ACCT1511 FINAL NOTES

1. Rule-based vs Principle-based
Rule based = list of detailed rules that must be followed
when preparing the financial statements
Principle-based = conceptual basis with a set of key
objectives set to ensure good reporting standards
involves the ethical use of professional judgement
Advantage Broad guidelines can be practical for a variety
for situation, while rules may be inflexible and can cause
complexity in preparation of FS. Rules are easier to work
around when financial engineering than working around the
principle.
Disadvantage Rules promotes accuracy and consistency
as it reduces ambiguity while for principle based approach
the guidelines may not be specific enough, therefore may
present multiple ways of reporting the same transaction
2. Conceptual Framework
Objective of general purpose financial reporting
Qualitative characteristics that determine the usefulness of
the information
Definition, recognition and measurement of the FS
elements
a. Objective
Provide information about f. position, f. performance and
cash flows that is useful to a wide range of users in making
decisions about providing resources to the entity
Cannot accommodate all users complete information
needs
b. Qualitative Characteristics what makes information useful?
Helps users assess the prospects for future net cash flows
to the entity
Relevance
o Capable of making a difference in the decisions made
by users by helping them evaluate past, present or
future or confirming or correcting past evaluation (i.e.
predictive value or confirmatory value)
o Predictive value = helps user predict the future
o Confirmatory value = confirms something in the past
o Materiality of information = omitting or misstating
could influence decisions of the users

Faithful Representation

o Free from error - Information is free from material

error and bias + can be depended to represent what
it purports to
o Completeness the complete financial information is
provided in all material respects
o Neutrality free from bias. Balanced view of the
transaction
Enhancing Qualitative Characteristics
o Comparability Ability to compare FS over time,
within industries, across countries to identify trends
in f. position and f. performance
o Verifiability Can trace back the information
o Timeliness Provided on time
o Understandability Users with reasonable business
knowledge should be able to understand the
information

3. Trade off between qualitative characteristics

Relevance vs Faithful Representation To ensure

completeness (i.e. faithful representation), irrelevant
information may have to be included
Faithful Representation vs Timeliness To ensure
information is free from error, extra time maybe required to
gather the information

4. Accounting Assumptions

Accrual Basis Revenue and expenses are recorded as they

are incurred as opposed to when cash is received
o Matching principle expenses are recorded in the
same period as the related revenue is recognised
Going concern Assumption that the company will
continue operations in the foreseeable future to fulfil its
commitments and will not liquidate
Economic Entity Transactions and balances of the entity
are accounted for separately from its owners
Monetary Unit Only transaction and events capable of
being recorded in a single unit of monetary currency are
recognised in the financial statement
Account period Time span in which certain financial
events took place and the account period must be
consistent
Historical cost Assets should be recorded at its costs at
the time of exchange

5. Asset Definition

Future economic benefit potential to contribute to the

flow of cash and cash equivalents
Controlled by the entity controls the benefits expected to
flow to the entity
Result from past transaction or event

6. Asset Recognition

Probable that any future economic benefit will flow to the

entity
Cost or Value can be measured with reliability (estimates
are okay)
7. Current vs Non-current

Classified as current if:

o Realised or intended for sale/consumption in the
entitys normal operating cycle (time between
acquisition of assets and realisation in cash)
o Held for the purpose of being traded
o Expected to be realised within 12 months
o Cash or cash equivalent unless restricted from being
exchanged or used to settle a liability for at least 12
months

8. Intangible Assets Definition

Identifiable non-monetary asset without physical substance

Must meet the 3 essential characteristics
Must meet identifiable criterion
o Capable of being separated or divided from the entity
either individually or together with an asset or
liability; or
o Arises from a legal right, regardless of wether those
rights are transferable or separable from the entity
Example: Patents, Licences, Copyrights, Franchises,
Trademarks

9. Intangible Assets Recognition

Probable that FEB will flow to entity

Cost can be measured with reliability

10. Acquisition vs Internally Generated

Acquisition purchased from outside the company

o Any intangible asset purchased is recorded at cost
Internally generated developed by the company

o Determine whether there is an identifiable asset with

FEB
o Determine the cost of the asset reliably
o Generation of asset is separated into 2 phases; research
phase & development phase
o Research undertaken with the prospect of gaining new
scientific or technical knowledge (i.e. search of
applications of research findings, search for alternative
materials, products and design/financial selection of
possible alternatives for new/improved materials
o Development Application of research findings to plan
or design production of new or improved products (i.e.
design of models and prototypes, design and
construction of pilot plant and testing of chosen
alternative)
o Research phase is classified as an expense because fails
recognition criterion
o Development phases can be classified as an asset if
satisfies the following; ability to complete the intangible
asset and make it available for use/sale, probable will
generate FEB, enough resources to complete project &
can measure the expense in development phase reliably
11. Goodwill Special Case

Value of entity over and above the value of its separate

identifiable assets less liabilities
Value of components difficult to measure and cannot be
separately listed on balance sheet
Internally generated goodwill not recognised as the
identifiable resources controlled by the entity cannot be
measure with reliability

12. Amortisation/Impairment

Based on useful life of the asset

If life in indefinite, not subject to amortisation but needs to
tested annually for impairment
Residual Value estimate amount that the entity would obtain
from the disposal of the asset at the end of its useful life, after
deducting costs of disposal
Useful life = period of time over which the asset will be
available for use or the number of units of production
expected to be obtained from the asset

13. Methods of Valuing Assets

Historical Cost cost to buy/develop the asset

Market Value/Fair Value current value of the asset in the

market
Value in use present value of the future expected cash flows
derived from the asset
Liquation value worth of the asset if it had to be sold quickly
Price-adjusted historical cost initial cost adjusted for inflation

14. Measurement at recognition: PPE

Recorded at cost
Includes the purchase price, import duties, non-refundable
purchase taxes, costs directly attributable to installing the
asset and making it ready for operation + cost of
dismantling/removing & restoring the site if required to do so
Example of directly attributable costs; employee benefits
directly from asset, site preparation, delivery + installation,
testing and professional fees

15. Cost Model vs Revaluation Model

Must apply the same model and related policies to an entire

class of asset (i.e. PPE, intangible)
Cost model record asset at cost less acc. depn and acc.
impairment
Revaluation model record asset at the fair value less acc.
depn and acc. impairment, if it can be measured reliably
Revaluations must be with sufficient regularity and the time
period must remain consistent (i.e. every 3 years)

16. Revaluation Model Method

a) Update depreciation depreciate asset until the time of
revaluation
b) Write down asset to carry amount reserve acc. depn and
take it out from asset value
c) Record the increment/decrement Add/Reduce the asset value
to match new carrying amount
d) Recalculate depreciation based on the new useful life and
carry amount, recalc depn and apply till reporting date
17. Revaluation Model Journals

Initial Increment DR Asset XX

CR Revaluation Reserve XX
Initial Decrement DR Loss on Revaluation XX
CR Asset XX
Increment after decrement DR Asset XX
CR Gain on Revaluation XX

CR Revaluation Reserve XX
Decrement after Increment DR Revaluation Reserve XX
DR Loss on Revaluation XX
CR Asset XX
Disposal of Asset DR Revaluation Reserve XX
CR Retained Earnings XX

18. Cost and Revaluation Model Intangible Assets

Initially recorded at cost

Cost includes purchase price, taxes, duties + directly
attributable costs + sum of expenditure from the date when
the asset meets recognition criteria for internally generated
intangibles
For revaluation reserve, there must be an active market, that
is
o Items traded in the market are homogenous
o Buyers and sellers can be found at anytime
o Prices are available to the public

19. Impairment

All assets must be assessed for indication impairment at each

reporting date (i.e. check if the asset is overstated) and then
tested for impairment if any such indicators are found
Intangibles with indefinite useful and goodwill need to be
tested at least annually
Indicators;
o External market value declined significantly, changes
with adverse affect in the technological, economic or
legal market
o Internal Obsolescence, plans to discontinue use of
asset and economic performance of asset worse than
expected
Testing for impairment compare carrying value to
recoverable amount and record an impairment if carrying
value > recoverable amount
Recoverable amount is the less of; fair value (less cost to sell)
and value in use
Journal Entry to record impairment
o Cost method DR Loss on impairment XXX
CR Acc. Impairment XXX
o Revaluation method recorded in the same way as a
decrement

20. Inventory

Cost of inventory includes cost of purchase, cost of

conversion, transportation and getting into working condition
Opening inventory + purchases = good available for sale
Good available for sale ending inventory = COGS
3 methods of valuation: FIFO, LIFO & Weighted Average
FIFO overstates inventory and profits
LIFO understates inventory and profits
Impairment of inventory; inventory has to be recorded at the
lower of cost and net realisable value
Net realisable value = estimated selling price in the ordinary
course of business less cost of completion and costs to make
the sale
Reason NRV may be lower than cost; obsolescence, damage &
demand
If inventory had to be devalued, the following journal entry is
applied;
o DR Inventory Loss XX
CR Inventory XX

21. Allowance for Doubtful Debts

Journal entry for creating/estimating allowance:

o DR Bad Debt Expense XX
CR ADD XX
Journal entry for writing off debts:
o DR ADD XX
CR Accounts Receivables XX

22. Qualitative characteristics for valuation methods

Relevance vs. Faithful Representation

o Fair value is more relevant than historical cost to the
users of the FS; however historical cost is harder to
manipulate therefore more reliable
Conservatism
o Inventory recorded at lower of NRV and cost, therefore
never overstated
o Increments in valuation are taken to BS while
decrements are record in PL, therefore profits not
overstated
o Testing for impairment ensures assets are not
overstated

23. Liabilities

Definition criterion
o Present obligation arising from a past event

o Potential to result in a outflow of economic benefits

Recognition criterion
o Probable that any future economic benefit will flow from
the entity
o Cost or value can be measured reliably

24. Current vs Non-Current

Current liabilities are those expected to be settled in the

entitys normal operating cycle or due to be settled within 12
months after the reporting date
Examples of current liabilities;
o Payables amounts owed to suppliers for g&s received,
invoiced but not paid for
o Accruals - obligation to pay for g&s received but not
invoiced or formally agreed on
o Interest bearing liabilities obligation to pay an amount
in the future but have interest bearing characteristics
Examples of non-current liabilities;
o Borrowing & Bonds need to account for time value of
money
o Superannuation obligations
o Long service leave

25. Bonds

A financial instrument to raise funds by issuing regular

interest payments and pay a specified amount at the maturity
date
Advantages; direct borrowing from bank can be more
restrictive and expensive, access to more risk friendly lender,
less collateral may beed to be put up
Can be issued at discount, premium or par to account for the
difference in the coupon rate and the market interest rate
Journal Entries;
o Issuing Bond; DR Cash XX
CR Bonds Payable XX
DR/CR Bond Discount/Bond Premium
XX
o Ammortisation + Coupon Payment + Interest Expense;
DR Interest Expense XX
CR Cash XX
DR/CR Bond Premium/Bond Payable XX
o Payment of Face Value; DR Bond Payable XX
CR Cash XX

26. Provisions vs. Contingent Liabilities

Provisions are liabilities that are either;

o Uncertain in timing
o Uncertain in amount
o Example; warranties, employee benefits
Journal Entry for Provision;
o Creating provision; DR Expense XX
CR Provision for XX
o When provision are settled; DR Provision for XX
CR Cash XX
Contingent liabilities are either;
o Possible obligation arising from past events but whose
existence is dependent on future events not wholly
within control of entity
o Liabilities that do not meet the recognition criteria

27. Owners Equity

Shareholders Equity = Share Capital + Retained Profits +

Reserves
Retained Profits = Opening retained profits + revenues
expenses dividends paid

Reasons for raising funds through issuing equity: Lower costs,

take over defence, employee benefits

2 main types of shares;

o Ordinary Shares full voting rights, rights to receive
dividends
o Preference Shares limited voting rights, fixed
dividends, may be redeemable

28. Method for Issuing Shares

Issue to Institutional Investor

o Advantage; No need for a costly prospectus, less need
for costly IB team and firm may be too young to gain
access to public market
o Journal Entry; DR Cash XX
CR Share Capital XX

Issue through IPO

o Advantage; float to gain the desired capital structure,
access to more funds

o Procedure Offer (Prospectus), Application and then

issue of shares
o The price of each share may be payable in full on
application
o When application is received; DR Cash Trust XX
CR Application XX
o Application is accepted; DR Cash XX
CR Cash Trust XX
DR Application XX
CR Share Capital XX
o Application is rejected; DR Application XX
CR Cash Trust XX
27. Issue
Undersubscription If too few applicants to meet the
minimum subscription conditions, an underwriter must be
used to purchase the additional shares or the share issue may
have to abandoned
Underwriter a stockbroker or financial institute which
guarantee to purchase any shares the company is unable to
sell to meet the minimum requirement
Oversubscription Directors decide who and how many shares
to issue to each applicant
When fewer shares the issued to the applicant then they
applied for, the company can either;
o Keep the excess money for future issue of shares
o Return the money back
28. Subsequent Share Issue
Rights Issues Shares offered in a ratio to number of shares
they already hold, usually below market price
Bonus Issues Giving existing shareholders additional shares
without requiring payment
Share options Give the holder with the right to purchase
shares at a later date at a fixed price
29. Dividends
Journal Entry for Issue of share
o Declaration + Authorisation; DR Retained Profits XX
CR Dividends Payable XX
o Payment: DR Dividends Payable XX
CR Cash XX
30. Reserve Accounts
Direct adjustments to equity
Examples;

o Revaluation Reserve; Created when an asset is revalued

upwards
o Foreign Currency Translation Reserve; Direct
adjustments to equity resulting from foreign currency
translation of assets and liabilities
o General Reserve Funds for re-investing or rainy day
contingencies (i.e. funds not to be used to pay dividends
31. Bonus Issue
Giving existing shareholders new shares in proportion to
existing holdings at no cost
Example; 1:4 = for every 4 shares held, an additional share is
issued
No change to overall owners equity, however reallocation of
funds between accounts
Price of share drops due to more number of shares making
shares more accessible to investors and helps with takeover
defence
Usually from Revaluation reserve or retained profits
Reasons;
o To capitalise long-term reserves of the company
o To signal company expects good future profitability
levels for cash dividends
o To satisfy shareholders dividend expectations without
use cash
Journal Entry; DR Revaluation Reserve XX
CR Share Capital XX
32. Share Split
Increases the number of shares available by the stated ratio
Example: 2:1 share split = number of shares are doubled
No journal entries are required
No effect on any equity account
Reduced shares price
33. Share buy-back
Shares are repurchased through a tender or through the
market and are cancelled
Reasons; market signal that company is undervalued, capital
structure management by reducing equity
Journal Entries;
o Buy back price = issue price; DR Share Capital XX
CR Cash XX
o Buy back price doesnt equal issue price; DR Share
Capital XX
DR Retained Earnings XX

CR Cash XX
34. Debt vs Equity Considerations
Voting rights
Temporary vs Permanent needs
Contractual implication
Interest vs Dividend
Tax Considerations
Expected cash flows
35. Takeovers and Capital Management
Bonus Share
o Increases market value due to markets anticipation of
increasing future flows
o May result in raider having to increase their takeover
offer
o Raider would have to either withdraw their offer or
modify the offer to include newly created shares
Share Split
o Raider would have to withdraw their offer or make a new
offer to include additional shares
Share buy-back
o The use up of company assets may make target less
attractive (i.e. if the target was being acquired to
increase cash)
o Decrease in number of shares may make is simpler to
take over firm
36. Determining Profit
Trade-off between faithful representation and relevance as
method of accrual accounting requires judgement as to when
revenues and expenses are recognised
The most reliable method is to determine profit at the end of
the enterprises life however that is not timely and not
relevant
Income definition criterion;
o Increase in economic benefit as to increase assets or
decrease liabilities
o Results in increase in equity
o Is other than owners contribution
In terms of recognition, revenue should be recognised when
the critical event with the following characteristics occurs;
o Significant risks and rewards of ownership have
transferred
o Amount can be reasonably measured

o Probable that the economic benefits will flow to the

seller
o Most of the revenue and expenses have been incurred
and the remaining ones can be reasonably estimated
Example of critical events; point of sale or delivery, % of
completion, on the completion of production, when cash is
received
Expenses definition criterion;
o Decrease in economic benefit
o Other than owners distributions
Expense recognition;
o Decrease in future economic benefits through decrease
in asset or increase in liability
o Can be measured with reliability
Matching Principle; Expense must be recognised in the same
period as its associated revenue

37. Income Statement

Following line items have to be disclosed separately;
o Revenues, expenses, finance cost expense, shares of
net profits and losses of associates/joint ventures,
income tax expense, profit from ordinary activities after
tax, net profit/loss, net profit/loss attributable to outside
equity interest, net profit/loss attributable to members
of parent entity
Significant items When a revenue or expense from ordinary
activities is of such size or nature such that its disclosure is
relevant in explaining the financial performance of the
company, it must be disclosed separately in the notes of FS
Example; write down of inventories, litigation settlements,
restructuring operations
Expenses classification method/layout of income statement;
o By nature of expense Aggregate expenses according
to their nature (i.e. depreciation, purchases, employee
benefits, advertising)
o By function of expense Involves disclosing cost of sales
separately from other expenses and others by function
(i.e. distribution, admin). Provides more relevant
information to users, however requires more judgement
to allocate expenses
38. Statement of Changes in Owners Equity
Summarises transactions affecting OE during the accounting
period
Must show the following;

o Total comprehensive income for the period, showing

amounts attributable to owners of parents and to noncontrolling interests
o For each component of equity the effect of
retrospective application or restatement
o For each component the o/b, c/b, changes resulting
from profit/loss, other comprehensive income and
transactions with owners
o Dividends may be in either statement in equity or in the
notes
39. What if Analysis
Analysing the impact of different accounting policy choices on
financial statements
Used to compare FS from different entities and used to
compare business decisions
40. Cash Flow Statement
Shows changes in the companys cash balance due to
operating, investing and financing activities
Provides information about a firms ability to remain solvent
and their ability to grow (i.e. financial stability)
Importance of cash flows;
o Business cannot operate without sufficient cash and
under accrual account, cash performance is difficult to
operate
o Cash is central to valuation of a company, as value of
company = sum of future cashflows
o Dividends can only paid with there is sufficient cash and
share price is a function of expected divdends
Operating activities;
o Cash flows from primary activities of buying, selling and
delivering g&s + activities that support primary
activities (admin)
o Inflows; receipt from sale, interest received, dividends
received
o Outflows; Purchase of inventories, tax, utilities, interest
to lender
Investing activities;
o Cash flows from buying and selling non-current assets,
lending money and collecting on the loans
o Inflows; sale of non-current assets
o Outflows; purchase of non-current assets
Financing activities;

o Cash flows from changing the capital structure of a

business
o Inflows proceeds from issuing shares, bond, borrowings
from bank
o Outflows; paying long-term debts, dividends
o Dividends considered financing activities as they change
capital structure by reducing equity
* Practise the Direct method of determining cash flows both
examples
41. Indirect method
Adjusting NPAT by reconciling NPAT to CFO
To reconcile; must adjust for permanent differences and
timing differences
o Permanent difference these will not reverse over time
(i.e. non-cash items that affect net profit, gain/losses on
disposal of non-current asset)
o Timing difference differences that will reverse over
time (accruals)
Adjusting for timing difference;
o CLICAD Rule Add current liabilities increase and
current asset decreases
o Includes all current assets except cash
o Includes all current liabilities except dividend payable (in
financing) and short-term borrowing (in investing)
For Australia, direct method used to prepare the state and
indirect method used to prepare the Note
42. How to analyse cash flow statement?
Relate the cash flow statement to the BS and IS
o Collection of AR If AR are increasing, while sales
revenue is steady, need to see cash flow statement to
see what is happening to cash from customer
o Payment of AP If inventory is decreasing and AP
increasing, need to check IS and cash flow statement to
see if the firm are straining to keep up inventory levels
or struggling to pay suppliers
o If company is improving its management of inventory
and debtor collection Inventory and AR should be
decreasing, Revenue to be close to cash from customers
& COGS should be close to cash paid from suppliers
Examine cash flows from CFO to total cash flows
o CFO should not be negative over an extended period of
time, as it suggests operations are running effectively

o Should also examine whether the firm is paying off

debts, dividends, buying more non-current assets.
Buying securities
Relating Operating, Investing & Financing Cash Flows
o Relationship between cash flows from the 3 different
activities can indicate the maturity of the business as
based on which stage of the life cycle the firm is in, the
cash flows from each type of activity varies
o For start-up/growth stage, CFO is < 0 or low, CFI is
negative and CFF > 0, as it will have low revenues, high
capital expenditure and high funding with minimal
repayment
o Maturity/Stability CFO is high, CFI is close to 0 and CFF
is < 0 because revenues will be high generating larger
returns from earlier investments, it ceases to invest in
new project and is repaying financing
o Decline CFO is low, CFI > 0 , CFF < 0 because it starts
to lose profitability, tends to sell projects and not gain
new financing
Calculate Cash flow ratios
o Free cash flows = CFO CAPEX (maintenance), measure
of financial slack
o Solvency & Liquidity
Operating cash flow ratio = CFO/Current Liabilities
Cash current debt coverage ratio = (CFO-Cash
dividends)/Current debt
o Viability as a going concern
Capital Expenditure ratio = CFO/CAPEX
Cash flow to total debt = CFO/Total debt
Identifying Risks of Bankruptcy
o CFF very high initially and decreasing sharply with
continual negative CFO and minimal investment

43. Comparative Analysis

Analysing a company and its ratio with another company
which is similar in nature by either industry or product
Examples of reason to pick the company; similar revenue
streams (i.e. similar products)
Examples of reason why not a appropriate company; one has
a broader range of products
Comparison of ratios may reveal which firm is performing
better
44. Business and Competitive Analysis

Involves analysing the unfair advantage held by each firm or

any other factor that might invalidate comparative analysis
Example; More premium brand with cult following, perception
of superior quality
Can also consider changes to management, competitive
threats

45. Valuation Analysis

Involving comparing the value of the shares of the company
relative to the value of the company
One ratio used is Price to Earnings Ratio = Share Price/EPS
Shows how much investor have to pay for $1 dollar of
earnings stream in perpetuity
When comparing identical firms, the one with lower PE is
undervalued, while the company with higher PE is over valued
PE ratio can be used to calculate the price target of a firm
using the following formula;
o Price Target = Share price * PE(comparable
firm)/PE(selected firm)
o If price target > share price, shares are undervalued and
recommendation is to buy
o If price target < share price, shares are overvalued and
recommendation is to sell
46. Market and Macro Factors
Involves investigating any market or economic factors that
may impact either of the firms and thus invalidate our analysis
Examples;
o Bull vs Bear market (Bull = even poor performing firms
experience an increase in share price, bear = even well
performing firms experience a decrease in share price)
o Impact of a global economic slow down (GFC)
o Free Trade Agreement
o Currency Fluctuations
47. Accounting Policy Choices
Depreciation
o 3 different method straight line, declining balance and
unit of production
o Estimate of useful life
o Estimate of residual value
o Impacts expenses, profits, equity and assets
Inventory
o Inventory Valuation LIFO, FIFO and Weighted average
o Impacts expenses (COGS), Assets and Equity
Revenue recognition

o Timing is dependent on the critical event used to

recognise revenue
o Sooner; pulls profit forward into current period
o Later; pushed profits into future periods
*Note
When analysing the impact, remember after tax impact =
equity impact = net asset impact
Timing issue regarding cash impact
o No change in cash impact from accounting policy
change
o Cash impact is via the cash payment more/less tax as
result of more/less profit
48. Choice vs Rules
Rules in place;
o Corporations Law
o Accounting Standards AASB

How to ensure rules are followed?

o Audit ensure they comply with the statement
o Corporate governance to ensure managers act in the
interest of the share holders
o Disclosure; AASB 108 Accounting Policies they need to
be disclosed in the notes
o Any changes in policies needs to be noted and
retrospective application assuming previous policies also
needs to be constructed

49. Cost Measurement & Allocation

Direct costs (costs that can be easily traced to a cost object)

actual rates are used to allocate costs
o Includes Direct Labour and Direct materials
Overhead costs
o The dollar value may not be known until later
o The number of units produced not known
o As a result, an arbitrary formula is used to assign OH
costs to cost objects
Allocation of OH
o Dependent on choice of denominator (DLH/DMH), the
estimate of denominator used (hour spend on the cost
object) and estimate of the numerator (overall OH costs)
o Reason for using this method

Case of timeliness vs reliability as exacts costs

can only be determined later while estimates are
not 100% accurate
Error in estimates are reconciled at year end
Allocation of OH may also be based on time rather than unit of
production or cost driver (DLM/DMH)

50. Process and Job costing

Job-Order costing
o Costs accumulated by jobs
o Unit cost computed by diving total job costs by units
produced on that job
o When costs are incurred on the job, following journal
entry ;
DR WIP Job #
CR DM/DL/MOH

Process Costing
o Costs accumulated by process or dept
o Unit cost computed by dividing process costs by units
produced in the period
o When the product moves from one process to the
second process;
DR WIP Process/Dept (2)
CR WIP Process/Dept (1)

51. Over-Application & Under-Application of OH

If the difference between the estimate and actual cost is

immaterial, the following journal entries should be used;
o Over-application; DR Overhead Control
CR COGS
o Under-application; DR COGS
CR Overhead Control
If difference is material, then the difference must be
added/deducted proportionally to WIP, FG & COGS based on
the composition of OH costs
o I.e. if the OH cost account was composed of $50 000
WIP, $25 000 FG and $25 000 COGS, then 50% of the
difference will be taken to WIP, and 25% to each of FG
and COGS

52. Problems with cost allocation

As cost of production influence price of the product, incorrect

allocation may distort product cost calculation and thus
incorrect base for price setting

The pre-determined overhead rate formula is based on

estimates of future costs (numerator) and cost driver values
incurred (denominator)

53. Role of Budgets

Used for planning; setting goals and targets

o Includes the plan for achieving the goals
Communication + Coordination
Control evaluating performance based on benchmarks
o Through the Plan-Do-Check-Act
o Plan develop objectives, financial targets and budget
o Do Implement the plan
o Check compare benchmarks set with actual perform,
determine reasons for variance
o Act correct the plan, developed revised budget for next
year and administer incentives based on performance

54. Budget Preparation

Master budget is the combination of operating, cash and

financial statement budgets
First the operating budget is prepared, followed by cash and
then FS
Operating budget preparation process
o Sales budget production budget DM, DL, OH
o Followed by; FG COGS
Cash Budgets
o Capex. Budget
o Cash Budget
FS Budget
o Budgeted CFS, IS, BS
55. Behavioural Dimensions

Problems that may occur with setting target and incentives

o Goal congruence; incentive to take actions not in
interest of the firm
o Slack creation; set eat to meet target
o Myopia; meet short term targets at the expense of long
term viability
Incentives causing the problem include;
o Commissions, bonus, stock options
o Promotions
o Avoid termination
Participants include employee (vs. Manager), CEO (vs.
Shareholders) and Company (vs. society)