ACC2022 Summary

ACC2022 Management Accounting 1
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Management Accounting 1 (ACC2022F)
What is management accounting?
The processes and techniques that focus on the effective and efficient use of organisational resources,
to support managers in their tasks of enhancing both customer value and shareholder value.
What are the objectives of a manager?
- To develop and pursue strategy

- To maximise shareholders’ wealth
- To use resources efficiently and effectively
Week 1: Cost and Cost Behaviour
What are costs?

- Resources given up to achieve a particular objective.
Cost Classification
Cost
The process of Behaviour
The relationship Using knowledge of
determining cost betweeen cost and cost behaviour to
behaviour; often activity. forecast the level of
focuses on historical cost at a particluar
data. level of activity.
Cost Cost
Estimation prediction

Cost Function – an equation used to describe a cost behaviour.
Cost object – an item for which management wants a separate measure of costs (e.g. products, periods,
contracts, etc.)
Direct and Indirect Costs
Direct Cost
- A cost that can be identified with, or traced to, a particular cost object in an economic manner.
- E.g. raw/direct materials; direct labour; other direct non-manufacturing expenses.
Indirect Cost
- A cost that cannot be identified with, or traced to, a particular cost object in an economic
manner.
- E.g. fixed and variable overheads; can be manufacturing or non-manufacturing.
Controllable and Uncontrollable Costs
Controllable Cost
- A cost that can be controlled or significantly influenced.
Uncontrollable Cost
- A cost that cannot be controlled or significantly influenced.
This concept is relevant to evaluating or measuring employee’s performance. Management accountants

generally focus on the managers ability to influence, rather than control costs, as few costs are
completely under the control of any individual.
Costs Across the Value Chain
What is a Value Chain?

- A set of linked processes or activities that begins with acquiring resources and ends with
providing (and supporting) goods and services that customers value.

Support Services
Research and Customer

Design Supply Production Marketing Distribution
Development Upstream
(non-manufacturing)
Manufacturing
Service Downstream
(non-manufacturing)
Primary Processes
Manufacturing and Non-Manufacturing Costs (Nature of Costs)
Manufacturing Costs
Direct Material
- Raw materials consumed in the production process, physically incorporated into the finished
product, and can be traced to products conveniently.
Direct Labour
- The cost of salaries and wages and labour on-costs for personnel who work directly on the
manufactured product.
- Labour on-costs: the additional labour related costs that businesses have to incur to employ
personnel, such as payroll tax, workers’ compensation insurance and employer contributions to
pension funds.
Manufacturing Overhead
- All manufacturing costs other than direct material and direct labour costs
- E.g. indirect materials, indirect labour, depreciation.
Prime costs – direct materials and direct labour

 major costs directly associated with the product
Conversion costs – direct labour and manufacturing overhead

 costs of converting raw materials into finished products
On the Statement of Financial Position, the line item inventory is broken up into:
- Raw materials
- Work in process
- Finished goods

Non-manufacturing costs
- Below gross profit in the income statement
- Includes advertising expenses and selling and admin expenses
Product Costs and Period Costs (Timing of Costs)
Product Costs
- A cost assigned to goods that were either manufactured or purchased for resale.
- Regarded as part of inventory (capitalised) until the goods are sold; the product cost is then
transferred to the cost of sales account (expensed).
Period Cost
- Costs that aren’t considered product costs.
- These costs are expensed in the accounting period in which they are incurred rather than being
attached to units of purchased or produced goods.
Cost Estimation
There are 3 methods to estimate costs: scatter graph, hi-low, least squares regression
 We will use hi-low.
Hi-Low Method
Y = a + bX
where:
Y = total cost
a = fixed costs
b = variable cost per unit
X = activity
1. Identify highest and lowest levels of activity

2. Find variable cost per unit (b)
b=(change∈cost )/(change ∈activity)
3. Substitute any values in for x and y to determine fixed costs (a)
Cost Behaviour
Fixed Cost
- The cost remains the same at all levels of activity

- Can be discretionary or committed
Variable Cost
- The cost changes in direct proportion to a change in the level of activity
- Can be engineered or on a unit level
Mixed / Semi-Variable Cost

- Has both fixed and variable components
Step Fixed Cost

- Remain fixed over a wide range of activity levels but jump to a different amount for levels
outside that range
Step Variable Cost

- Different costs for different blocks of activity ranges (many more intervals than SFC; ranges are
much smaller and more frequent)
Committed Cost
- A cost resulting from an organisations basic structure and facilities, which is very difficult to
change in the short term
Discretionary Cost
- A cost resulting from a management decision to spend a particular amount of money for some
purpose, where the decision can be changed easily
Engineered Cost
- A cost that bears a defined physical relationship to the level of output
Unit Level Cost

- A cost relating to an activity that is performed for each unit produced
Exam Question Tips
When comparing month to month revenues, there are only two factors which can change the amount:
- Selling price
- Quantity sold
When doing any questions of forecasted income statements, always draw up a table of the units
(opening balance + production – sales = closing balance)
When working out the closing inventory figure, divide total production costs by number of units
produced to get cost per unit, then multiply this by the number of units in the closing balance.

Week 2: Job Order Costing
Why are Costing Systems Important?
- Deciding what margins to put on goods or services.

- Helps to market products at the right prices.
- Can be used to determine if the business should introduce new products or if old products are
out of date and need to be scrapped.
What is Job Costing?
A costing system that traces manufacturing costs to individual jobs. The features for job costing are:
- Many different products are produced each period.
- Products are manufactured to order.
- Costs are directly traced or allocated (not directly traced) to jobs.
- Cost records must be maintained for each distinct product or job.
The Flow of Documents in a Job Order Costing System

The Flow of Costs in the Manufacturing Business
- Raw materials inventory

- Work in process inventory
- Finished goods inventory
- Cost of goods sold expense
- Profit and loss account
Why do we allocate manufacturing overhead to our job order cost before we see our actual?
- If we’ve sold the product, we need to know the cost of the product.
- To track how much we’ve incurred on the job for better estimates.

The cost of a job includes:

- Actual direct materials
- Actual direct labour
- Manufacturing overheads applied to the job using the predetermined overhead rate
Accounting for Manufacturing Overhead
Actual manufacturing overhead

- Manufacturing overhead costs incurred throughout the accounting period
- Debited to the manufacturing overhead account
Applied manufacturing overhead

- Estimate of the overhead resources used to manufacture a product
- Applied to products using a predetermined overhead rate
- Credited to the manufacturing overhead account
Steps in a Job Costing System
1. Identify the job

2. Put any opening or closing balances you may have into the accounts
3. Charge direct material and direct labour to each job as work is performed
4. Charge indirect material and indirect labour to manufacturing overhead
5. Apply the indirect costs using the predetermined overhead rate
6. Find the total costs of the job by summing up all the cost components
Predetermined Overhead Rate
PDOHR=( Estimated total manufacturing overhead cost for thecoming period)/(Estimated total units∈the allo
Application bases:
- Direct labour hours
- Machine hours
- Direct labour cost (PDOHR is given)
Overhead applied=POHR × actual activity
Underapplied Manufacturing Overheads

- If actual manufacturing overheads is greater than applied manufacturing overheads (debit
balance), then overhead cost is underapplied.
- The cost of goods sold has been understated and net income has been overstated.
- We correct this by debiting cost of goods sold and crediting manufacturing overheads.
Overapplied Manufacturing Overheads

- If actual manufacturing overheads is less than applied manufacturing overheads (credit

balance), then overhead cost is overapplied.
- The cost of goods sold has been overstated and net income has been understated.
- We correct this by crediting cost of goods sold and debiting manufacturing overheads.
Schedule of Cost of Goods Manufactured
Exam Question Tips
If depreciation for the year amounts to R700 000, and R560 000 relates to factory and R140 000 relates
to selling and admin, the journal entry will be:
- Dr Manufacturing overhead 560 000
Dr Depreciation expense 140 000
Cr Accumulated depreciation 700 000

Week 3: Process Costing
What is Process Costing?
A costing system that traces all production costs to processes or departments and averages them across
all units produced. The features of process costing are:
- Mass production of one product.
- Each product looks identical.
- Each product undergoes identical production procedures.
- Each unit consumes the same amount of direct and indirect costs.
Process Costing Cost Classification
- Direct materials: added into the production process at a specific point in time
- Direct labour
Conversion costs: incurred throughout the process
- Manufacturing overhead
Originally cost was determined as follows:
Average cost per unit=(Total cost per process)/(Total units produced)
 this doesn’t consider goods that are incomplete at the end of the period, incomplete units from the
previous period, and spoilage. Process costing allocates the costs more effectively.
Incomplete Unit
- Units still in the production process, partially completed, by the end of the period (work in
process).
Equivalent Unit
- Based on the percentage of costs incurred on those incomplete units
- We translate the number of incomplete units into equivalent units
Spoilage
- Units produced that do not meet the specified quality standards; taken out of production and
discarded (they cannot be reworked)
- Normal spoilage: can be expected under normal efficient operating conditions (included as a
product cost)
- Abnormal spoilage: not expected under normal efficient operating conditions (treated as a
period cost; sent directly to cost of sales)
Departme

epartment A
Steps to Answering a Process Costing Question
1. Draw timeline
Transferred
in
0%
2. Draw up work in process physical units account
O/B
Department B
WIP (physical units)
Opening balancex Completedx

Started and transferred inx Spoilage: POI
Normalx
C/B
Abnormalx
Closing balancex
xx xx
100%
3. Calculate equivalent units
Physical Units Transferred-in costs Material Costs Conversion Costs

% complete Units % complete Units % complete Units
Opening balance WIP x
Started x
xx
Total completed and transferred out x x x x x x x

Normal Loss x x x x x x x
Abnormal Loss x x x x x x x
Closing balance WIP x x x x x x x
Equivalent units xx xx xx xx
*IF WAC, STOP HERE*
Less: opening inventory x x x x
Equivalent units x x x
4. Calculate cost per equivalent unit

Transferred in Materials Conversion

Current year production costs x x x
Opening balance (N/A if FIFO) x x x
Total Costs x x x
Equivalent units x x x
Cost per equivalent unit x x x
5. Production Report
Reconciliation of Costs R
Opening Inventory
Balance x
Completed in current period
- Conversion costs x
Cost of opening inventory completed and transferred to finished goods xx
*START HERE IF USING WAC*

Started and completed
Good Units x
Normal losses
- Transferred in x
- Materials x
Cost of units completed xx
Abnormal losses
- Transferred in x
- Materials x
Closing inventory
- Transferred in x
- Materials x
6. Draw up work in process account (rand values)
Cost of units
completed
Work in Process
Opening balancex Finished goodsx

Transferred inx Cost of Salesx Total of
Current Raw materialsx Closing balancex abnormal
period Total of
Salaries and wagesx losses
costs closing
Manufacturing overheadx inventory
xx xx

If asked for the cost of sales amount, don’t draw up WIP account.
 COS = cost of units completed + abnormal losses.
Week 4: Absorption and Variable Costing
Absorption and variable costing are the two costing systems. They have different objectives and are
used for different purposes.
Variable Costing
- All fixed costs are treated as period costs

 expensed as incurred
- Fixed manufacturing overheads are excluded from the product cost
Absorption Costing
- All manufacturing costs (fixed and variable) are product costs.
- Manufacturing fixed costs form part of the product cost
 expensed when the product is sold
Product Costs
- Traced directly to the product
 form part of the cost and are expensed when the product is sold
Period Costs
- Costs incurred with the passage of time
 expensed each financial period
Variable Manufacturing Overheads

- Vary with the level of production.
- E.g. indirect materials, indirect labour, water, electricity.
Fixed Manufacturing Overheads

- Do not vary with the level of production
- E.g. factory manager’s salary, factory rent, depreciation on machinery, insurance on machinery.
Product Cost:
Variable Absorption
Direct Materials xx xx
Direct Labour xx xx
Variable MOH xx xx
Applied Fixed MOH - xx
Product Cost xx < xx
Variable Costing Income Statement
Sales Revenue x
Less: Variable cost of goods sold (x)
Opening inventory x
Variable
costs Add: production x
Less: closing inventory (x)

Less: Variable selling & admin expenses (x)
Contribution Margin x
Fixed Less: Fixed expenses

costs Fixed manufacturing overheads (x)
Fixed selling and admin expenses (x)
Operating Profit x
Absorption Costing Income Statement
Sales Revenue x
Less: Cost of goods sold (x)
Product Opening inventory x
costs Add: production x
Less: closing inventory (x)
Gross Profit x
Less: Selling and admin expenses

Period
costs Fixed (x)
Variable (x)
Operating Profit x
Revenue will always be the same under both methods (Units x Selling Price)
This is because the mark-up is always done on the product cost under the absorption method.
To calculate how much fixed manufacturing overheads was recognised in a period:

Sales x overhead rate per unit
The Effect of an Increase in Inventory

- Absorption costing profit > Variable costing profit
- Produced > Sold
- Under absorption costing, some of the FMOH is being deferred to the next period (not recognising
all the increase in inventory)
 less FMOH are recognised, thus profit is greater.

The Effect of a Decrease in Inventory

- Variable costing profit > Absorption costing profit
- Sold > produced
- Under absorption costing, you are recognising some of the FMOH that was deferred from the
previous period, thus this profit is lower.
When Inventory is the Same

- Variable costing profit = Absorption costing profit
- Sold = produced
Reconciliation
Net profit under variable costing x

Less: Fixed MOH in opening inventory (x)
Add: Fixed MOH in closing inventory x
Net profit under absorption x
The FMOH in the opening balance increases the opening balance which results in an increase in the cost
of goods sold. This decreases profits compared to variable costing.
The FMOH in the closing balance increases the closing balance which results in a decrease in the cost of
goods sold. This increases profits compared to variable costing.
Advantages of Absorption Costing

- In line with external reporting requirements.
- More closely matches costs with revenues as it recognises the importance of fixed costs in
production.
- FMOH are essential in the production process and should be assigned to products (especially when
making pricing decisions).
- Some businesses rely on seasonal sales, and thus building up inventory is an essential part of the
business. Under variable costing this will result in big losses reported in one period (quarter),
distorting the true results.
Advantages of Variable Costing

- Data required for CVP analysis can be taken directly from the contribution margin profit statement.
- Profit for the period not affected by changes in stock therefore not open to manipulation by
management.

- Variable costing profit is closer to net cash flow, which is important for companies having cash flow
problems.
- Impact of fixed costs on profits is emphasized.
Manipulation by Management
- Under absorption costing, managers will build up inventory and defer FMOH to the next period
which increases profits.
Week 5: Service Department Allocation
A method of equitably allocating service department costs to operating departments using an

appropriate basis.

What is a service (support) department?

- Departments that provide services within the business.
- Cost centres: focusing on costs; the departments do not earn revenue.
- We allocate the costs of these service departments to different departments.
While a service department is a cost centre that provides services within the company, an operating
department (also known as a production department) is a profit centre that provides goods and services
to customers outside the company.
Why do we allocation indirect costs?

- To evaluate performance.
- To measure profitability.
- To encourage managers to make wise use of services provided by service departments.
- To develop overhead rates in operating departments.
What is the best way of allocating indirect costs?

- It should be fair and equitable, based on usage, using an appropriate allocation base.
The Direct Method

- Interactions between service departments are ignored and all costs are allocated directly to
operating departments
- Problem: doesn’t take inter service department use into account
Example:
Service Departments Production Departments

Personnel Property Machining Assembly Total
Departmental costs 2 000 000 500 000 1 500 000 1 000 000 5 000 000
Number of employees 4 40 70 86 200
Space occupied (metres) 100 150 400 350 1000
Departmental costs before allocation 2 000 000 500 000 1 500 000 1 000 000 5 000 000
Allocations:
Personnel costs (2 000 000) 897 437 (W1) 1 102 564 (W2)
Property services costs (500 000) 266 666 (W3) 233 333 (W4)
Total costs after allocations 0 0 2 664 103 2 335 897 5 000 000
W1 (Personnel costs to machining): 2 000 000× 70/156=897 437
W2 (Personnel costs to assembly): 2 000 000× 86 /156=1102 564
W3 (Property services costs to machining): 5 000 000 ×400 /750=266 666

W4 (Property services costs to assembly): 5 000 000 ×350/750=233333
The Step Method

- Accounts for one inter service department relationship
- We start with the service department that provides the greatest amount of services to the other
service departments
Example:
If starting with personnel, how much cost would If starting with property, how much cost would
be allocated to property? be allocated to personnel?
40 /196=20.4 % 100/850=11.76 %
 We start with personnel, as it offers the greatest amount of services to other departments.

Departmental costs before allocation 2 000 000 500 000 1 500 000 1 000 000 5 000 000
Allocations:
Personnel costs (2 000 000) 408 163 (W1) 714 286 (W2) 877 557 (W3)
Property services costs (908 163) 484 353 (W4) 423 810 (W5)
W1 (Personnel costs to property): 2 000 000× 40 /196=408163

W3 (Personnel costs to assembly): 2 000 000× 86 /196=877 557
W4 (Property service costs to machining): 908 163 × 400/750=484 353
W5 (Property service costs to assembly): 908 163 ×350/750=423 810
How would the step method work with 3 service departments?

- We would allocate the service department offering the most service to the other two service
departments as well as all the operating departments.
- Then, we would allocate from the remaining two service departments to the operating
departments.

The Reciprocal Method

- Fully accounts for all inter service department interactions
To determine what amounts need to be taken out of each of the service departments, we use
simultaneous equations.
Example:
1. Assign values X and Y to the service departments
X = total amount to be reversed out of personnel

Y = total amount to be reversed out of property services
2. Determine the equations for X and Y
X =2 000 000+ 100/850 Y

Y =500 000+ 40/196 X
3. Rearrange the equations
X =2 000 000+(100 /850 ×(500 000+ 40/196 X ))
Y =500 000+(40/196 ×(2000 000+100 /850Y ))
4. Simplify the equations and solve for X
X =2 000 000+(58 823,53+0.024 X)

X =2 058 823,53+ 0.024 X
0.976 X =2 058 823,53
X =2109 450,34
5. Solve for Y
Y =500 000+ 408 163,27+0.024 X
0.976 Y =908 163,27Y =930504.31


Departmental costs before 2 000 000 500 000 1 500 000 1 000 000 5 000 000
allocation
Allocations:
Personnel costs (2 109 471) 430 504 (W1) 753 383 (W2) 925 584 (W3)
Property services costs 109 471 (W4) (930 504) 437 884 (W5) 383 149 (W6)
W1 (Personnel costs to property): 2 109 471× 40 /196=430 504
W3 (Personnel costs to assembly): 2 109 471× 86/196=925 584
W4 (Property service costs to personnel): 930 504 ×100 /850=109 471
W5 (Property service costs to machining): 930 504 × 400/850=437 884
W6 (Property service costs to assembly): 930 504 × 350/ 850=383 149
Week 6 and 7: Relevant Costing
A decision-making tool that helps to identify costs and revenues (and other qualitative data) that are
relevant (and not relevant) to a decision for the purpose of establishing the financial (and non-financial)
impact of that decision on an enterprise.
Relevant Cost
- Differential future cash flow; future cash flows that differ between alternatives.
- Those future costs and revenues that will be changed by a decision.

Irrelevant Cost
- A cost that does not differ between alternatives, and/or does not represent a future cash flow.
- These costs and revenues will not be changed by the decision under consideration.
Opportunity Cost
- The best alternative foregone.
- An opportunity that is sacrificed if the decision under consideration is made.
Sunk Cost
- A cost that has already been incurred or irrevocably committed to.
- The cost will not change with the decision; they are irrelevant to the financial impact.
Differential Cost
- A cost that differs between alternatives
Tactical Decisions
- Short-term decisions which can be made or changed quickly to take advantage of opportunities.
Strategic Decisions
- Longer term decisions with longer term effects that may be difficult to reverse
How do you determine if you should make a product?

- If it has a positive contribution margin in the short term.
- In the long term, some of our fixed costs become relevant and we no longer just look at contribution
margin.
Special Orders
- The decision to supply a customer with a single, once-off order for products at a special price.
- The relevant cost is the difference between the revenue at this special price, and the cost to make
this order.
- When the company is already operating at capacity, consider the lost contribution margin from the
sales that would have been made without the special order (this takes into consideration the
revenue and the cost).
Constrained Resource
- When a limited resource of some type restricts the company’s ability to satisfy demand.
- Generally only occurs in the short run; in the long run we can invest in more of the resource.
- We will first cut back on the product with the smallest contribution margin per limiting factor.
How do you Manage your Constraints?

- Hire new workers or acquire more machines (increasing capacity)

- Reduce number of defective units (quality management)

- Subcontract production (outsource)
- Improve business processes (E.g. supply chain management)
Joint Products
- Two or more products that are produced simultaneously from one production process.
- Split off point: where the products can be recognised as separate products.
- Joint costs are irrelevant in decisions regarding what to do with a product from the split-off point
forward.
Make or Buy Decision

- The business’s choice of whether to produce particular products itself or purchase them from an
external supplier.
When should you include fixed and variable costs in the relevant cost?
- Fixed costs: decide to include based on if the cost is differential or not.
- Variable costs: always include (direct labour is always variable unless otherwise stated).
Adding or Dropping a Product or Segment

- Dropping: involves considering which costs and benefits will disappear if the decision is taken.
- Adding: involves estimating the additional costs and revenues that will arise from the decision.
Strategic Considerations
- Long term effects of short-term decisions (time value of money)
- Financing of products and capital structure
- Outsourcing: quality, just-in-time, capacity, bargaining power
- Opportunities: new markets, new products, new customers, repeat orders
- Hiring or firing: creation or loss of jobs
- Competitors
- Reputation
Week 8: Cost-Volume-Profit Analysis
The purpose of CVP analysis is to determine how a change in cost and volume affects a company’s
operating and net income.
Assumptions in CVP Analysis

- Sales mix in a multiproduct scenario remains constant.
- All inventory produced in a period is sold in that period (units produced = units sold).
- For both variable and fixed costs, sales volume is the only cost driver.

Profit = revenue – total costs

= (SP x units sold) – (VC/u x units sold) – FC
Fixed cost – remains unchanged despite changes in level of activity.
Profit-making area
Break-even
Loss-making area
Break-even Point
- Where revenue = total costs
- Anything below this point is a loss-making area
- Anything above this point is a profit-making area
Contribution Margin = selling price – variable costs

- The margin you earn that can contribute to covering fixed costs
Contribution Margin Income Statement

- Used for internal purposes (decision making).
Sales x
Less: Variable costs (x)
Contribution margin x
Less: Fixed costs (x)
Net profit x

Contribution margin ratio = (Contribution margin)/( Revenue /sales) ( or

(CM per unit)/( SP per unit ))
- Percentage of each rand of sales that is available to cover fixed costs and profit.
Break-even Units = (¿ costs)/(CM per unit )
Break-even Sales = (¿ costs)/( CM ratio)
- Shows how close you are to making a loss.

- The closer you are to break-even, the riskier it is that you may not sell enough to cover your costs.
Margin of Safety Rands = budgeted/current sales – break-even sales
Margin of Safety Ratio = ( Budgeted sales−breakeven sales)/(Budgeted sales) x 100
- How much your sales can drop before you start making a loss.
Target Profit
- Net income (profit) = sales – total costs
- Target profit = (SP X units sold) – (VC/u x units sold) – FC
Target Units = (¿ costs+ target profit)/(CM per unit )
Target Profit After Tax = (¿ costs+((Target profit)/(1−tax rate)))/(CM per unit)

- Answer is units to sell to get target profit
Sales Mix
- The relative proportions in which a company’s products are sold.
- A constant ratio.
Budgeted Operating Income (profit) = Contribution margin – fixed costs
Weighted Average Method to Find Break-even
1. Calculate total units in 1 batch

2. Find weighted average contribution margin:
Item 1 CM/u x number of units/total batch units


Weighted average CM Total
3. Calculate BE units = (¿ costs)/(Weighted average CM )

4. Sum of (BE units x CM weighted accordingly for each item) = total units to BE
Low cost companies

- Low selling price, money for fixed costs has to come from high units sold.
Cost Structure
- High fixed costs: sensitivity to change in sales is higher (higher contribution margin)
 More risky; high benefits when sales increases. Causes concern when sales decreases, especially
when close to break-even.
- High variable costs: lower contribution margin; less risk.
When asked about two companies with different cost structures and you need to analyse both,
calculate:
- Contribution margin
- Contribution margin ratio
- Break-even
- Margin of Safety
Percentage increase in net profit = ( Increase ∈revenue × CM ratio)/(Increase ∈revenue)
Degree of operating Leverage = (Total contribution margin)/(Net profit)

- How much fixed costs is used in the cost structure.
- High operating leverage; higher effect of change in sales in net profit.
Week 9: Activity Based Costing
Activity based costing is a costing system that allocates overhead costs to products based on a cost
driver.
Traditional Approach
- Direct materials and direct labour are traced to products
- Manufacturing overhead costs are allocated using a predetermined overhead rate

 rates are calculated using volume-based cost drivers (units produced, labour hours, etc)
- PDHR = ( Budgeted overhead costs) /(Budgeted level of activity)
- Non-manufacturing costs a treated as period costs (they are expensed)
- Used in job order costing
Manufacturing overheads are becoming more non-volume driven due to:

- Increased automation; decreased labour intensity, therefore more non-volume overheads such as
insurance, depreciation etc.
- Increased product diversity; increase in manufacturing overheads
- Downstream and upstream investing e.g. research, customer service, marketing.
- Increased competition.
ABC and the Value Chain
Research and Customer

Design Supply Manfacturing Marketing Distribution
Development Service
In traditional costing, only manufacturing costs will be included. It is obvious that all these costs add to
the value of the product, so they need to be considered.
Consequences of poor costing systems:

- Incompatible cost structures and cost allocation will result in arbitrary allocations.
- If costs are allocated incorrectly, selling price will be incorrect.
- Product under costing – selling price too low (selling at a loss).
- Product over costing – selling price too high (loss of customers; they go to competitors).
Activity Based Costing

- Allocates manufacturing and non-manufacturing overhead costs.
- Allows volume based and non-volume-based drivers.
- Accounts for product diversity.
Types of Capacity
- Theoretical: maximum operating capacity based on 100% efficiency with no interruptions for
maintenance and other factors.
- Practical: maximum capacity that is likely to be supplied by the machine after taking into account
unavoidable interruptions arising from maintenance and public holidays.
- Normal: measure of capacity required to satisfy average customer demand over a longer period of
time after taking into account seasonal and cyclical fluctuations.

- Budgeted: activity level based on the capacity utilisation required for the period (set by
management year-to-year).
- Actual production: what the business actually produced for the year in question.
Approach to ABC
- Excludes facility sustaining costs - costs incurred by whole business to keep it running (e.g. rent).
 don’t always assume that rent is facility sustaining; if we can somehow change rent by cutting
down products, for example, then it should be allocated.
- Fixed costs are based on practical capacity.
- Variable costs are based on actual production.
Traditional ABC
Only manufacturing OH are allocated Manufacturing OH and non-manufacturing OH are
allocated
All manufacturing costs are allocated Excludes some manufacturing costs (FS)
Uses pre-determined overhead rates Uses activity rates
Overhead rate is volume driven Activity rates can be volume or non-volume
Uses budgeted level of output to calculate PDHR Uses practical capacity to determine activity rates
Capex – purchase of equipment (once off cost upfront).

Depreciation – the cost of capex split over a number of years.
Traditional Costing
Product A Product B
Per Unit Total Per Unit Total
Direct Materials
Direct Labour
Overheads
Total Cost
Steps to Doing and ABC Question
1. Identify the activity centres of the organisation (work areas).

2. Assign costs to the activity centre.
3. Identify the cost drivers for each activity (the greatest cause and effect; can be volume or non-
volume based)
4. Calculate the activity rates using the cost drivers.
5. Assign costs to products using the activity rate.

ABC Table
Product A Product B
Overhead Cost Activity Rate Usage OH allocation Usage OH allocation Total Allocation
(cost ÷ (rate x usage) (rate x usage)
activity
)
Total cost is then determined by direct materials + direct labour + allocated overheads.
Spare Capacity
- The capacity that exists and is able to be utilised but is not currently as there is no product demand
for it (only calculated on fixed costs).
- To determine spare capacity: find the difference between the overhead allocation and the cost for
all fixed costs.
Indicators of an Inappropriate Costing System

- Profits margins are difficult to explain
- Company profits are being eroded despite increase in sales volumes
- Departments all using their own cost system
- Competitors prices seem too low in comparison
- Customers demand does not change and there are no complaints when prices increase (products
have been under costed)
Disadvantages of Activity Based Costing

- Substantial resources and investment required to implement ABC (time consuming and expensive)
- Breaking down into detail each cost pool obscures the bigger picture (can sometimes focus on spare
capacity and maximising production rather than quality)
- Cost outweighs the benefits as ABS is not applicable to all organisations (e.g. a manufacturer with a
single product; they only have manufacturing costs, no upstream or downstream).
- ABC requires an arbitrary measure of allocation of costs, which may be difficult to measure or may
not be adequate to explain the cost behaviour in isolation.
- Opposition by management as it exposes wastage.
Exam Question Tips
- Activity based costing can be applied to service businesses (i.e. banking) where there isn’t always a
practical capacity.
- Often the business’s traditional method of costing may not look like regular traditional costing.

- When doing your ABC table, identify which costs are fixed or variable, this can help if needed to
consider spare capacity.
- Look out for facility sustaining costs.
Week 10: Budgeting
What is a Budget?
- A detailed plan that shows the financial consequences of an organisation’s operating activities for a
specific future time period.

2. Annual plan (within 3. Monitor outcomes and

1. Strategic planning
context of long- term respond to changes from
(long -term)
plans. planned outcomes
Long-term broad estimates for Implementation of long-term plan Compared budgeted to actual for
several years via a detailed short-term plan progress and update plans
Purposes of Budgeting
1. Planning – forces the business to plan and quantify their resources that they need.
2. Facilitates communication and coordination – forces all managers to communicate their need,
better resource allocation.
3. Allocating resources – especially those that are limited in nature.
4. Controlling profit and operations – serves as a benchmark and a performance evaluation tool.
5. Evaluating performance and providing incentives – looking at actual vs. budgeted.
Responsibility Accounting
- The practice of holding managers responsible for the activities and performance of there are of the
business; only hold people responsible for things that they can control.
Responsibility Centre
- A sub-unit in an organisation whose manager is held accountable for the sub-units’ activities and
performance (which they can control).
Types of Responsibility Centres

- Cost centre: only manages cost; nothing sales related (e.g. human resources).
- Revenue centre: only manages revenue (e.g. sales department).
- Profit centre: manages costs and revenues (e.g. a certain branch of the business).
- Investment centre: manages revenue, costs, and investment decisions (e.g. the entire company).
Assumptions that can Affect the Budgets

- Your strategy
- Market share
- Sales volume and prices
- Wages
- Legislation
Operating Budgets
- Sales budget: a detailed summary of the estimated sales units and revenues from the organisations’
products for the year, based on the sales forecast.
- Cost budget: details the cost of operations that will be carried out to support the forecasted
demand for goods and services; depends on industry e.g. manufacturing firms focuses on units

produced; retail and wholesale firms purchase and resell products; service firms focus on number of
services they provide.
Financial Budgets
- Capital expenditure budget: looks at the acquisition of long-term budget; cash inflows from
financing activities.
- Budgeted SOFP and SOCI
Behavioural Consequences for Budgeting

- Human reactions have a considerable influence on an organisation’s overall effectiveness.
- Budgets affect everyone in the business (preparers, the users who base their decisions on them, the
performance evaluation that comes from the budget)
Participative Budgeting
- Top-down: senior management impose the budget targets on other staff; little participation.
- Bottom-up: participative process where people at lower operational levels play an active role;
allows managers to develop their own initial estimates; requires review by senior management.
Top-down Budgeting
Advantages Disadvantages
- Time efficient: no engagement so swift - Senior management know less about the
decisions are made. operations than the operational managers in
- Cost effective: less time spent = lower costs their responsibility centres.
- Limited involvement causes a lack of
commitment to achieve the strategy by those
who the budget is imposed upon.
Bottom-up Budgeting
- Encourages communication and coordination - Expensive and time-consuming
between managers which leads to a greater - If managers can’t agree, the participation can
understanding of the business’s objectives cause conflict.
- Improves accuracy of the budget as it is being - Creates opportunity to pad the budget if the
set by those with the best knowledge. projections are not accurate.
Budgetary Slack
- The difference between a person’s projection and a realistic estimate.
- This makes managers performance look better, helps them deal with uncertainty, and ensures they
get adequate resources.
Padding the Budget

- In setting a budget, sales managers will be incentivised to underestimate sales and cost managers
will be incentivised to overestimate costs.
- This overestimation of costs and underestimation of revenue is call padding the budget.
How to Solve the Budgetary Slack Problem

- Avoid relying on the budget as a negative evaluation tool
- Give incentives to not only achieve budgetary projections but to provide accurate projections.
Difficulty with Budgets

- Budget motivation: trying to get employees motivated to achieve their budgets.
- Budget acceptance: trying to get employees to accept the budget as fair
- How to overcome these difficulties: develop targets with employee participation, provide frequent
feedback on performance, achievements of targets is accompanied by rewards.
Incremental vs. Zero-based Budgeting
Incremental Zero-based
- Starting point: last period’s budget - Starting point: set to zero
- Adjust last period’s budget for expected - Every manager has to justify the usefulness
changes (e.g. inflation) of their activities to get allocated resources
- Focus on money - Makes managers think about alternatives
before they spend money
- Focus on goals and strategy
Zero-based Budgeting
- Avoid deficiency of incremental and you - Very expensive
only need to allocate what you need - Requires extensive in-depth analysis of activities
- Creates a questioning attitude about your - Will go out of date on a few years
current practices
- Focuses attention on outputs for creating
value.
Incremental Budgeting
- Time efficient - Past inefficiency and wasteful expenditure is
- Not costly to implement passed on
- The base level of expenditure is never looked at

Activity Based Budgeting

- A process of building up budgets from the major activities of the business.
- Similar to activity-based costing, but in reverse.
- Estimate volume for products  estimate demand for activities  determine what resources are
required  estimate quantity of resources needed to meet demand  adjust capacity of resources
to meet demand.
- Advantages: enhances the visibility arising from showing the outcomes of the expenditure, identifies
where you need to invest or cut down.
- Disadvantages: time intensive, requires understanding of resource consumption, costly to set up.
Benefits and Difficulties with Budgeting
Benefits Difficulties
- Forces managers to think and plan for the - Setting attainable budgets
future - Budgetary slack
- Provides a means for allocating resources - Consumes managements time when time could
to those parts of the organisation where be spent on developing future strategies
they can be efficiently used - If budgets aren’t kept up to date
- Coordinates the activities of the - Unrealistic goals can demotivate management
organisation by integrating plans. - May constrain creativity
- Defines goals and objectives that serve as - Managers may manipulate the budget.
benchmarks for evaluating performance.
Week 11: Standard Costing
What is Control?
- Those actions which ensure that managements objectives and plans are achieved. Consists of:
1. A pre-determined standard or performance level
2. A measure of actual performance
3. A comparison between standard performance and actual performance.

Decision Making Process

1. Identify objectives
2. Search for the alternative course of action
3. Gather data about alternatives
4. Select course of action
5. Implement decision
6. Compare actual and planned outcomes
Control Process
7. Respond to divergencies from plan
What is a Standard?
- A level of quality or attainment
- Used or accepted as normal or average
Why is there a Need for Standards?

- Time consuming to track exact price of inputs
- Helps to plan budgets
- Helps to manage and control costs
- Tool for evaluating performance
How are Standards Set?

1. Analysis of historical data: considering standards from last year and making changes; best suited for
mature companies; danger of including past inefficiencies.
2. Engineering methods: analysis of production process and determining what should be used, based
on careful specifications of inputs and equipment.
3. Combined approach.
4. Benchmarking with similar companies.
Ideal/Theoretical/Perfection Standards
- Only attainable under nearly perfect operating conditions
- Assumes peak efficiency
- No breakdowns or other interruptions and 100% effort from all employees
- Some managers believe that it motivates employees to achieve the lowest cost possible
- This could lower staff morale; could end up sacrificing quality for time; large variances from ideal
standards.
Practical/Attainable Standards
- Assumes a production process that. Is as efficient as it is practical
- Allows time for machine breakdowns and normal amounts of raw material wastage
- Reasonable effort from employees is required
- This encourages more positive and productive employee attitudes than perfection standards
- Variance represents variations from ‘normal’ operations
Static/Original Budget

- Planned for one specific level of activity (expected output) at the beginning of the period.
Will budgeted units to be produced always equal actual units produced?

- No; budgeted is determined as the beginning of the year and actual determined at the end.
- Anything can happen during the year that would result in actual units produced being more or less
than budgeted (change in demand, managers can decide to build up stock etc).
How does a change in units produced affect costs?

- Costs will change as direct materials, direct labour and variable manufacturing overhead depend on
quantity produced.
How does the fact that costs increase or decrease (due to level of activity) impact my objective of
trying to control costs using standard costing?
- Using the static budget to calculate the variances will result in the following: a portion of the
variance will be attributable to an increase or decrease in costs purely because production changed.
- Costs related to this portion can’t be controlled or minimised
 highlight abnormal behaviour by adjusting the static budget for actual output.
Flexed Budget
¿ standard quantity input allowed per unit × actual output × standard cost per unit of input
Static Budget
¿ standard quantity input allowed per unit × budgeted output × standard cost per unit of input
Actual Results
¿ actual quantity input used per unit × actual output × actual cost per unit of input
If there is a difference between the static budget and actual results, it could be due to production, price,
or quantity. We create a flexed budget which eliminates the option of production.
If there is a difference between the flexed budget and the actual results, it is not due to production. It is
either due to price or quantity.
Variance Analysis
- Variance: the difference between the actual cost and what should have happened
- Management will only investigate significant variances; this allows them to focus only on areas
where the business is not performing to their plan and goals. Allows them to be more efficient.
What is classified as a significant variance?

- Depends on the size, if it is recurring, if it is a trend, and the controllability.

The Bucket Method
Actual Flexed
Material Price Actual Price x Actual Standard Price x Actual
Quantity Quantity
Price Variance
Material Usage Standard Price x Actual Standard Price x

Quantity Used Standard Quantity*
Quantity Variance
Labour Rate and Actual Rate x Actual Standard Rate x Actual Standard Rate x Standard
Efficiency Hours Hours Hours*
Rate Variance Efficiency Variance
Variable Overheads Actual VOH Rate x Standard VOH Rate x Standard VOH Rate x
Actual Hours Actual Hours Standard Hours*
Spending Variance Efficiency Variance
Fixed Overheads Actual FOH Cost Budgeted FOH FOH Costs to be Applied
to WIP
Budget Variance Volume Variance
Standard Quantity* = standard price x standard quantity of input allowed x units produced
Standard Hours (Labour)* = standard rate x standard hours of input allowed x units produced
Standard Hours (VOH)* = standard rate x standard hours required per unit x units produced
FOH Costs Applied ¿ WIP=standard rate × standard hours × actual output

budgeted FOH cost
¿ × standard hours × actual output
budgeted activity
Causes of Variances
Direct materials Direct Labour
- Quality - Productivity (employee satisfaction,
- Quantity (bulk discounts) corporate culture)

- Suppliers - Experience and training

- Urgency of orders - Normal time vs. overtime
Who is Responsible for Variances?

Direct materials Direct Labour
Usually (not always): Usually (not always):
- Price: purchasing manager - Rate: production manager and HR
- Quantity: production manager/supervisor department
and production engineers - Efficiency: production manager
Journal Entries
- All inventory in a standard costing system is recorded at standard costs

- Differences between actual and standard will be sent to separate variance accounts
Purchase of Raw Materials
Dr Raw materials SP x AQ
Cr Goods received not yet vouched for (GRNV) SP x AQ
When you receive the invoice and know the actual price:
Dr Goods received not yet vouched for (GRNV) SP x AQ

(Dr Raw materials price variance – if unfavourable Variance amount
OR
Cr Raw materials price variance – if favourable Variance amount)
Cr Bank AP x AQ
Raw Materials Issued into Production
Dr Work in process SP x SQ*

(Dr Raw material usage variance – if unfavourable Variance amount
OR
Cr Raw material usage variance – if favourable Variance amount)
Cr Raw materials SP x AQ

Week 12: Segmental Reporting
What is Segmental Reporting?

- Breaking up a company’s financial data by segments.
Why do we Need Segmental Reporting?

- Small companies can keep all their decision making centralised and they have no need for segments
(or segmental reporting).
- Bigger companies need more systems to maintain control and will delegate decision-making to
segments (e.g. divisions).
Centralised Organisations
- Decisions are handed down from the top management and subordinates carry them out.
Decentralised Organisations
- Decisions are made at divisional and departmental levels.
Benefits and Costs of Decentralisation

Benefits Costs
- Lower level managers are closer to the - Managers may focus too narrowly on their
operations and can operate a division more own performance instead of the big picture.
effectively. - Managers’ goals may not be the same as the
- Lower level managers can gain experience in organisations.
decision making and you can promote from - There could be a lack of communication
within. between autonomous managers.
- Having decision-making power improves your - Will have more costs due to duplication of
motivation and job satisfaction. roles.
- Delegating operational decisions gives top - May start to lose control of your operations.
management more time to focus on strategy.
- Can evaluate managers more effectively.
The Behavioural Challenge

- Autonomous managers may be unaware of other segments’ performance, might not be performing
to achieve the company’s goals (humans can be inherently selfish)
- Goal congruence is needed: when the managers of subunits throughout the organisation have
incentives to perform in the common interest of the organisation.
- We achieve goal congruence through the use of responsibility accounting
-  knowing exactly what managers are in control of and holding them responsible while using tools
and incentives to measure their performance.
Segment/Responsibility Centre
- Any part or activity of an organisation about which a manager seeks cost, revenue or profit data.
- Can be an individual store, a sales territory, or a product line.
As you increase how centralised a company is, the managers’ financial responsibility decreases.
Setting the Right Level of Responsibility

- What your manager is responsible for, will affect the segment’s performance
- Increasing responsibility by changing from a cost centre to a profit centre can improve total
efficiency.
- Setting the incorrect level of responsibility could result in missed opportunities, not focusing on
value added, and decreased creativity.
When measuring the performance of a manager, it is important to not only look at financial information
but look at all of the six capitals (while still keeping in mind what they can and can’t control).
The Six Capitals

- Financial
- Manufactured
- Intellectual
- Social and relationship
- Natural
- Human
Type of Responsibility Centre Financial Responsibility Financial Performance Measures

Investment Centre Profit and assets used to create Return on investment
that profit
Profit Centre Profit (all revenues and costs) Measure of profit
Revenue Centre Revenue Revenue
Cost Centre Costs Costs and variances
Shared Services
- Bringing together all shared services used in the wider entity into a separate unit to service internal
customers e.g. having one HR department for all branches.
- Appropriate for non-strategic areas (like service departments) with high levels of autonomy.
Benefits of Shared Services

- Reduces costs
- Improves service delivery (bigger budget)
- Improves productivity through better scale of operations, common systems and procedures.
- Enables managers of the service entity to become experts.
Segmented Income Statements
- Preparing an income statement but breaking it down into each of your managers’ segments.
- Shows the key financial results appropriate for each type of responsibility centre.
- This will allow us to evaluate the financial performance of our managers.
- A contribution format should be used because it separates fixed from variable costs and it enables
the calculation of a contribution margin
- Traceable fixed costs should be separated from common fixed costs (don’t allocate common costs)
to enable the calculation of a segment margin/profit.

Traceable and Common Costs

- Traceable costs would disappear over time if the segment itself disappeared.
- Common costs arise because of overall operation of the company and are not due to the existence
of a particular segment (e.g. overall admin department).
- Some fixed costs that are traceable on one segmented statement can become common if the
company is divided into smaller segments.
Segmented Income Statement

Total Departments
Company A B
Sales
Less variable expenses
Contribution margin
Less traceable fixed costs
Divisional segment margin
Less common fixed costs not traceable to departments
Net operating income
Performance of the Division vs. Performance of the Manager

- In evaluating a manager, we must only look at what they can control.
- Some costs are attributable to the whole division but are not controllable by the manager (we must
show these separately because the manager has no say on these costs).
- E.g. A good manager appointed to a bad division to turn it around.
Net operating income

Return on Investment =
Average operating income
Net operating income Sales
¿ ×
Sales Average operating assets
Profit Margin Asset Turnover
How Can you Improve your Return on Investment?

- Improve your profit margins:
o Increase your selling prices
o Increase your volumes
o Decrease your expenses
- Decrease your asset base:
o Can sell off assets like property, plant & equipment Are these always good
o Decrease how much inventory you hold decisions?

Advantages of ROI
1. Managers must consider their profits AND the asset that generate those profits.
2. Discourages excessive investment in assets.
3. Enables you evaluate relative performance between your managers and divisions.
Limitations of ROI
1. Encourages short term focus at the expense of long- term (could cut discretionary expenditure
like training or research & development)
2. Encourages management to not reinvest in assets (assets depreciate which makes assets smaller
and ROI higher if you do not reinvest; managers do not want to invest in new machinery, etc.;
managers could even downsize to make ROI higher)
3. Can discourage acceptance of profitable projects (managers will not accept a project that is less
profitable than their current projects as it will bring their ROI down).

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ACC2022 Management Accounting 1

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Management Accounting 1 (ACC2022F)

What is management accounting?

What are the objectives of a manager?

- To develop and pursue strategy

Week 1: Cost and Cost Behaviour

What are costs?

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Cost Function – an equation used to describe a cost behaviour.

Controllable and Uncontrollable Costs

This concept is relevant to evaluating or measuring employee’s performance. Management accountants

Costs Across the Value Chain

What is a Value Chain?

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Research and Customer

Manufacturing and Non-Manufacturing Costs (Nature of Costs)

Prime costs – direct materials and direct labour

Conversion costs – direct labour and manufacturing overhead

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Product Costs and Period Costs (Timing of Costs)

1. Identify highest and lowest levels of activity

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- Can be discretionary or committed

Mixed / Semi-Variable Cost

Step Fixed Cost

Step Variable Cost

Unit Level Cost

Exam Question Tips

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Week 2: Job Order Costing

Why are Costing Systems Important?

- Deciding what margins to put on goods or services.

What is Job Costing?

The Flow of Documents in a Job Order Costing System

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The Flow of Costs in the Manufacturing Business

- Raw materials inventory

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The cost of a job includes:

Accounting for Manufacturing Overhead

Actual manufacturing overhead

Applied manufacturing overhead

Steps in a Job Costing System

1. Identify the job

Predetermined Overhead Rate

Overhead applied=POHR × actual activity

Underapplied Manufacturing Overheads

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- If actual manufacturing overheads is less than applied manufacturing overheads (credit

Schedule of Cost of Goods Manufactured

Exam Question Tips

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Week 3: Process Costing

What is Process Costing?

Process Costing Cost Classification

Originally cost was determined as follows:

Average cost per unit=(Total cost per process)/(Total units produced)

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START HERE IF USING WAC