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FIA MA2
Management Accounting 2
For exams in 2014
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ExPress Notes
FIA MA2 Management Accounting
Contents
Page | 2
1.
Management Information
2.
Cost Recording
14
3.
Costing Techniques
20
4.
Decision making
33
5.
Cash management
47
6.
Spreadsheets
50
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ExPress Notes
FIA MA2 Management Accounting
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FIA MA2 Management Accounting
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FIA MA2 Management Accounting
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ExPress Notes
FIA MA2 Management Accounting
Chapter 1
Management Information
KEY KNOWLEDGE
Management Information Requirements
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ExPress Notes
FIA MA2 Management Accounting
Accurate,
Complete,
Cost-beneficial,
User-targeted,
Relevant,
Authoritative,
Timely and
Easy to use
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ExPress Notes
FIA MA2 Management Accounting
Management responsibilities
Responsibilities correspond to specific areas and functions within an organisation. They are
best understood in relation to the following diagram:
Responsibility centres
Cost Centres
Revenue Centres
Profit Centres
Investment Centres
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ExPress Notes
FIA MA2 Management Accounting
KEY KNOWLEDGE
Cost Accounting Systems
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ExPress Notes
FIA MA2 Management Accounting
The characteristics of a coding system shares some of the features of good information: it
must be standardized, logical, objective, brief (i.e. capable of being summarized), verifiable,
comprehensive and yet flexible (allowing development to cover all relevant situations in a
relevant manner).
Cost units: The units are the discreet items to be measured, such as packs of nails (batches)
or a student.
KEY KNOWLEDGE
Cost Classification
Non-production costs: These are expenses that are incurred independent of production and
include administrative, selling, distribution and finance costs. These costs can have the
character of period costs, as they relate to the period of time in which they occur.
Direct vs. Indirect
Direct costs: are costs that can be directly attributable to a product.
Indirect costs: these are costs that cannot be directly attributable to a product.
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ExPress Notes
FIA MA2 Management Accounting
Fixed costs: are costs that remain constant regardless of the volume of production. A variety
of indirect costs are fixed.
Variable costs: vary in proportion with the volume produced. Direct costs are by their nature
variable in behaviour.
High/Low Method
Analyze the following operating costs as a function of output:
Output
(units)
Costs
($)
1,000
1,200
1,400
1,600
250,000
295,000
325,000
370,000
Take the maximum and minimum levels of output (the independent variable) and the
associated costs (dependent variable) and calculate the differences:
Max
Min
Diff.
Output
1,600
1,000
600
Costs
370,000
250,000
120,000
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ExPress Notes
FIA MA2 Management Accounting
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When fixed costs change (step) along the output range; and
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ExPress Notes
FIA MA2 Management Accounting
Chapter 2
Cost Recording
KEY KNOWLEDGE
Accounting for materials
Every company which buys, processes and sells materials will have established procedures
for ordering, receiving and issuing (such materials) which are generically similar. Some may
have highly automated systems in place, while others record the steps manually.
The key documents one should be familiar with are:
Purchase requisition form: This is an internal form that provides the authorization for
materials to be ordered from a supplier (external).
Purchase order (PO): The buyer issues a PO to the seller, indicating the
Description
Quantity
Price
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ExPress Notes
FIA MA2 Management Accounting
Goods Received Note (GRN): This is completed by the buyer upon delivery to verify whether
the order has been properly fulfilled. It will contain:
Order No.
Description
Quantity ordered
Quantity delivered
Materials issuance (or requisition) form: This is the form necessary to authorize the release
of materials from inventory into the production process at the company.
Materials
The ordering, receiving and issuing of materials from inventory must be controlled according
to procedures and documented at all stages with forms appropriate to the purpose.
The controls and procedures are designed to monitor inventory movements so as to
minimise discrepancies and losses and theft.
Accounting entries
Materials
Debit (Dr) entries
=
Inventory
Credit (Cr) entries
=
Increase in
inventory
Decrease in
inventory
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ExPress Notes
FIA MA2 Management Accounting
= PxD
+ C x D/Q
+ H x Q/2
Ordering costs rise the more frequently one places (during the year); and
Holding costs rise the fewer times one places orders (due to larger quantities being
ordered each time),
It follows that there is a trade-off between the Ordering and the Holding costs.
The optimal order quantity (Q*) is found where the Ordering and Holding costs equal each
other, i.e.
C x D/Q = H x Q/2
Rearranging the above and solving for Q results in
EXAMPLE
A trucking company uses disposable carburettor units with the following details:
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ExPress Notes
FIA MA2 Management Accounting
Weekly demand
500 units
Purchase price
USD 15 / unit
Ordering cost
USD 40 / order
Holding cost
KEY KNOWLEDGE
Accounting for labour
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ExPress Notes
FIA MA2 Management Accounting
Remuneration methods
There are two basic forms of remuneration:
Time-based, and
Effective incentive schemes are designed to ensure that the interests and behaviour of
individual employees and groups of employees are in-line (i.e. consistent) with the
companys objectives.
Managerial metrics relating to labour
The key ratios to learn are:
Labour turnover
=
Labour efficiency
=
Labour capacity
=
This last ratio is the result of multiplying the labour efficiency with the labour capacity ratio.
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ExPress Notes
FIA MA2 Management Accounting
KEY KNOWLEDGE
Accounting for other expenses
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ExPress Notes
FIA MA2 Management Accounting
Chapter 3
Costing Techniques
KEY KNOWLEDGE
Absorption costing
This is one method which seeks to make the link between overheads and (product) cost
units. The diagram below provides a useful roadmap.
Total Production Costs
Direct Costs
Production A
Production B
Service C
1. Allocate
3. Reapportion from
Service to Production
Production A
Production B
4. Absorb
Cost Unit
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ExPress Notes
FIA MA2 Management Accounting
The focus (above) is production. Overhead costs that are not incurred at the time of
production do not find their way into inventory.
It is useful to think of production costs as being those that end up as part of the inventory
(valuation) while other (non-production) costs are incurred outside, and normally after the
product leaves inventory.
Allocation and Apportionment
Allocate, Apportion and Re-apportion indirect production costs (shown on the right side of
the diagram) to cost units.
Our focus is on the first category (production); the other overhead costs are not incurred at
the time of production and do not find their way into inventory. Always think of the costs
going into inventory and those that occur after the product leaves inventory!
EXERCISE
A company producing refrigerators and toasters has identified the following overhead costs
relating to production:
$
8,000
1,500
3,000
2,500
15,000
Rent
Indirect materials
Power
Equipment insurance
The company has 3 cost centres, 2 production workshops (A & B) and 1 warehouse (C,
service centre).
1. Suggest the basis on which the costs shown above might be charged to the various cost
centres.
Rent
Indirect materials
Power
Equipment
Page | 21
8,000
1,500
3,000
2,500
Basis
sq.m.
Specific
kWh
Book
A
4000
600
1500
1000
B
2500
700
1000
1400
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C
1500
200
500
100
ExPress Notes
FIA MA2 Management Accounting
insurance
value
15,000 sq.m.
7100
5600
2300
As a manager with cost centre responsibility, what could be your concerns with respect
to the bases selected above?
2. Re-apportion the service centre costs to the production workshops.
Assumption: C is used by A (65%) and B (35%):
A
Costs apportioned to A, B, C:
7,100
5,600
1,500
800
Total overheads:
8,600
6,400
C
2,300
(2,300)
1,400
950
Overheads
$
Overhead Absorption
Rate (OAR) $
8,600
6,400
6.14
6.74
Each workshop uses its OAR to keep track of overhead costs as it produces.
Alternatively, the company can use a blanket or company-wide OAR, calculated as:
Total overhead costs
Total labour hours
15,000 =
2,350
6.38
A companys cost cards for two products (toasters and refrigerators) could look as follows:
Refrigerator (cost per unit)
Direct materials (15kg @ $2/kg)
Direct labour (1.75hrs @ $15/hr)
Variable OHs
Fixed OHs (1.75hrs @ $6.38/hr)
Total
Page | 22
$
30.00
26.25
5.00
11.17
72.42
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ExPress Notes
FIA MA2 Management Accounting
$
3.00
4.50
2.00
1.91
11.41
Method of measuring the cost of products or services by including a fixed overhead fair
share into the product manufacturing/service provision cost
Results in reporting higher ending inventories and higher operating profits (as fixed
factory overheads are taken to inventory cost instead of being expensed as incurred)
Step 2: Take the total quantity recorded for the absorption base
o
Most common absorption bases selected: direct labour hours, machine hours,
units of output
Step 4: Obtain unit overhead cost per product line, by multiplying the OAR with the
absorption base quantity recorded per unit
Step 5: For each product, multiply Step 4 by total output to determine factory
overhead to absorb in the production cost.
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ExPress Notes
FIA MA2 Management Accounting
When actual activity levels differ from those used in pre-determining absorption
rates, this results in over- or under-absorption.
KEY KNOWLEDGE
Marginal costing
Is an alternative costing method, with variable costs only being charged as a cost of
sale (excludes fixed factory overheads from manufacturing costs)
Results in reporting lower ending inventories and lower operating profits (as fixed
factory overheads are fully expensed as incurred instead of being absorbed in
inventory cost)
Recognizes that fixed costs become irrelevant for short term production decision
making based on product profitability (sunk costs)
Avoids arbitrary bases for fixed overhead absorption into the production cost
Contribution
Contribution is defined as the difference between Sales revenue and the marginal cost of
sales, or
Contribution = Sales Variable costs (both production and non-production)
Example
Below is data on a manufacturing company.
Selling price (per unit):
Cost card (per unit):
Direct materials
Direct labour
Page | 24
120
45
18
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reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
9
72
Year 2
(units)
1,100
1,100
Actual Production
Actual Sales
1,000
950
1,100
1,150
Year 2
$
114,000
138,000
3,600
Production costs:
o
Variable
(1,000 x $72)
(1,100 X $72)
Page | 25
72,000
79,200
(3,600)
(68,400)
(82,800)
(1,900)
Contribution
43,700
52,900
(16,500)
(16,500)
(2,300)
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these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
(7,000)
Profit
(7,000)
20,200
29,400
Absorption Costing
This method argues that focusing on marginal costs is potentially misleading in the longer
run because fixed production costs have also to be covered. Accounting conventions require
that fixed production costs be reflected in each unit produced.
Revised cost card (Absorption costing)
Cost card (per unit):
Direct materials
Direct labour
Variable production O/Hs
Fixed production O/Hs
Total production costs
45
18
9
15
87
Year 1
$
Year 2
$
114,000
138,000
4,350
Production costs:
o
Page | 26
Variable
(1,000 x $72)
(1,100 X $72)
72,000
Fixed
(1,000 x $15)
(1,100 X $15)
15,000
(4,350)
Over/(under) absorption
1,500
79,200
16,500
0
(84,150)
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information presented in these materials as to its application to any specific cases.
(100,050)
ExPress Notes
FIA MA2 Management Accounting
Gross Profit
29,850
37,950
1,900
2,300
7,000
(9,300)
28,650
Absorption Costing
Marginal Costing
Variable/Fixed
production costs
Variable production/
non-production costs
Revenue
Less: Cost of Sales
Gross profit
Contribution
Less: Expenses
Variable/Fixed
non-production costs
Fixed production/
non-production costs
Net Profit
Reconciliation of the two methods
The different profit figures calculated under Absorption costing and Marginal costing can be
reconciled thus:
The difference in profit = Net change in inventory (no. of units) X the fixed cost per unit
It follows that:
Page | 27
If the level of inventory increases in a given period, then profits (for that period)
under the Absorption costing system will be greater than under Marginal costing; and
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these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
If the level of inventory decreases, then profits under the Absorption costing system
will be smaller than under Marginal costing
If the inventory level does not change, then the profit calculated under both methods
will be equal.
KEY KNOWLEDGE
Job costing / Batch costing
This refers to the calculation of costs associated with a specific job or customer order. This
is appropriate in situations where each product or service is distinct, and possibly unique, in
its delivery.
Batch costing is similar to job costing; the distinction lies in the identification of costs with
specific batches, which are numbered (separately identified) for this purpose.
KEY KNOWLEDGE
Process costing
Process costing is a technique that applies to the mass production of a large number of
identical products, moving through a series of processing stages. The accumulated costs of
production can be averaged over the number of items produced.
Illustration 1
units
Input units
from Process A
Additional:
Materials
Labour
Overheads
1,000
1,000
Avg.cost/unit:
Page | 28
Process B
$
20,000
5,000
3,000
2,000
30,000
Output to
Process C
units
1,000
30,000
1,000
30
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information presented in these materials as to its application to any specific cases.
30,000
ExPress Notes
FIA MA2 Management Accounting
The total cost of inputs refers to labour, materials and overhead costs of production. If
losses occur along the way that necessitate the scrapping of defective units, then to the
extent that these items fetch a scrap value, then that (scrap) value will reduce the total
costs.
Similarly, an accounting is made of the number of units introduced into a process with the
expectation that a normal loss will be incurred. The number of good units emerging from a
process will therefore be the number of units entering it, minus the expected number lost in
processing.
Illustration 2
Normal loss
10% of input
1,000 =
Avg. cost / unit
900 +
good
100
NL
33.3
Conclusion:
Average cost per unit =
units
Input units
from Process A
Additional:
Materials
Labour
Overheads
1,000
1,000
Page | 29
Process B
$
20,000
Output to
Process C
units
900
30,000
100
1,000
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information presented in these materials as to its application to any specific cases.
30,000
ExPress Notes
FIA MA2 Management Accounting
Illustration 3
Scrap value
scrap/unit
Avg cost/unit
5
32.78
Conclusion:
Average cost per unit =
Process B
$
units
Input units
from Process A
Additional:
Materials
Labour
Overheads
1,000
20,000
1,000
Output to
Process C
units
900
29,500
100
500
1,000
30,000
Abnormal gains and losses are accounted for as an adjustment to the accounts using the
same value as the good output (deducted in the case of loss and added in the case of
gains).
Illustration 4
Abnormal loss
1,000 =
850 +
good
100 NL
50
AL
Conclusion:
Average cost per unit =
Input units
Page | 30
units
1,000
Process B
$
Output to
units
850
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information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
20,000
from Process A
Additional:
Materials
Labour
Overheads
27,861
Process C
1,000
100
50
500
1,639
1,000
30,000
By-products are goods which are incidental to the production process and which generate
cash from sales, though the amount is modest in comparison to the overall revenues of the
firm. The cash received for by-products can be viewed as a bonus that reduces production
costs.
Joint processing and further processing
Decisions need to be taken as to the further processing of products after their point of
separation.
Care must be taken to focus on the incremental (relevant) values.
EXAMPLE
Page | 31
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material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
Determine which of the following products should be sold immediately (at the indicated
price) or processed further (for later sale):
A
B
C
Cost at point of
Separation
Immediate
Price
25,000
30,000
40,000
27,000
28,000
45,000
Further (variable)
processing cost
5,000
5,000
4,000
Post-processing
Price
30,000
32,000
50,000
KEY KNOWLEDGE
Service costing
Services distinguish themselves from products in the following ways:
Heterogeneity: The quality of the service is rarely exactly the same, due to the human
touch; e.g. hair cuts;
Intangibility: Services are not tangible;
Perishability: One cannot place a service in inventory;
Simultaneity: Services are produced and consumed at the same time
(Think of HIPS)
Cost units
Finding an appropriate cost unit is a challenge in service costing. In many cases, a
Composite cost unit is identified; e.g.
Student lunches, or
Man-days
The cost per service unit is found by dividing the total cost of the service by the number of
service units involved.
Page | 32
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reproduction. All examples presented in these course materials are for information and educational purposes only and
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information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
Chapter 4
Decision-making
KEY KNOWLEDGE
Cost-Volume-Profit (CVP) Analysis
The breakeven formula
Total Costs = Fixed Costs + Unit Variable Cost x Number of Units
Total Revenue = Sales Price x Number of Units
If
TC = Total Costs,
FC = Fixed Costs,
V = Unit Variable Cost,
X = Number of Units,
TR = Total Revenue,
SP = Selling Price,
C = SP V = Unit Contribution and
Page | 33
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private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
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information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
Then the break-even point (the output level at which TR=TC) is:
KEY KNOWLEDGE
Break-Even Analysis
Marginal costing is useful in calculating the break-even level of sales.
The break-even point is the level where the company achieves zero profit (neither gain
nor loss). It just manages to cover its fixed costs.
Below is data on a manufacturing company.
Page | 34
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reproduction. All examples presented in these course materials are for information and educational purposes only and
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information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
Direct materials
Direct labour
Variable production O/Hs
Total variable production costs
45
18
9
72
Additional info:
Selling price per unit
120
16,500
7,000
EXAMPLE
Based on the data in the previous example, calculate the break-even point of the
company.
Total fixed costs:
Contribution per unit:
23,500
46
Fixed costs
C/S ratio
Page | 35
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reproduction. All examples presented in these course materials are for information and educational purposes only and
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information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
KEY KNOWLEDGE
Short-term decision-making
Limiting factors
When a single limiting factor is present in a production plan, then it is necessary to identify
it and to plan production around it.
Take the following example:
Product
Selling price
Labour cost per unit ($)
Material cost per unit ($)
X
30
10
5
Y
40
16
8
Z
50
20
10
Contribution
15
16
20
It appears that in the face of unlimited demand for all three products, Product Z would be
given priority as it maximizes the contribution per unit.
Now, assume that labour hours are limited to 500 and that labour costs $2 per hour
(demand remains unlimited for all three products).
In the above case,
Product
Labour cost per unit ($)
No. of hours per unit
Contribution per hour
X
10
5
Y
8
8
Z
20
10
Now it becomes clear that Product X is favoured for the full number of hours available (500).
100 units of X can be produced.
If demand for X were limited to, say, 80 units (requiring 400 labour hours), then the
remaining available hours (100) could be used to produce either Y or Z (in this case there is
indifference between the two).
The steps to be followed in working out the optimal production plan are:
(1) Calculate the contribution per unit of product;
(2) Calculate the contribution per unit of limited resource;
(3) Rank the products according to Step 2;
Page | 36
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ExPress Notes
FIA MA2 Management Accounting
(4) Produce according to the priority established in Step 3, up to the demand limit of
each product or until the limited resource is exhausted
Make-Buy
A make-buy decision requires the determination of all relevant costs.
EXAMPLE
An automotive components producer can supply itself externally with car heaters for USD
210 per unit. In considering whether to make these internally, the company calculates that
an equivalent unit can be made in 2 labour hours using USD 100 worth of materials.
Labour is currently at full capacity producing carburettors which generate contribution of
USD 100. A carburettor takes 2.5 hours to produce. Labour costs USD 10 per hour. The
carburettor also absorbs fixed overhead costs at the rate of USD 20 per labour hour.
The relevant costs are ($):
Materials:
100
Contribution lost
(carburettors):
80
Labour (added-back): 20
200
It is cheaper to produce internally.
Relevant costs
One of managements responsibilities involves making decisions affecting the firm in the
A relevant cost is a cash cost which is uniquely incurred (or avoided) as a consequence of
taking a decision; cash, because it is the main determinant of value (unlike accounting
profit); and unique in the sense that is not common to the alternative choices that are under
consideration.
Page | 37
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ExPress Notes
FIA MA2 Management Accounting
EXAMPLE
A company seeking to determine whether to continue to transport its products by truck or to
switch to the railroad discovers that insurance costs are identical in both choices; in that
case, insurance costs are not relevant to the decision.
If, however, there is a difference in the two insurance costs, then one can speak as the
difference between the two choices as being incremental; this difference (referred to in
some places as the differential) is relevant to the decision under consideration.
Future
Relevant costs refer to the future, i.e. they can be influenced prospectively by choice. It
follows that:
Sunk costs are not relevant: They have already taken place and cannot be reversed.
Committed costs, if they cannot be avoided, are likewise not relevant, even if the timing of
their occurrence is in the future. Their unavoidability has already been established in the
past (making them effectively the equivalent of sunk costs).
In keeping with the above logic, relevant costs therefore involve cash, are incremental and
relate to the future.
Costing projects
It is a standard management accounting practice to determine the relevant costs of a new
project in order to come up with a price quotation. Setting a price without having an
accurate understanding of costs can put a company at a competitive disadvantage,
particularly if there is intense competition.
EXAMPLE
A proposed project lasting 6 months requires the following inputs:
1) Labour
Page | 38
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reproduction. All examples presented in these course materials are for information and educational purposes only and
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information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
A specialist specifically qualified for this work needs to be hired at a cost of USD
10,000 per month;
The specialist will be assisted by two subordinates who are existing employees, each
paid USD 40,000 p.a. One is not working on anything else for the foreseeable future,
while the other is fully involved on another project and would need to be replaced for
the duration of the proposed one at a cost of USD 5,000 per month;
A division manager has agreed to supervise the project and estimates that 5% of his
time (equivalent to USD 6,500) be allocated for this purpose.
2) Materials
The project calls for the use of 200 litres of Agent Q and 50 kg. of Compound P.
Additional data:
Agent Q
In stock
Historical price
Current price
Scrap value
150 litres
USD 7
USD 5
USD 1
USD 12
USD 15
USD 2
3) R&D
The project manager notices that R&D relevant to this project had been performed for
another contract (later abandoned) at a cost of USD 15,000. He sees an opportunity to
recover that cost now.
4) Equipment
The company needs equipment for the project which would cost USD 15,000 to buy.
Alternatively, it has some existing unused equipment that could be deployed. The used
equipment is in good condition and could have been scrapped for USD 8,000 now or for USD
5,000 in 6 months. (Note: Ignore time adjustments of monetary values)
Prepare the costs for the proposed project.
Page | 39
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private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
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information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
Relevant costs need to be identified with care, as they may include opportunity costs.
EXAMPLE
A company considers building a storage facility on the site of a parking lot. If the parking lot
had been generating parking fees which will now be lost, then this foregone revenue is an
opportunity cost.
Shut Down decisions
Whether to close a plant making (accounting) losses depends on relevant costs:
Revenues (m)
40
Costs (m)
(44)
Profits (m)
(4)
If 25% of the costs are fixed costs allocated by H.O., then it appears that closing the plant
will leave the company worse off, as 40m in revenues and only 33m in costs will be
disappear. A careful examination of all costs needs to be made before arriving at a final
decision.
KEY KNOWLEDGE
Principles of discounted cash flow
Simple vs. Compound interest
Simple interest is the calculation of interest applied to the principal amount only. If $100 are
lent at a simple interest of 5% p.a. then interest payments will be based only on the
principal, as for example, an annual interest payment of 5% of $100, or $5 p.a.
If interest is payble semi-annually on a compunded basis, then at the end of the first year,
the interest will be $5.0625, calculated as:
Page | 40
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reproduction. All examples presented in these course materials are for information and educational purposes only and
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these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
5% on $100 for the 1st half of the year, plus 5% on $102.50 for the 2nd half (i.e. the interest
of $2.50 from the 1st half of the year is added to the principal amount and forms the basis
for the interest calculation in the 2nd half).
Nominal vs. Effective interest
In the example above, 5% serves as the nominal interest rate, while the effective interest
rate is 5.0625%; this is the total interest achieved on a compounded basis ($2.50 plus
$2.5625).
The preeminence of cash
Cash, both its receipt and possession, lies at the basis of economic value. Cash is used to
pay the bills and bonuses. It is a better indicator of wealth when compared with measures
defined by accounting conventions, such as accounting profit.
The relevance of cash flow to capital investment appraisal
The appraisal process is predicated on the fact that capital expenditures are investments
which will (hopefully) confer future benefits referred to as the payback. The payback may be
a lengthy (and risky) one.
Timing and value
Tracking and measuring cash flows on a time-adjusted basis is critical: cash received quickly
can be used to repay debt (avoiding interest costs) or invested (earning interest). Cash paid
with a delay can reduce costs (as long as penalties are not incurred).
It follows that the longer one waits for a receipt of cash, the less that cash is worth in
todays terms. Among other factors, its purchasing value may diminish due to the effects of
inflation.
Compounding
Instead of receiving USD 100 today, assume it will be received after one year. To
compensate for the delay, what should the value be after one year?
Page | 41
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private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
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these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
In the above example, if r = 5% p.a. then the FV after one year will be USD 105.
This process can be repeated year after year.
Discounting
The above relationship between PV and FV:
PV x (1+r) = FV
PV = FV
(1+r)
100
100
125
105
140
If discounted at r = 10%, then the above cash flows can be restated at their present values:
Page | 42
FV discounted:
100
1.10
100
(1.10)2
125
(1.10)3
105
(1.10)4
140
(1.10)5
PV:
90.9
82.6
93.9
71.7
86.9
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should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
100
1.10
100
(1.10)2
100
(1.10)3
100
(1.10)4
100
(1.10)5
PV:
90.9
82.6
75.1
68.3
62.1
100
100
125
105
140
Investment: (200)
FV:
PV:
(200)
90.9
82.6
93.9
71.7
86.9
Page | 43
2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
The IRR includes among its assumptions the following: any cash flows generated in the
course of a project being evaluated are calculated as being reinvested at the IRR rate. This
is illustrated thus:
Time
Cash flows
0
1
2
(20,000)
5,000
30,000
The IRR of the above cash flows (using interpolation or calculator) is 35.61%.
The above cash flows is equivalent to re-investing the 5,000 (Year 1) at the IRR rate
(35.61%) to maturity (Year 2).
Time
0
1
2
(20,000)
5,000
30,000
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2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
EXAMPLE
Year
-5,000
6,000
-7,500
8,850
IRR
NPV:
10%
14%
20%
454
263
172
18%
545
263
129
EXAMPLE
Year
IRR
-500
-500
NPV (9%)
100
600
20%
97
500
155
25%
89
Payback method
Initial Investment:
40,000
Cash flows
(A)
Year 1
Year 2
Year 3
Year 4
Year 5
Total
Payback
Page | 45
5,000
6,000
12,000
13,000
15,000
51,000
Year 5
Cashflows
(B)
15,000
13,000
12,000
6,000
5,000
51,000
Year 3
2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
16%
ExPress Notes
FIA MA2 Management Accounting
Advantages
It is easy to understand and to use. It focuses on the time needed to cover the investment
(in money terms) and no more; it can be considered a minimalists approach
(psychologically).
If you invest in a Central American country where you expect a coup in the next 2 years, the
payback method may be for you! But remember, the net (money) returns start only after
that point!
Disadvantages
It is a crude measure. It does not take opportunity costs or expected returns on money
invested into account.
Discounted Payback
We can apply the concept of discounting to the Payback method in order to capture the time
value of money element.
Year:
100
100
125
105
140
Investment: (200)
FV:
PV:
(200)
90.9
82.6
93.9
Page | 46
2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
71.7
86.9
ExPress Notes
FIA MA2 Management Accounting
Chapter 5
Cash Management
KEY KNOWLEDGE
Cash and Cash Flow
Cash comprises both cash and bank deposits payable on demand and also cash equivalents
which are defined as short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.
The amount of cash held by a business at a point in time is found in the balance sheet
under current assets.
Cash flow refers to the movement of cash in and out of a business over a period of time.
This information is found in a statement of cash flows, which is a primary financial
statement. Such a statement is useful in that it is structured to show the extent to which a
company is able to generate net cash from its operating activities and how such net cash is
used in investing and/or financing activities.
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2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
Operating: cash flow from trading activities, e.g. cash received from customers, cash
paid to suppliers and to employees;
Financing: Cash paid on interest;
Taxation: Actual cash paid during the year;
Investing: Cash flows on purchase or sale of non-current assets;
Financing: Cash flows on raising or redeeming long-term finance, such as shares or
Debentures; dividends can also be included here.
Cash flow is vital to going concern and commercial success, regardless of profitability.
Having enough cash on hand is therefore critical in being able to settle obligations when
they fall due (both planned and unforeseen); however, holding too much cash in a business
is costly. There is a trade-off between liquidity and profitability.
Determining the optimal amount of cash to hold becomes the challenge facing managers.
Cash management functions are typically handled by treasury, and include:
Page | 48
2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
KEY KNOWLEDGE
Cash budgets
A cash budget is an estimate of the receipt and payments of cash in and out of the business
for a defined future period based on existing conditions and operating assumptions.
By understanding the nature and timing of cash receipts and expenditures, management is
better able to influence them and plan/budget for the future. The purpose is to ensure that
the company has sufficient cash on-hand to avoid missing disbursements when they fall
due.
There are statistical techniques which assist management in planning cash levels.
Cash budget/forecast
Businesses should develop their cash budget/forecast formats in a way which best reflects
the type of business conducted and transactions generated. Such tools serve as a
mechanism for monitoring and control.
Investing and Financing
Cash surpluses and deficits occur as a result in timing differences between the receipt of
cash and the necessity to settle obligations punctually. If a deficit results, then the company
should have overdraft faciltities in place with a bank.
If deficits prove to be longer-term in nature, then the company should consider short-term
borrowing, or possibly, longer-term forms of finance if the deficit is expected to persist.
In the event of surpluses, these can be invested (e.g. T-bills mentioned earlier); other types
of investments include:
Bank deposits
Money- market deposits
Certificates of deposit
Government bonds
Local authority stock
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2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.
ExPress Notes
FIA MA2 Management Accounting
Chapter 6
Spreadsheets
KEY KNOWLEDGE
Use of spreadsheets
The use of spreadsheets is a basic skill that all accountants and business analysts should
possess.
A spreadsheet is a computer program that is organised in a tabular format. The vertical and
horizontal arrangement of cells allows the input and processing of large amounts of data in
a systematic way.
Spreadsheets contain sophisticated formulae which can be used to operate on the data.
Instead of merely adding up columns of numbers, spreadsheet formulae can handle
discounting (i.e. net present value) calculations as well as simple logical (IF) functions.
Apart from processing a large volume of data quickly, spreadsheets permit analysis to be
performed with great efficiency. Thus, if an assumption is modified, then the spreadsheet
can automatically adjust all affected values (known as what-if analysis), meaning that the
management acccountant can focus on interpeting the output.
Page | 50
2014 This material is the copyright of the ExP Group. Individuals may reproduce this material if it is for their own
private use. It is illegal for any individuals to reproduce this for commercial use or for companies to reproduce this
material partially and/or in full by any means, be it printed, photocopied, on electronic devices or any other means of
reproduction. All examples presented in these course materials are for information and educational purposes only and
should not be applied to a specific real life situation without prior advice. Given the nature of information presented in
these materials, and given that legislation may change at any time, The ExP Group will not be held liable for any
information presented in these materials as to its application to any specific cases.