual worker.
Individual bonus schemes – individual employees qualify for bonuses based on achieving
personal objectives or as a result of personal productivity.
Share options – employees have the right to buy shares in the company over time, usually at
preferential prices. These can then be held to benefit from a rise in the share price. Share prices
will rise if the business grows and becomes more efficient and profitable.
Profit related pay – employees are entitled to a pre-agreed proportion of the company’s profit
for the year. The amounts involved often depend upon the seniority of the employee and their
length of service. This allows both production and non-production staff to be incentivised.

77
 Direct versus Indirect Labour costs Chapter 4

Direct labour costs

1. Basic rate of pay on productive hours
2. Overtime premiums on work outside normal hours specifically requested by the customer.
Indirect labour costs
1. Wages paid and overtime to non-production staff.
2. Overtime premiums to production staff except on work outside normal hours specifically
requested by the customer.
3. Idle time of production staff at basic rate of pay
4. Bonus and incentive payments to staff

78
Idle time Chapter 4

Idle-time occurs when the production workers, through no fault of their own, are unable to work
on the production line. However, they are still paid by the company. For example there may be
a machine breakdown, shortage of components, staff training or other issues. Since the workers
are not making anything, the basic wage paid to them will be treated as an indirect cost.
Idle time = Hours paid – productive hours

79
 Labour efficiency ratio Chapter 4

Relates to the productivity of the workforce. It is calculated as:

*Expected time to achieve actual output
× 100%
Actual time to achieeve actual output
If this ratio is > 100% then we have achieved our actual outputs faster or more efficiently
than expected.
* budgeted time per unit x Actual output

80
Capacity utilisation ratio Chapter 4

The ratio shows whether the factory or production line has performed above or below its
expected capacity. It is calculated as:
Actual productive working hours
× 100%
Available working hours*
* this is sometimes shown as budgeted hours

81
 Production volume ratio Chapter 4

Measures whether the business has achieved a higher or lower level of output than
originally budgeted:
Expected time to achieve actual output
× 100%
Available working houurs*
* this is sometimes shown as budgeted hours

82
Labour turnover ratio Chapter 4

The number of people who are leaving a business in relation to those who are joining.
• Complement = the number of employees
Number of employees at start of the yeear +
Number of employees at the end of the year
• Average complement =
2
• Turnover = the amount of employees leaving and being replaced
Turnover
• Labour turnover = × 100%
Average complement

83
 Accounting for labour costs Chapter 4

An example of the labour control account:

Labour control account

$ $
Total wages 25,000 WIP (direct labour) 15,000
Production overhead 9,000
(indirect labour)
Production overhead (idle time 1,000
etc.)
25,000 25,000

84
 Chapter 5
Cost Accounting Techniques
(Overheads)

85
 Absorption Costing Chapter 5

Absorption costing is a key costing concept. It involves calculating a cost per unit; the full cost
of manufacturing a unit of production or in the case of a service, the full cost of providing a
particular service.
There are three key reasons why we should do this:
• Setting selling prices
• Assessing product profitability
• Valuing inventory accurately

86
‘Product’ versus ‘period’ costs Chapter 5

Under absorption costing the following applies:

Period costs
• All other indirect costs!!
Product costs
Direct costs
• Direct labour
• Direct material
• Direct expenses (e.g. royalties payable)
Indirect costs
• Share of variable production overhead
• Share of fixed production overhead

87
 Absorption costing methodology Chapter 5

1. Allocation – any indirect production cost that specifically relates to a single cost centre is
allocated wholly to that cost centre
2. Apportionment – other indirect production costs must be shared out (‘apportioned’) on a
‘fair’ or ‘equitable’ basis between cost centres
3. Re-apportionment – the costs of the service cost centres are shared out fairly between
production cost centres
4. Absorption – As they pass through production cost centres, cost units pick up (‘absorb’)
those production cost centre overheads on a pre-determined basis.

88
Overhead absorption rate (OAR) Chapter 5

Budgeted Overhead Cost

OAR =
Budgeted Level of Activity
Where:
• Budgeted overhead cost is the cost centre’s overhead that we have either been given or have
computed after steps 1 to 3 above.
• Budgeted levels of activity are usually based on the following bases:
– time basis – usually direct labour hours (this is the most common)
– number of units produced (only suitable where different products use similar amounts of
overhead cost)
– some other basis, e.g. product percentage of total material cost

89
 Overhead absorption for multiple cost centres Chapter 5

A real-life business is likely to have multiple costs centres and it is not unusual for these cost
centres to use different bases of absorption, for example:
• Machining department – machine hours
• Hand-finishing department – labour hours
• Packaging department – number of units of finished goods.

90
Under/over absorption of overhead into cost units Chapter 5

The OAR is based upon two estimates:

• the budgeted overhead cost
• the budgeted level of activity
Every time a unit is made, the standard or expected share of overhead is absorbed into that unit.
The more units that are made, the more overhead is absorbed. There is a problem however in
that the actual expenditure and/or level of activity may differ from the budget.
This can lead to the income statement being charged either too much (over-absorption) or too
little overhead (under-absorption) for the period.
We must then make an adjustment at the end of the period to ensure that only the actual
overhead is charged to the income statement.

91
 Accounting for overhead cost Chapter 5

An example of the production overhead control account:

Production overhead control account

$ $
Indirect production cost 51,000 WIP (overhead absorbed) 55,000
Indirect labour 9,000 Underabsorbed overhead 6,000
Direct labour – idle time 1,000 (to income statement)
overtime premium
production bonuses
61,000 61,000

92
 Chapter 6
Marginal and Absorption Costing

93
 Marginal Costing Chapter 6

Marginal costing focuses on how costs vary with activity, namely their cost behaviour. No
attempt is made to absorb fixed costs into cost units, as with absorption costing.
Variable cost per unit is constant – making and selling one more unit causes one extra (or
‘marginal’) amount of variable cost to be incurred.
• marginal costing treats variable cost as a product cost
• inventory is valued at variable production cost only
Fixed cost in total does not change if one extra unit is made.
• fixed costs are treated as a period cost
• fixed costs are charged to the income statement as they are incurred
• no fixed cost is included as part of the inventory valuation

94
Uses of marginal costing Chapter 6

• Marginal costing is very effective in situations where ‘short-term’ decisions need to be made.
• Fixed costs are assumed to be irrelevant, as they will be incurred whatever decision is taken
in the short term
• Marginal Costing can be used when setting standards and budgets
• Inventory may NOT be valued at marginal cost for statutory reporting purposes – it must be
valued at absorption cost (as required by IAS 2)

95
 Marginal costing definitions Chapter 6

1. Marginal Cost = the sum of the variable costs incurred by a business. These costs will vary in
direct proportion to activity.
2. Marginal Cost per unit = variable cost per unit. This can be obtained from a ‘standard cost
card’ in an exam question.
3. Contribution per unit = sales price per unit – marginal cost per unit. This is a critical concept.
Every extra unit made and sold will generate an extra revenue (equivalent to the sales price)
and also an extra cost (the marginal or variable cost per unit). Therefore the more units that
are sold, the more ‘contribution’ is made.
4. Total Contribution = Sales -Variable Costs. We can work out how much contribution is made
in total by taking total variable costs away from total revenues.
5. Total Contribution = Fixed Costs + Profit.

96
Marginal Costing Profit Statement Chapter 6

$
Sales X
Less Variable costs (X)
Equals Contribution X
Less Fixed costs (X)
Total Profit X

Contribution per unit is found by taking variable (i.e. marginal) cost per unit away from selling
price per unit
No attempt is made to calculate fixed cost per unit
Total contribution is found by multiplying contribution per unit multiplied by sales volume
Total fixed costs do not change
Therefore, every extra dollar of total contribution gives us an extra dollar of total profit

97
 Marginal Costing (MC) versus Absorption Costing (AC) Chapter 6

We have looked at two methods of costing, namely absorption costing and marginal costing. The
activity of the organisation is the same, and we have two slightly different methods of accounting
for this activity:
• Absorption Costing charges both variable and fixed production costs to cost units. Therefore
fixed production overhead is treated as a product cost.
• Marginal Costing charges only variable production costs to cost units. Therefore fixed production
overhead is treated as a period cost, being written off to the Income Statement as incurred.
The only difference between the two methods is the way in which fixed production
overheads are treated.

98
Difference between reported AC profit and MC profit Chapter 6

The reconciling item between the two methods of cost accounting is:
Fixed Cost/unit × change in inventory level
You need to know how to quickly calculate the difference between reported profit figures
using MC and AC
• for an increase in inventory:
AC profit > MC profit
• for a decrease in inventory:
AC profit < MC profit
• for no change in inventory:
AC profit = MC profit

99
 Comparison of AC and MC Chapter 6

Absorption Costing (AC)

• Inventory is valued in accordance with Generally Accepted Accounting Practice for Financial
Reporting purposes.
• Fixed production overhead is incurred because the business makes and sells units. It should
be included in the inventory valuation
• Overall profitability should be ensured if the selling price exceeds the AC.
Marginal Costing (MC)
• Fixed Costs are unavoidable and do not vary with output levels – contribution is key to judge
the impact on profits of changing activity levels.
• Problems associated with unrealistic allocation and apportionment is avoided. Similarly no
over/under absorption of fixed overhead occurs.
• MC is of significant assistance in making short-term decisions (e.g. breakeven analysis)

100
 Chapter 7
Alternative Cost Management
Techniques

101
 Activity-based costing (ABC) Chapter 7

ABC tackles the problems of absorption costing by adopting a much more accurate way of
charging overhead to cost units.
In essence the business carefully considers what the primary activities are of the business. In
making units of production what does the business actually do to be able to make those units?
Rather than then absorbing all overheads from a cost pool under one uniform basis (eg labour
hours), ABC then absorbs overhead into cost units by identifying the relevant cost driver. This is
likely to mean that there will in essence be multiple absorption rates within a business.

102
Target costing Chapter 7

A business, through proper marketing research, will try to find out how much customers are willing
to pay for its current products and for products that might be slightly different and which might
therefore need a different price. Once this is established, the business will deduct its required
profit margin in order to identify the cost ceiling that it will need to work to if a profit is to be made.

Methods of reducing the gap

• Reduce the number of components used in manufacture
• Reduce production complexity
• Revise the specification of the product

103
 Life cycle costing Chapter 7

• Products tend to have shorter product life cycles. There is less time between products being
introduced to the market and subsequently withdrawn.
• Increased initial costs to design, develop and launch a new product.
• Increased end-of-life costs as environmental regulations mean that businesses are more
likely to be required to clean-up sites after use.

104
Total quality management (TQM) Chapter 7

TQM is not a single technique or process but rather a culture or a different way of doing things
compared with traditional management practices. It places quality at the heart of the business
and all processes and systems are benchmarks evaluated as to whether they can be said to be
excellent or not.

105
106
 Chapter 8
Job, Batch and Service Costing

107
 Costing methods Chapter 8

Overview

Costing methods

Specific Order
Costing Process Costing

Job Batch
Costing Costing

Service
Costing

108
Costing methods Chapter 8

Specific Order Costing – This involves making a product or service specific to the needs of
a customer or customers. These products/services remain clearly identifiable during the
production process (they are not ‘mixed’ with other products). This can be subdivided into:
• Job Costing – where individual items of work are undertaken to meet a specific customer’s
needs and requirements
• Batch Costing – where a group of similar products/services are made in a production run.
Process Costing – where products are made in a continual process and it is not possible to
separately identify individual units in the process.
Service Costing – the above techniques are specifically applied to a service business rather than
a manufacturer.

109
 Cost records Chapter 8

Records will be kept of the input costs incurred. For example:

• Materials and direct expenses – material requisition notes, purchase invoices for job specific
materials/expenses etc.
• Labour – time sheets, clock cards etc.
• Overheads – pre-determined overhead absorption rates and labour hours from timesheets etc.

110
Control Accounts Chapter 8

Job 378 control account

$ $
Bal b/f (opening WIP) — Cost of Sales 94,500
Raw material 23,500
Direct labour 15,000
Variable overhead 1,000
Fixed overhead 55,000
Bal c/d (closing WIP) —
94,500 94,500
Bal b/d —

111
 Service costing Chapter 8

Service costing applies to service sector organisations. There is no specific costing method
applicable to service costing. Indeed we could apply job, batch or process costing techniques to
establish a cost/unit for a service business.
Differences to product costing:
• no production costs
• minimal material costs
• high labour costs
• high overheads

112
Service costing cost units Chapter 8

We identify the two components of a cost unit:

• to whom is the service being provided?
• what is the nature of the service being provided?
Type of business To whom service Nature of Possible cost unit
is provided service provided
Railway company Passenger Distance travelled Passenger kilometre
Hospital Patient Treatment Patient treatment day
Restaurant Diner Meal (course) Diner course
College Student Exam course Student course

113
114
 Chapter 9
Process Costing

115
 Process costing Chapter 9

Input costs from

previous process
Output costs from
Process process (average
cost) per unit of
Material and/or output
conversion costs
from current process

116
Use of ledger accounts Chapter 9

Step 1 – calculate the flow of units

Step 2 – calculate the cost per unit.
This is done by calculating an overall average cost per unit by computing an average cost per unit
based on the expected level of output:
Total Input Cost
• Cost / Unit =
Normal Output
• Normal output = Input – Normal loss
Step 3 – value the process account

117
 Normal (or expected) loss – scrap value Chapter 9

The scrap proceeds obtained from scrapping these normal loss units is offset against the overall
cost of the process. This ensures that the ‘net’ cost of inputs is calculated when working out the
cost/unit of good production.

118
Abnormal losses and gains Chapter 9

If production is more or less efficient than expected, then the actual number of units lost in
production will differ from the normal loss units:
• Production less efficient than expected: Actual loss > normal loss
• Production more efficient than expected: Actual loss < normal loss.
The effect of this is that we will have an abnormal loss where actual losses are bigger than
expected and an abnormal gain where actual losses are smaller than expected.

119
 Process Costing with WIP Chapter 9

Any process in real life is likely to have work-in-process (WIP) at the start and/or end of an
accounting period. We will denote this as:
• OWIP – opening work-in-process
• CWIP – closing work-in-process
The concept of equivalent units (EU) allows us to recognise products at varying stages of
production in a process, and hence allocate process costs to products accurately:
Equivalent units (EU) = Physical units × %age degree of completion

120
Process Costing with WIP (continued) Chapter 9

For instance, if we have CWIP of 400kg of product, which is 100% complete in terms of materials
but only 60% complete in terms of conversion costs,
EU Materials = 400kg × 100% = 400 EU
EU Conversion cost = 400kg × 60% = 240 EU
The CWIP should have 400 EU of material cost allocated to it, but only 240 EU of conversion cost
allocated to it. The remaining 40% of conversion will occur in the next accounting period – in that
period we will deal with this work.
N.B. You will not be asked about both process losses, and WIP, within the same question
on this paper.

121
 Weighted Average method (AVCO) Chapter 9

Step 1 – Establish the physical flow of units

Step 2 – Establish the EU under the average method
• We are not concerned with where the units came from
• No distinction is made about whether OWIP has been completed before new production
begins or not
• All units are treated as wholly worked within the period
Average method
Equivalent units Include work done on OWIP from previous periods
Period costs Add the cost of OWIP from previous periods

Step 3 – Establish the period costs

Step 4 – Calculate the cost per EU
Step 5 – Evaluate your results

122
First In First Out method (FIFO) Chapter 9

Step 1 – Establish the physical flow of units

This time, make sure you split the units completed in the period so as to distinguish between the
units of OWIP that were completed, and the units that were wholly started and finished in the
period. You will need this for step 2.
Step 2 – Establish the EU under the average method
• Now we are concerned with where the units came from
• A distinction has been made (in step 1) between OWIP completed and new production
started and finished in the period
• The EU calculation only takes account of work done during this period
• Work done in previous periods is ignored at this stage

123
 First In First Out method (FIFO) (continued) Chapter 9

FIFO method
Equivalent units Only includes work done on OWIP to completion
Period costs Only includes current period costs in the cost/EU calculation

Step 3 – Establish the period costs

Step 4 – Calculate the cost per EU
Step 5 – Evaluate your results
• Take care to add the cost of OWIP to the units of OWIP completed in the period.

124
Joint Products and By-Products Chapter 9

Many processes create more than one type of product, for example, the process of oil refining
produces petrol, diesel, aviation fuel, lubricating oils, tar, bitumen etc.
Those with significant commercial value to the organisation we refer to as ‘joint products’, and it is
important that a fair and equitable way is found of sharing process costs between these products.
‘By-products’ might also be created by the process, and it is important that these relatively low
value products are also accounted for correctly. The sales revenue of these by-products is used to
offset the material input cost of the process.

125
 Joint Products and By-Products Chapter 9

Material Petrol
input cost
(Crude oil)

Process Diesel Joint

products
Conversion
cost
(electricity
labour) Aviation fuel

Bitumen By-
product

126
Accounting for joint products Chapter 9

There are two main methods of apportioning process costs to joint products:
• Sales value of individual joint products
• Physical units produced of each individual joint product
It is important to remember that the method used, and therefore inventory valuation created, is
arbitrary – it is not possible to clearly identify the individual units of process cost with one joint
product or another.
Steps to take:
Step 1 – calculate net process costs
Net process costs = Input costs – By-product income

127
 Accounting for joint products (continued) Chapter 9

Step 2 – apportion process costs on basis specified in the question

Sales value method:
Net process costs
Cost / unit =
Sales value of joint productss
(in $ / $ of sales value)
Sales volume method:
Net process costs
Cost / unit =
kg of joint product output
(in
n $ / kg)

128
Process ledger accounts with Joint and By-Products Chapter 9

It is possible to show the effect of joint and by-product accounting in a cost ledger account:

Process account
kg $ kg $
Material 10,000 30,000 Joint Product A 5,000 25,000
Conversion — 11,000 Joint product B 3,000 15,000
By-product C 2,000 1,000
10,000 41,000 10,000 41,000

129
130
 Chapter 10
Process Costing with WIP

131
 Average method Chapter 10

Step 1 – Establish the physical flow of units

Step 2 – Establish the EU (average method)
Step 3 – Establish the period costs
Step 4 – Calculate the cost per EU
Step 5 – Evaluate your results (possibly using a process T account)

132
FIFO (First-in-first-out) method Chapter 10

The main difference now is to consider the underlying assumption for FIFO. We assume that
the OWIP must be completed before any other units can be started. Therefore OWIP must be
completed in the period and passed to the next process. This would occur for example on a
production line where OWIP must be finished and leave the production line before further work
can be undertaken. The steps are very similar to the Average method:

Step 1 – Establish the physical flow of units

Step 2 – Establish the EU (FIFO method)
Step 3 – Establish the period costs
Step 4 – Calculate the cost per EU
Step 5 – Evaluate your results (possibly using a process T account)

133
134
Chapter 11
Budgeting

135
 Budgeting concepts Chapter 11

A budget is defined as ‘a quantitative statement, for a defined period of time, which may include
planned revenues, expenses, assets, liabilities and cash flows for a forthcoming accounting period’.
Budgets are used for two key purposes:
• planning, providing guidance as to future actions
• control, providing a yardstick against which to judge actual performance

136
Objectives of budgeting Chapter 11

Remember the CRUMPET mnemonic:

• Coordination – budgets should allow the planned activities of the organisation to be
coordinated with one another
• Responsibility – an individual manager should be responsible for each budget
• Utilisation of resources – a budget challenges the manager responsible for it to make the
most efficient use of the business’s resources possible
• Motivation – by linking achievement of budgetary targets to reward systems, managers are
motivated to try to achieve budgetary targets
• Planning – budgeting processes force managers to think ahead and plan for the future
• Evaluation of performance – budgets provide a target against which performance
can be assessed
• Telling – budgets communicate the plans of the organisation to others

137
 The process of budgeting Chapter 11

Step 1: Long-term business objectives are set through strategic planning processes
Step 2: These long-term objectives are translated into quantifiable short-term targets
Step 3: A budget committee is appointed, and budget manual produced
Step 4: Detailed functional budgets are prepared by budget holders, and negotiated and
authorised by senior managers and the management accountant (as shown on next page)
Step 5: The authorised functional budgets are collected together and used to form a master
budget, which consists of
• budgeted income statement
• budgeted statement of financial position
• budgeted cashflow statement

138
Preparing Financial budgets Chapter 11

Sales budget – budgeted sales units × standard

sales prices = budgeted sales revenue revenues Sales overhead budget – budgeted
sales units × standard sales units ×
standard sales overhead unit costs =
Production budget – budgeted sales units + budgeted sales overheads
required closing stock of finished goods –
budgeted opening stock of finished units =
budgeted production levels Production overhead budget –
budgeted production units × standard
production overhead unit costs =
Material usage budget – budgeted production budgeted production overheads
units × material usage per unit (say Kg) =
budgeted material usage (Kg)
Labour budget – budgeted
production units × standard labour
hours per unit = labour usage. Labour
Material purchases budget – material usage
(say in Kg) + required closing stock of material (Kg) usage × standard labour cost per
– opening stock of material (Kg) = material hour = budgeted labour cost
purchases budget (Kg)
Material purchases (Kg) × standard cost per Kg
of material = material purchases budget ($)

139
 Fixed, Flexible and Flexed budgets Chapter 11

Fixed budgets are budgets that are set for a single level of activity. They are not intended to
change with changing activity levels, and are useful for capping discretionary expenditure
Flexible budgets are budgets which, by recognising different cost behaviour patterns, is designed
to change as volume of activity changes. Flexible budgets are capable of being flexed, i.e.
amended to reflect actual activity levels. Flexible budgets are used for control.
A flexed budget is a flexible budget that has been amended to reflect actual activity levels. A
flexed budget can be compared to actual costs and revenues in a meaningful manner. This is a
form of variance analysis.

140
Cash Budgets Chapter 11

A cash budget is a statement of all the inflows and outflows of cash for a given period. There are
3 key rules to remember in relation to cash budgets:
1. We are only concerned with the inflow and outflows of cash.
2. It follows that non cash flows such as depreciation are ignored.
3. Items are only recorded in the cash budget in the month the cash inflow/outflow actually
occurs. For example, credit sales are recorded in the cash budget in the month that the
payment for the sale is actually received.

141
 Statement of Profit or Loss Budget Chapter 11

The budgeted income statement shows the budgeted sales revenue and costs for the period:
Statement of Profit or Loss
$
Sales X
Less Cost of sales (X)
Gross Profit X
Less Expenses (X)
Net profit X

142
Statement of Financial Position Budget Chapter 11

The budgeted statement of financial position shows our budgeted assets and liabilities at the end
of the period.
$ $
Non Current Assets
Current Assets
Inventory
Receivables
Cash at bank
Current Liabilities
Payables
Net current assets
Net assets and liabilities
Share Capital
Revenue reserves
Profit for the period

143
144
 Chapter 12
Statistical Techniques 1

145
 Scattergraph Chapter 12

A scattergraph plots the individual costs against their associated activity levels but makes no
attempt to identify a linear relationship between them:

Cost $
2400
2200
2000
1800
1600
1400
1200
1000

400 500 600 700 800 900 Output (units)

146
High/low analysis Chapter 12

We can use the techniques previously seen to estimate the linear relationship between
output and costs.
Step 1 – calculate variable cost/unit
Step 2 – calculate fixed cost (using the high set of data)
Step 3 – estimate the daily/weekly/monthly costs
This was described more fully in Chapter 2.

147
 Linear regression Chapter 12

This statistical technique uses all of the pairs of data and identifies a line which ‘best fits’ (gets as
close as possible) to all of the pairs of observations.
The formula sheet in the exam will give you the following equations for a line
y = a + bx
where a is the intercept of the line on the y axis, and b is the gradient (slope) of the line:

a=
∑ y - b∑ x
n n
n∑ xy - ∑ x ∑ y
b-
n∑ x 2 - (∑x)
2

Where n = numbers of pairs of observations (each level of output and its associated cost
x = each dependent variable (here the output or activity level)
y = the dependent variable (here cost)
xy = each x observation multiplied by its associated y observation
x2 = each x observation multiplied by itself
Σ = ‘sigma’ or the ‘sum’ of (which essentially means add up!!)

148
Correlation co-efficient Chapter 12

To try to identify how accurate that line of best fit is, we can calculate a ‘correlation coefficient’.
The correlation coefficient measures the degree of dependence between two variables.
For example if the independent variable (e.g. output) were to rise, what would happen to the
dependent variable (e.g. costs).
• If costs were to rise, this would show a positive correlation of between 0 and +1
• If costs were to fall, this would show a negative correlation of between 0 and -1
• If costs did not change at all there would be no correlation between the variables.
The closer the correlation coefficient comes to either +1 or-1, the stronger the relationship is
between the independent and dependent variables.

149
 Perfect positive correlation (+1) Chapter 12

Dependent
variable Perfect positive correlation (+1)
(y axis)

Independent variable (x axis)

150
Perfect negative correlation (-1) Chapter 12

Dependent
variable Perfect positive correlation (–1)
(y axis)

Independent variable (x axis)

151
 No correlation (0) Chapter 12

Dependent
variable No correlation (0)
(y axis)

Independent variable (x axis)

152
Co-efficient of determination Chapter 12

The co-efficient of determination measures what proportion of changes in the dependent

variable can be explained by a change in the independent variable. The remaining changes in the
dependent variable must be caused by other (possibly random) factors.
Mathematically it is measured by squaring the correlation co-efficient (r2). The result will always
be a number between 0 and +1.
If you have to calculate the co-efficient of determination, you should use the following
formula (provided):
n∑ xy -∑ x ∑ y
r=
n∑ x - ( ∑ x ) n∑ y2 - ( ∑ y )
2 2 2

... and then square the result to get (r2).

153
 Spreadsheets and management accounting Chapter 12

Spreadsheets are used in many areas but are particularly useful in:
• Preparing management accounts (e.g.monthly income and cash flow statements)
• Preparation and ongoing updating of cash flow forecasts
• Analysing and comparing (e.g. via variance analysis) costs, revenues and key asset/
liability accounts
• Assisting in forecasting and decision making. Spreadsheets could be set up to analyse the
different possible outcomes of a project.

154
Time Series Analysis Chapter 12

A time series is a set of observations or measures taken at equal intervals of time. The
observation could be taken hourly, daily, weekly, monthly, quarterly or yearly.

Activity

Time period

155
 Time Series Components Chapter 12

T The trend – the way in which the time series appears to be moving over a long
interval of time.
S The seasonal component – short term fluctuations in results.
C The cyclical component – long/medium term fluctuations in results caused by
repeating cycles.
R The residual (or irregular/random) component

Calculations are only required in this paper for calculating the Trend and the Seasonal Variation.

156
Calculating the trend – moving averages Chapter 12

Example of calculating the 3 month moving average:

Month Sales 3 Month moving Moving Average
Total
1 90
2 60 250 83.33
3 100 280 93.33
4 120 325 108.33
5 105 310 103.33
6 85

By calculating the moving average, the seasonal variations have been removed.

157
 Calculating the trend – moving averages Chapter 12

Once the moving averages have been calculated, the overall increase or decrease in sales per
month can be calculated.
Increase/decrease per month = Total increase in trend/number of time periods
= (103.33 – 83.33)/3 = 6.67
Therefore, the trend is for sales to increase by 6.67 per month.

158
Calculating the trend – moving averages Chapter 12

Showing the above information on a graph:

140
Moving Averages
120
100 Sales
80
Sales

60
40
20
0
0 2 4 6 8
Month

159
 Calculating the seasonal variation – additive model Chapter 12

Using the additive model we apply the equation:

Actual Sales = Trend + Seasonal Variation
So, Seasonal Variation = Actual Sales – Trend
Month Sales (Actuals) Moving Average Seasonal
(Trend) Variation = A – T
1 90
2 60 83.33 -23.33
3 100 93.33 6.67
4 120 108.33 11.67
5 105 103.33 1.67
6 85

160
Calculating the seasonal variation – multiplicative model Chapter 12

Actual Sales = Trend x Seasonal Variation

So, Seasonal Variation = Actual Sales/Trend
Month Sales (Actuals) Moving Average Seasonal
(Trend) Variation = A/ T
1 90
2 60 83.33 0.72
3 100 93.33 1.07147
4 120 108.33 1.1077
5 105 103.33 1.01616
6 85

161
 Forecasting – Additive model Chapter 12

Using the above results, we can forecast what actual sales will be in Month 2 of the following year.
Actual = Trend + Seasonal Variation
Trend in Month 5 Year 1 = 103.33
We know that sales will increase by 6.67 units per month.
There are 9 months between Month 5 year 1 and Month 2 year 2.
Trend in Month 2 Year 2 = 103.33 + 6.67 x 9 months = 163.36 units
Using the additive model, the seasonal variation for month 2 is -23.33.
This means that actual sales in month 2 will be 23.33 units below the trend
Actual Sales = 163.36 – 23.33 = 140.03 units

162
Forecasting – Multiplicative model Chapter 12

Using the above results, we can forecast what actual sales will be in Month 2 of the following year.
Actual = Trend × Seasonal Variation
Trend in Month 5 Year 1 = 103.33
We know that sales will increase by 6.67 units per month.
There are 9 months between Month 5 year 1 and Month 2 year 2.
Trend in Month 2 Year 2 = 103.33 + 6.67 × 9 months = 163.36 units
Using the multiplicative model, the seasonal variation for month 2 is 0.72
This means that actual sales in month 2 will be 72% of the trend.
Actual Sales = 163.36 × 0.72 = 117.6192 units

163
 Time Series and Line of Best Fit Chapter 12

Regression analysis can be used where in the line y = a + bx

y = T, the trend x = t, time where t = 1, 2, 3 ... etc for each time period
Month X Sales Y XY X2
1 90 90 1
2 60 120 4
3 100 300 9
4 120 480 16
5 105 525 25
6 85 510 36
21 560 2025 91

Applying the regression analysis formulae for a and b:

b = 3.714 a = 80.33 T = 80.33 + 3.714t

164
Index Numbers Chapter 12

Index numbers measure how a group of related quantities vary over time.
value in any given year × 100
Index number =
value in base year
Subtracting 100 from the index give the percentage increase since the base year. An index of 147,
for example, tells us that there has been an increase of 47% since the base year.

165
 Index Numbers – adjusting for price movements Chapter 12

One use of index numbers is to adjust data for the effect of price changes. This is referred to
sometimes as ‘taking out inflation’ or ‘expressing the figures in real terms’.
Price adjusted figure for any actual year = Actual figure for the actual year × RPI in reference
year/RPI in actual year.

166
 Chapter 13
Statistical Techniques 2

167
 Continuous, discrete, grouped and ungrouped data Chapter 13

Data can be continuous (like weight) or discrete (like floors in a building).

Continuous data will always be displayed as grouped data in a frequency distribution (eg 4
people weighing 65 - <65kg). Discrete data can be shown wither grouped or ungrouped)
Location (central tendency) of data
Indicates around where the data is clustered and can be measured by:
• Arithmetic mean
• Median
• Mode

168
Arithmetic mean (common ‘average’) Chapter 13

The formulae given by the ACCA are:

∑x
x=
n
∑ fx
x= ( frequencydistribution)
∑f
Advantages and disadvantages of the arithmetic mean
The main advantages of the arithmetic mean are:
• All available data is taken into account
• It is commonly understood as the ‘average’
• It is often used as a component in further statistics calculations
The main disadvantages of the arithmetic mean are:
• It might not represent a feasible figure (eg 2.4 children as the average family size).
• It is easily distorted by extreme values (outliers).

169
 Median Chapter 13

The median value is the value of the middle item when all items are arranged in ascending or
descending order.
For grouped data, find the interval or group which contains the median item. Then estimate how
far up that group the median item can be found
Advantages and disadvantages of the median
The main advantages of the median are:
• Not affected by extreme values.
• It is simple to understand
• It can often be applied to qualitative data
• Provided there is an odd number of readings and ungrouped data, the median value will be a
value that actually occurs.
The main disadvantages are:
• It can be time-consuming to arrange the data in ascending order
• Statistically, the median is not useful to further statistically calculations.

170
Mode Chapter 13

The mode is the most frequently occurring value in the data. To find the mode, create a
frequency distribution in which shows how often each value occurs. If there are two or more
values that occur with the same frequency, the distribution has more than one mode.
Advantages and disadvantages of the mode
The main advantages of the mode are:
• Easy to understand.
• Not affected by extreme values
• The mode will be a member of the population (eg the commonest dress size is 12).
• Can be applied to qualitative data (for example, the most common car colour is red)
The main disadvantages of the mode are:
• Not all sets of data have a mode; some can have several.
• Not useful in further statistics calculations.

171
 Measures of dispersion Chapter 13

Dispersion refers to how ‘spread out’ the set of data is. There are three measures to look at:
• The variance, σ2
• The standard deviation, σ
• The coefficient of variation

172
Variance and standard deviation Chapter 13

The formula for the variance of a set of data is:

Variance = ∑ ( x − x ) / n
2

The standard deviation, Ã = √ ( Variance )

Where:
x = the value of each reading / piece of data
x = the arithmetic mean of the data
n = the number of readings
∑ means to add up
For grouped data the formula for standard deviation in the formula sheet can be used:
2
∑ fx 2  ∑ fx 
Ã= − 
∑f  ∑f 

173
 Coefficient of variation Chapter 13

Coefficient of variation as a ratio = Standard deviation/Arithmetic mean

Coefficient of variation as a percentage = 100 x Standard deviation/Arithmetic mean

The coefficient of variation adds scale to the standard deviation. Standard deviation of 100
means little. Only when you know that the mean is (say, 200 or 20,000) can you judge how
dispersed the data is.

174
Normal distributions Chapter 13

The normal distribution (or normal curve) is a symmetrical, bell-shaped curve that is completely
defined by its mean and its standard deviation.
Frequency

Mean, µ
For all normal curves, when you move out a given number of standard deviations from the mean,
you capture the same proportion of the total area under the curve. The area captured can be
looked up in normal distribution tables.

175
 Normal distributions Chapter 13

The key is to measure the distance above or below the mean as a number of standard
deviations. the number of standard deviations is known as the Z value.
z = ( x − µ) / σ

176
Expected values Chapter 13

Expected values are used when there can be several outcomes from a project and the
probabilities of the different outcomes occurring are known or can be estimated. It is a method
for dealing with risk. The expected value approach multiplies (or weights) each outcome by
multiplying by the probability of the outcome occurring and then adds up the results.
Expected value = ∑ px
Problems with expected value
• It will usually be very difficult to estimate the probability of each outcome.
• For a once-off project, the expected value is not usually a figure that is expected to occur.
A favourable EV can hide the possibility of a very poor outcome: EV obscures risk.

177
178
 Chapter 14
Investment Appraisal Techniques

179
 Capital and Revenue Expenditure Chapter 14

Capital expenditure is expenditure on assets that are not for resale (ie what would be termed
fixed assets) the purpose of which is to generate ongoing profits for the business.
Revenue expenditure is anything that is not capital expenditure. It is typically bought with a view
to resale (eg inventories) or it is the expenditure on administration, distribution or maintenance.

180
Simple Interest Chapter 14

Simple interest involves adding interest to an invested capital sum of money, whereby the
interest that is added each period is added to the capital sum only and not to the interest earned
in previous periods.
Simple interest formula FV = PV (1 + rn)
Where FV = total at end of period
PV = amount invested
r = rate of interest
n = number of periods

181
 Compound Interest Chapter 14

Compound interest is a system that adds interest each year to both the original capital plus any
interest added to date.
Compound interest formula FV = PV (1 + r)n
Where FV = total at end of period
PV = amount invested
r = rate of interest
n = number of periods

182
Compound Discounting Chapter 14

Would you rather receive £100 now or £100 in one year’s time?
£100 is worth more now than it will be in one year’s time due to factors such as inflation.
This is called the time value of money.
Discounting is calculating the present value of a sum of money which will be received at some
point in the future.
PV = FV ÷ (1 + r)n
Where: PV = present value
FV = future value
r = rate of interest
n = number of periods

183
 Net Present Value Chapter 14

This technique is used to evaluate whether or not a project should be accepted. There are 3
steps to apply in a question on NPV:
Step 1 Sort out the numbering of the years between the investment and each future value
Step 2 Decide what cost of capital to use and find discount factors using present value tables
Step 3 Multiply each future value by the relevant discount factor to give the present values

If the investment has a positive NPV then the project should be accepted (negative rejected).

184
Internal Rate of Return Chapter 14

The internal rate of return (IRR) is the rate of return at which the NPV is zero.

NPV

IRR

Discount Rate

185
 Calculating the IRR Chapter 14

The IRR can be estimated be using linear interpolation. The following formula applies:
 NL 
IRR = L +   × (Hx - L )
 NL - NH 
Where: L = lower discount rate
H = higher discount rate
NL = NPV at lower discount rate
NH = NPV at higher discount rate

The formula is not given in the exam.

186
Annuities Chapter 14

An annuity is an investment that gives a return in the form of a series of equal cash flows.
The present value of an annuity can be calculated as:
Value of periodic cash inflow x annuity factor (taken from annuity tables)
Example:
What is the present value of an annuity of $2,000 which will be received for 5 years. The discount
rate is 10% and the first payment will be received 1 year from now.
PV of annuity:
$2,000 × 3.791 = $7582
Where 3.791 is the value of an annuity of $1 payable for 5 years at a rate of 10% (per tables)

187
 Annuities (continued) Chapter 14

Example:
Suppose the annuity above does not begin until year 3. In this case, the time line for the
annuity would be:
Year Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Cash flow 0 0 0 $2,000 $2,000 $2,000 $2,000 $2,000

In this case, 2 steps are required to find the present value of the annuity (i.e. the value of the
annuity in Year 0)
Step 1 calculate the value of the annuity in the year before the first payment by using the
annuity tables.
Step 2 discount back to year 0 using the present value tables.

188
Annuities (continued) Chapter 14

Solution to example:
Step 1
Use annuity tables to calculate the value of the annuity in Year 2:
$2,000 × 3.791 = $7,582
Step 2 – discount back to year 0
If the annuity is worth $7582 in 2 years, then the PV now is:
$7,582 × 0.826 = $6,263
Where 0.826 is the discount factor when n = 2 and r = 10% per the present value tables

189
 Perpetuities Chapter 14

A perpetuity is an annuity which arises forever.

PV of a perpetuity = Cash flow per annum / Interest rate

190
Payback Chapter 14

This is the length of time it takes for cash inflows from trading to pay back the initial investment.
Payback period = Initial investment / Annual inflow

191
 Nominal and effective interest rates Chapter 14

Nominal Interest rates: Rate of interest that have not been adjusted for inflation.
Effective Interest rates: Rates of interest that have been adjusted for inflation.
(1 + m) = (1 + r) (1 + i)
Where: r = effective rate of interest
m = nominal rate of interest
i = inflation rate

192
 Chapter 15
Standard Costing and Variance Analysis

193
 Standard costing and standard cost cards Chapter 15

The standard cost of a unit is the expected cost of making one unit of production.
The unit standard costs are presented via a standard cost card, which displays:
• standard (expected) usage of physical resources per cost unit
• standard (expected) cost of each unit of physical resource

194
Nominal and effective interest rates (continued) Chapter 15

Example of a standard cost card:

Cost Standard usage of Standard cost per Standard cost
resource unit of resource per cost unit
Direct material 8kg $2.50/kg $20.00
Direct labour 4 hours $8.50/hour $34.00
Variable overhead 4 hours $3.00/hour $12.00
Standard marginal $66.00
cost per cost unit
Fixed overhead 4 hours $4.75/hour $19.00
Standard absorption $85.00
cost per cost unit

195
 Uses of standard costing Chapter 15

• Variance analysis – actual usage and cost of resources can be compared with standard usage
and cost of resources. This allows major differences (i.e. variances) to be identified and
investigated. This is an example of using management accounting information for control.
• Inventory valuation – providing the difference between standard and actual cost per kg is
not significant, thus makes valuing inventory straightforward
• Budgeting – budgeted expenditure can be calculated from the standard cost of a cost unit

196
Variance analysis Chapter 15

Variance analysis is the process of calculating, and seeking explanations for, differences between
the standard and actual cost of cost units produced.
A single proforma can be used to calculate all variable cost variances:
SQ × SP
} Usage / efficiency variance
AQ × SP
} Price / rate variance
AQ × AP
where: SQ = standard quantity of physical resource required to achieve actual production
AQ = actual quantity of physical resource used to achieve actual production
SP = standard cost per unit of physical resource
AP = actual cost per unit of physical resource

197
 Material variances Chapter 15

Calculate this in two steps:

Step 1. Material usage variance – this is the difference between how much material should have
been used for actual production (standard quantity), and how much material was actually used
for actual production, valued at standard cost per kilogram.
Step 2. Material price variance – this is the difference between how much should it have cost for
the material purchased or used, and the actual cost of the material purchased or used
SQ × SP
} Material usage variance
AQ × SP
} Material price varriance
AQ × AP
where:
SQ = standard quantity of material required to achieve actual production
AQ = actual quantity of material used to achieve actual production
SP = standard cost per kg of material
AP = actual cost per kg of material

198
Possible reasons for material variances Chapter 15

Material price variances Material usage variances

Incorrect standard cost per kg set Incorrect standard kg per cost unit set
Poor/good purchasing Labour skill or motivation factors
External factors (e.g. inflation) Quality of material used
Quality of material used

Note the possible inter-relationship between material price and usage variance caused by
quality of material used. If poor quality material is purchased, this might cause an adverse usage
variance (since more will be wasted than expected), yet also cause a favourable price variance
(since the purchase price per kg should be lower than for expected (good) quality material).
Look out for inter-relationships with other variances that you calculate, too.

199
 Labour variances Chapter 15

Calculate this in two steps:

Step 1. Labour efficiency variance – this is the difference between how many labour hours
should have been used for actual production (standard quantity), and how many labour hours
were actually used for actual production, valued at standard cost per labour hour.
Step 2. Labour rate variance – this is the difference between how much should it have cost for
the labour hours worked, and the actual cost of the labour paid to the workers.

200
Labour variances Chapter 15

Note that although the letters used in the proforma have changed slightly, the essence of the
proforma remains the same:
SH × SR
} Labour efficiency variance
AH × SR
} Labour rate varriance
AH × AR
where:
SH = standard number of labour hours required to achieve actual production
AH = actual number of labour hours used to achieve actual production
SR = standard cost per labour hour
AP = actual cost per labour hour

201
 Possible reasons for Labour variances Chapter 15

Labour rate variances Labour efficiency variances

Incorrect standard cost per labour hour used Incorrect standard labour hours per cost unit
used
Quality (grade) of labour used Quality (grade) of labour used
Wage inflation or unexpected bonuses Motivation levels of workers
Unplanned overtime Idle time – unexpected time paid to workers
whilst unproductive

202
Variable overhead variances Chapter 15

Calculate this in two steps:

Step 1. Variable overhead efficiency variance – variable overheads will always be ‘absorbed’ on
the basis of direct labour hours in this exam. Therefore, this is the difference between how many
labour hours should have been used for actual production (standard quantity), and how many
labour hours were actually used for actual production, valued at standard variable overhead cost
per labour hour.

203
 Variable overhead variances (continued) Chapter 15

Step 2. Variable overhead rate variance (sometimes called, ‘variable overhead expenditure
variance’) – this is the difference between how much variable overheads should have cost for
the labour hours worked, and the actual cost of the variable overheads.
SH × SR
} Variable overhead efficiency variance
AH × SR
} Variiable overhead rate (or 'expenditure') variance
AH × AR
where:
SH = standard number of labour hours required to achieve actual production
AH = actual number of labour hours used to achieve actual production
SR = standard variable overhead cost per labour hour
AP = actual variable overhead cost per labour hour

204
Possible reasons for variable overhead variances Chapter 15

Variable overhead rate variances Variable overhead efficiency variances

Incorrect standard variable overhead cost per Incorrect standard labour hours per cost unit
labour hour used used
Further analysis of cost of individual indirect Same as for labour efficiency variances
costs used required

205
 Fixed overhead variances – Absorption costing Chapter 15

Fixed overhead volume variance compares the standard fixed overhead cost of the actual units
produced (i.e. flexed budget fixed overhead cost) to budgeted fixed overhead cost.
Fixed overhead expenditure variance compares actual fixed overhead cost to budgeted fixed
overhead cost, i.e. budgeted units produced valued at standard fixed overhead cost per cost unit
Notice that the sum of fixed overhead expenditure variance and fixed overhead volume variance
is equal to the over- or under-absorption of fixed overheads for the period.

206
Fixed overhead variances – Absorption costing Chapter 15

Flexed budget FO cost

} Fixed overhead volume variance
Origin
nal budget FO cost
} Fixed overhead expenditure variance
Acttual FO cost
where:
Flexed budget FO cost = fixed overhead absorbed (i.e. Std FO/unit × actual units)
Original budget FO cost = budgeted fixed overhead (i.e. Std FO/unit × budgeted units)

207
 Fixed overhead variances – Absorption costing Chapter 15

If fixed overheads are valued on a labour hour basis, then the volume variance subdivides into
efficiency and capacity variances
Fixed overhead efficiency variances are similar to labour and variable overhead efficiency
variances. They are caused by workers working faster or slower than expected.
Fixed overhead capacity variances are caused by workers working for more or less hours than
the budget expected them to work.
Notice that the sum of fixed overhead efficiency variance and fixed overhead capacity variance is
equal to the fixed overhead volume variance.
Overall, this gives the proforma:
SH × SR
} Fixed overhead efficiency variance
AH × SR
} Fixed overhead capacity variance
BH × SR
} Fixed overhead expenditure variance
AH × AR

Where:
208
Fixed overhead variances – Absorption costing Chapter 15

SH = standard number of labour hours required to achieve actual production

AH = actual number of labour hours used to achieve actual production
BH = standard number of labour hours required to achieve budgeted production
SR = standard fixed overhead cost per labour hour
AP = actual fixed overhead cost per labour hour

209
 Fixed overhead variances – Marginal costing Chapter 15

Marginal costing techniques do not charge fixed production overhead to cost units. Instead, they
treat fixed production overhead as a period cost. Therefore, there is no fixed overhead volume
variance to calculate.
The only fixed overhead variance to be calculated under marginal costing is the fixed overhead
expenditure variance.
Original budget FO cost
} Fixed overhead volume variance
Actu
ual FO cost
where:
Original budget FO cost = budgeted fixed overhead (i.e. Std FO/unit × budgeted units)

210
Possible reasons for Fixed overhead variances Chapter 15

Fixed overhead Fixed overhead efficiency Fixed overhead

expenditure variance variance capacity variance
Incorrect standard fixed Incorrect standard labour hours Incorrect standard labour
overhead cost per labour hour per cost unit used hours per cost unit used
used
Further analysis of cost of Same as for labour efficiency More/less actual labour
individual indirect costs used variances hours than budget being
required worked

211
 Sales variances Chapter 15

Sales volume variance – this is the difference between the number of units budgeted to be sold,
and the number of units actually sold, valued at the standard margin per unit.
The calculation of standard margin per unit differs between absorption and marginal costing:
Absorption costing:
Standard profit margin per unit = Standard selling price per unit – standard absorption cost per unit
(AS – BS) × SPM
where:
AS = actual sales quantity
BS = budgeted sales quantity
SPM = standard profit margin per unit

212
Marginal Costing Chapter 15

Standard contribution margin per unit = Standard selling price per unit – standard marginal
cost per unit
(AS – BS) × SCM
Where:
AS = actual sales quantity
BS = budgeted sales quantity
SCM = standard contribution margin per unit

213
 Sales price variance Chapter 15

Sales price variance – this is the difference between the standard selling price per unit, and the
actual average selling price per unit achieved.
This variance is calculated in the same way, regardless of whether an absorption or marginal
costing approach is taken:
(ASP – SSP) x AS
where:
ASP = actual average selling price per unit achieved
SSP = standard selling price per unit
AS = actual sales quantity

214
Possible reasons for Sales variances Chapter 15

Sales price variances Sales volume variances

Incorrect standard selling price per unit used Incorrect budgeted volume of sales used
Customers demanding lower prices Market conditions
Product quality issues Production efficiency gains/losses

215
 Operating statements for absorption costing Chapter 15

Operating statements (or ‘profit statements’) set out all variances so as to formally reconcile
budgeted with actual profit.
For absorption costing, they should follow the following proforma:
$
Budgeted profit X
Sales volume variance X
Flexed budget profit X
Sales price variance X
X
Cost variances: F$ A$
Material price variance X
Material usage variance X
Labour rate variance X
Labour efficiency variance X
Variable overhead rate variance X
Variable overhead efficiency variance X
Fixed overhead expenditure variance X
Fixed overhead efficiency variance X
Fixed overhead capacity variance X
X X
Total cost variance X
Actual profit X

216
Operating statements for marginal costing Chapter 15

For marginal costing, they should follow the following proforma:

$ $
Budgeted contribution X
Sales volume variance X
Flexed budget contribution X
Sales price variance X
X
Cost variances: F$ A$
Material price variance X
Material usage variance X
Labour rate variance X
Labour efficiency variance X
Variable overhead rate variance X
Variable overhead efficiency variance X
X X
Variable costs X
Actual Contribution X
Budgeted fixed overhead X
Fixed overhead expenditure variance X
X
Actual profit X

217
218
 Chapter 16
Performance Measurement

219
 Mission Statements Chapter 16

The mission statement (also known as the vision) is a statement that describes the basic purpose
or what an organisation is trying to accomplish. This will include:
1. States the aims (or purposes) of the organisation.
2. Does not include commercial terms, such as profit.
3. Not time assigned.

220
External Factors Chapter 16

The performance of a company may be affected by government policies or the external

economic environment.
External factors which affect performance include:
• Tax changes
• Inflation
• Currency movements

221
 Financial Performance Measures Chapter 16

Financial measures can be used to measure the following three areas of performance:
1. Profitability
2. Liquidity
3. Gearing.
Measures used can be financial or non-financial.

222
Profitability – Return on Investment Chapter 16

Profit before interest and tax

Return on Investment = × 100
Capittal Employed
This is a relative performance measure (i.e. it is calculated as a percentage).
It can therefore be used to compare the performance of different divisions within the
organization.

223
 Profitability – Residual Income Chapter 16

Residual income is calculated as:

Profit – imputed interest (Investment × Required Return) = Residual income.
This is an absolute measure (i.e. it is not calculated as a percentage).

224
Liquidity Chapter 16

A company must have sufficient funds to operate. If a company runs out of cash it does not
matter how profitable the company is it will risk becoming insolvent and failing. There are two
measures of liquidity:
1. Current ratio
2. Quick (acid test) ratio
Current Ratio = Current assets / Current liabilities
Quick (acid test) ratio = (Current assets – inventory)/Current liabilities

225
 Gearing Chapter 16

A company may be funded either using equity (share capital) or debt (eg bank loans).
Gearing = Debt / (Equity + Debt)

226
Non-financial Performance Measures Chapter 16

Non-financial performance can be assessed in a number of ways:

• Balanced Scorecard
• Performance indicators
• Value of money
• Benchmarking

227
 Balanced Scorecard Chapter 16

The Balanced Scorecard looks at the company performance from 4 different perspectives:
Financial Perspective Customer Perspective
How do we look to shareholders? How do customers see us?
Cash flow Customer service
Share price Customer satisfaction
Market share. Customer retention.
Internal Perspective Innovation and learning perspective
What must we excel at? Can we continue to improve and create value?
Workforce motivation % sales from new products
Quality performance Product diversification

228
Performance Indicators Chapter 16

A critical success factor (CSF) is an element of a company’s business (for example it could
be a division, or a particular service that the company offers), without which the company
could not succeed.
Key performance indicators are measures of performance applied to the critical success factors.
Example:
Suppose one of the critical success factors for a budget airline is to minimise costs.
The Key Performance Indicator might be variance analysis i.e. ensuring that the company is
staying within agreed standard costs.

229
 Value of money Chapter 16

Value for money looks at the 3 E’s:

Economy means resourcing and purchasing the inputs at minimum cost consistent with the
required quality of the output.
Effectiveness means doing the right thing. It measures the extent to which the output meets its
declared objectives; is the output the required quality, the right specification etc?
Efficiency means doing the right thing well. It relates to the level of output generated by
a given input.

230
Benchmarking Chapter 16

There are 3 types of benchmarking:

Internal
This is where another department of the organisation is used as the benchmark because
conformity of service is the critical.
Competitor
Uses a direct competitor with the same or similar process because the competitor is the
threshold benchmark.
Functional
Focuses upon a similar process in another company which is not a direct competitor to look for
new innovative ways to create advantage as well as solving threshold problems.

231
 Service Industries Chapter 16

The Building Block Model can be used to assess the performance of service organisations:

Dimensions
Standards Rewards

Standards – the targets set within the organisation

Rewards – benefits to workforce for achieving objectives
Dimensions – how performance will be measured. Results measures:
Financial
Competitive performance
Determinant measures
Quality of service
Flexibility
(Resource) utilisation
Innovation.

232
Cost reduction and value enhancement Chapter 16

Cost control: Cost control refers to the systems that a business employs to ensure that it meets
its target or standard costs.
Cost reduction: Cost reduction focuses on actually reducing costs to below the target or
standard cost.
Value analysis: Providing customers with the product or service they want at the lowest
possible cost.

233
 Not for profit organisations Chapter 16

In a not for profit environment there are specific problems:

• Low emphasis on financial aims.
• Multiple objectives
Performance measures in a not for profit organisation might include a Value for Money analysis

234
Problems with performance measures Chapter 16

1. Tunnel vision
2. Ossification
3. Gaming
4. Sub-optimisation
5. Myopia
6. Measure fixation
7. Misrepresentation
8. Misinterpretation

235
 Preparing Reports Chapter 16

A number of different tools can also be used to present quantitative data in a report or
memorandum, including:
Tables
Bar charts
Pie charts
Scattergraphs

236
Bar Charts Chapter 16

Product Sales January February March

DVD’s 5,000 4,000 6,000
CD’s 3,000 2,500 2,000
Books 1,500 1,000 3,000

7,000
6,000
5,000
DVD’s
4,000
CD’s
3,000
Books
2,000
1,000
0
January February March

237
 Pie Charts Chapter 16

Pie charts can also be used to represent the information above, but a separate pie chart would
be used for each month.

January Sales

DVD’s
CD’s
Books

238