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Culture Documents
ACCA
Management
Accounting
F2 基础课程
[2015 大纲]
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ACCA F2 CONTENTS
INTRODUCTIONS OF PAPER .................................................................................................................... 4
1. AIM OF PAPER ...................................................................................................................... 4
2. MAIN CAPABILITIES.............................................................................................................. 4
3. DETAILED SYLLABUS .......................................................................................................... 5
A. THE NATURE, SOURCE AND PURPOSE OF COSTAND MANAGEMENT ACCOUNTING 5
B. COST ACCOUTNING PRINCIPLES AND METHODS .......................................................... 5
C. BUDGETING .......................................................................................................................... 5
D. STANDARD COSTING .......................................................................................................... 5
E. PERFORMANCE MEASUREMENT ...................................................................................... 6
4. EXAM FORMAT ..................................................................................................................... 6
PART A BASIC KNOWLEDGE ..................................................................................................................... 7
CHAPTER 1. THE NATURE, SOURCE AND PURPOSE OF MANAGEMENT ACCOUNTING.......... 7
1. The managerial processes of planning, decision making and control ................................... 7
2. Data and information .............................................................................................................. 8
3. Management accounting and financing accounting............................................................. 18
4. Exercise questions ............................................................................................................... 19
CHAPTER 2. COST CLASSIFICATION ............................................................................................. 20
1. Classifying costs ................................................................................................................... 20
2. Analysis of costs into fixed and variable elements .............................................................. 22
High-low method .......................................................................................................................... 23
High-low method with stepped fixed cost .................................................................................... 23
High-low method with changes in the variable cost per unit ....................................................... 24
3. Cost objects, cost units and cost centres............................................................................. 25
4. Responsibility accounting ..................................................................................................... 25
5. Exercise questions: .............................................................................................................. 26
CHAPTER 3. STATISTICAL TECHNIQUES ....................................................................................... 30
1. Linear regression analysis.................................................................................................... 30
2. Correlation coefficient ........................................................................................................... 31
3. Coefficient of determination.................................................................................................. 32
4. Exercise question: ................................................................................................................ 32
PART B COST ACCOUNTING METHODS AND SYSTEMS .................................................................... 34
CHAPTER 4. ACCOUNTING FOR MATERIALS ............................................................................... 34
1. Purchasing materials ............................................................................................................ 35
2. Ordering, purchasing and receiving inventory ..................................................................... 35
3. Physical inventory and book inventory ................................................................................. 36
4. Valuation of Stock ................................................................................................................. 36
5. Inventory problem ................................................................................................................. 39
6. How much to order? ............................................................................................................. 40
7. The costs of holding inventory ............................................................................................. 40
8. Ordering costs ...................................................................................................................... 41
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9. Re-order quantity .................................................................................................................. 41
10. When to reorder? .......................................................................................................... 44
11. What stock control system to use? ............................................................................... 45
12. Exercise questions ........................................................................................................ 46
CHAPTER 5. ACCOUNTING FOR LABOR ....................................................................................... 48
1. Direct labor and indirect labor .............................................................................................. 48
2. Direct labor cost and indirect labor costs ............................................................................. 49
3. Labor turnover ...................................................................................................................... 51
4. Labor efficiency .................................................................................................................... 51
5. Exercise question .................................................................................................................... 52
CHAPTER 6. ACCOUNTING FOR OVERHEADS ............................................................................. 53
1. When costs are incurred, they ban be recorded as: ............................................................ 53
2. Absorption costing ................................................................................................................ 54
3. The absorption process ........................................................................................................ 54
4. Absorption in cost units ........................................................................................................ 61
5. Overhead absorbed:............................................................................................................. 61
6. Under/over absorbed:........................................................................................................... 63
7. Ledger entries for manufacturing cost.................................................................................. 65
8. Exercise questions ............................................................................................................... 66
CHAPTER 7. ABSORPTION AND MARGINAL COSTING ................................................................ 67
1. Contribution .......................................................................................................................... 68
2. Profit statement .................................................................................................................... 68
3. Explanation of the difference in profit ................................................................................... 70
4. Exercise questions ............................................................................................................... 71
CHAPTER 8. JOB, BATCH AND PROCESS COSTING .................................................................... 72
1. Job costing ........................................................................................................................... 72
2. Batch costing ........................................................................................................................ 73
3. Process costing .................................................................................................................... 73
4. Exercise questions ............................................................................................................... 84
CHAPTER 9. SERVICE AND ALTERNATIVE COSTING ................................................................... 87
1. Servicing costing .................................................................................................................. 87
2. Alternative costing ................................................................................................................ 89
3. Exercise questions ............................................................................................................... 96
PART C BUDGETING ................................................................................................................................ 97
CHAPTER 10. FORECASTING ..................................................................................................... 97
1. The planning and control cycle ............................................................................................ 98
2. Statistical techniques ............................................................................................................ 98
3. Times series analysis ......................................................................................................... 102
4. Forecasting ......................................................................................................................... 106
5. Forecasting problem ........................................................................................................... 107
CHAPTER 11. BUDGETING........................................................................................................ 108
1. Budgeting ........................................................................................................................... 108
2. Budget preparation ............................................................................................................. 109
3. Fixed and flexible budgets.................................................................................................. 117
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4. Spreadsheet ....................................................................................................................... 119
5. Budgetary control ............................................................................................................... 119
6. Behavioral aspects of budgeting ........................................................................................ 120
CHAPTER 12. METHODS OF PROJECT APPRAISAL .............................................................. 123
1. The payback period ............................................................................................................ 123
2. Interest ................................................................................................................................ 123
3 Discounted cash flow (DCF) .............................................................................................. 125
Part C EXERCISE QUESTIONs .............................................................................................................. 129
Part D Standard Costing .......................................................................................................................... 133
CHAPTER 13. VARIANCE ........................................................................................................... 133
1. Standard costing................................................................................................................. 133
2. Variances ............................................................................................................................ 134
3. Operating statements ......................................................................................................... 138
4. Exercise questions ............................................................................................................. 139
Part E PERFORMANCE .......................................................................................................................... 144
CHAPTER 14. PERFORMANCE MEASUREMENT.................................................................... 144
1. Performance measurement overview ................................................................................ 144
2. Critical success factors....................................................................................................... 145
3. The problem of short-termism ............................................................................................ 146
4. Different objectives are appropriate to each business, so different performance measures
may be appropriate for any given objective. ............................................................................. 146
5. Financial performance measures ....................................................................................... 147
6. Non-financial performance measures ................................................................................ 149
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INTRODUCTIONS OF PAPER
1. AIM OF PAPER
2. MAIN CAPABILITIES
Budgeting
(C)
Performance measurement
(E)
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3. DETAILED SYLLABUS
ACCOUNTING
2. Source of data
3. Cost classification
4. Presenting information
C. BUDGETING
2. Statistical budgets
3. Functional budgets
4. Flexible budgets
D. STANDARD COSTING
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E. PERFORMANCE MEASUREMENT
4. EXAM FORMAT
F2/FMA is being restructured with effect from February 2014, to introduce longer style questions.
Section B will contain 3 ten mark multitask questions each of which will examine Budgeting, Standard
costing and Performance measurement sections of the syllabus
P5 Advanced Performance
Management
F5 Performance Management
F2 Management Accounting
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PART A BASIC KNOWLEDGE
SYLLABUS CONTENT
4. Sampling
5. Reporting
1.1 Planning
1.1.1 Planning involves establishing the objectives of an organization and formulating relevant
1.1.2 Planning can be either short-term (tactical planning) or long-term (strategic planning)
A. Planning hierarchy
(a) At a strategic level, senior managers formulate long-term objectives and plans (strategies), and seek
to achieve these long-term goals.
(b) At a tactical level, senior managers make short-term plans for, say, the next year e.g. annual plans
or budgets.
(c) At an operational level, managers take day-to-day decisions about what to do next and how to deal
with problems arise.
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2. Raise new funds 2. Expand into markets in Asia
Tactical 1. Set a target for this year for examination Carry out a cost reduction program next
plans results year
Operational 1. Prepare teaching schedules for the next 1. Obtain prices from more than one
plans term supplier before purchase material
Decision-making involves considering information that has been provided and making an informed
decision.
1.3 Control
-- Managers use the information relating to actual results to take control measures and to re-assess and
amend their original budgets or plans.
-- Internally sourced information, produced largely for control purposes, is called feedback.
‘Data’ means facts. Data consists of numbers, letters, symbols, raw facts, events and transactions which
have been recorded but not yet processed into a form suitable for use.
Information is data which has been processed in such a way that it is meaningful to the person who
receives it (for making decisions)
2.1. Data
Secondary data are data which have already been collected elsewhere, for some other purpose, but
which can be used or adapted for the survey being conducted.
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Internal sources of data
The advantage of using a primary source of data is that the user of the information knows where it came
from, the circumstances under which it was collected, and any limitations or inadequacies in it.
Secondary external sources of data are stores of data collected by outside orginsations.
Governments
Banks
Newspapers
Trade journals
Internet
Economic environment
The data is collected for general rather than specific purposes and so there are a number of possible
limitations.
The data may not be suitable for the purpose it is being used for.
2.1.3 Sampling
Data are often collected from a sample rather than from a population. If the whole population is examined,
the survey is called a census.
Sample data are data arising as a result of investigating a sample. A sample is a selection from the
population.
Population data are data arising as a result of investigating the population. A population is the group of
people or objects of interest to the data collectors.
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A. Sampling methods
Probability sampling methods - is a method in which there is a known chance of each member of the
population appearing in the sample.
Random sampling
Systematic sampling
Multistage sampling
Cluster sampling
Random sampling
Random sampling means every item in the population has an equal chance of being
selected.
--- Selected items are subject to the full range of variation inherent in the population
--- It might be difficult to obtain the data if the selected items cover a wide area
--- It might be costly to obtain the data if the selected items cover a wide area
* Sampling frame is a numbered list of all items in a population. Once a numbered list of all items in the
population has been made, it is easy to select a random sample, simply by gathering a list of random
numbers.
This involves dividing the total population into strata or categories (for example age
groups) and then taking random samples from each of the strata or categories.
Advantages:
The selected sample will be representative of the population as a whole, as all strata will be
represented.
Precision is increased, as variation between strata does not enter as a chance event. A random sample
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could miss an entire stratum.
Disadvantage:
Example:
The numbers of management accountants in each type of work in a particular country are as follows.
Partnerships 500
Sample
Partnerships 500/2500×20 4
20
Systematic sampling
Systematic sampling is a sampling method, which works by selecting every nth item after
a random start. The gap is the sampling interval.
Advantages:
It easy to use
It is cost effective
Disadvantages: ·
It is possible that a biased sample might be chosen if there is a regular pattern to the population, which
coincides with the sampling method.
It is not completely random since some samples have a zero chance of being selected.
Multistage sampling
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Multistage sampling involves dividing the population into a number of sub-populations
and then selecting a small sample of these sub-populations at random.
Each sub-population is then divided further, and then a small sample is again selected at
random. This process is repeated as many times as is necessary.
Advantages
Disadvantages
There is possibility of bias if, for example, only a small number of regions are selected
The method is not truly random as once the final sampling areas have been selected the rest of
the population cannot be in the sample
If the population is heterogeneous, the areas chosen should reflect the full range of the diversity.
Otherwise, choosing some areas and excluding others will result in a biased sample.
Cluster sampling
Cluster sampling involves splitting the population into convenient groups and then
selecting a number of groups at random. Every item in the sample is then investigated.
For example people travelling on particular buses could be taken as representative of the
travelling public in general. All the passengers on the selected buses would then be
interviewed.
Advantages
It is cheap to operate as the members of each cluster are all in one place; this is particularly useful if
face-to-face interviews are required.
Useful if a sampling frame does not exist (for example if you can’t identify your potential population of
customers to sample from).
Disadvantage
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the population appearing in the sample is not known.
Quota sampling
Advantages:
It may be the only possible approach in certain situations, such as television audience research.
Disadvantage
Management information is information used by managers to help control the business. Management
information is provided by the management accountant.
Strategic information is used by senior managers to plan the objectives of their organistaion, and to
assess whether the objectives are being met in practice.
Tactical information is used by middle management to decide how the resources of the business should
be employed, and to monitor how they are being and have been employed,
Operational information is used by ‘front-line ‘managers such as foremen or head clerks to ensure that
specific tasks are planned and carried out properly within a factory or office and so on.
(a) Accuracy
(b) Completeness
(c) Cost-effective
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(d) Understandable (clarity)
(e) Relevance
(f) Confidence
(g) Communication
(h) Volume
(i) Timing
2.3. Reports
To assist management
Control action.
Planning decisions.
The report writer should communicate information in an unbiased way. Information should be
communicated impartially.
Any assumptions, evaluations and recommendations by the writer should be clearly ‘signaled’ as
such.
Avoid ‘jargon’
As simple as possible
Planning a report
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Who am I writing to?
Title
To:
From:
Date:
Contents page
Conclusion
Appendices
Short formal report - is used in formal contexts such as where middle management is reporting to
senior management
Short informal report - is used for less complex and lower-level information. The structure is shorter
and less complex, not require elaborate referencing and layout.
Memorandum report - used for flexible, informal reports. No particular requirement for structure,
headings or layout. The writer may consider what is logical, convenient and attractive for the reader.
A table is a matrix of information in rows and columns, with the title. And only show two variables
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9.1.3 Presenting and interpreting information in charts
A. Bar chart
Bar chart is a method of presenting information in which quantities are shown in the form of bars on a chart.
The length of the bars being proportional to the quantities.
It often conveys the meaning or significance of data more clearly than would be a table.
A simple bar chart is a chart consisting one or more bars, in which the length of each
bar indicates the magnitude of the corresponding information.
Example:
A component bar chart is a bar chart that gives a breakdown of each total into its
components.
Example:
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The difference between a component bar chart and a percentage component bar chart:
Percentage component bar chart: total length of each bar is the same. The only varying lengths are
the lengths of the sections of a bar.
Example:
A multiple bar chart ( or compound bar chart) is a bar chart in which two or more
separate bars are used to present sub-divisions of information
Example
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It presents information similar to component bar chart, except for the following:
B. pie chart
A pie chart is a chart, which is used to show pictorially the relative size of component elements of a total.
--- They give a simple pictorial display of the relative sizes of elements of a total
--- They show clearly when one element is much bigger than others
Preparing financial statements is required by the law and accounting standards. Information produced
from the financial accounting system is usually insufficient for management’s need.
Management accounting systems use the cost accounts and other information sources to provide a
financial reporting system for management.
Cost accounting provides a detailed analysis of the costs of products and services, activities and
responsibility centre of an organization.
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3.4 Summary of management accounting and financial accounting
Management accounting Financial accounting
Information mainly produced for Internal use: e.g. Managers and External use: e.g. Shareholders,
employees creditors, lenders, banks,
government
Purpose of information To aid planning, controlling and To record the financial
decision making performance in a period and the
financial position at the end of
that period
Nature of information Financial & non-financial Financial information
information
Legal None Limited companies must
produce financial accounts
Format Decide by the management and Format and content of financial
the most useful way of accounts intending to give a true
presenting it and fair view should follow IAS
and company law
Time period Historical and forward-looking Mainly a historical record
4. Exercise questions
2. Which of the following would be best described as a short term tactical plan?
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D Monitoring actual sales to budget
A It is relatively expensive
C It doesn’t yield enough accurate information for many forms of commercial market research
SYLLABUS CONTENT
1. Classifying costs
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Direct cost is expenditure that can be directly identified with a specific cost unit or cost center
Prime cost is the total of direct material cost, direct labor cost and direct expenses.
Indirect costs / overheads: is expenditure that cannot be directly identified with a specific cost unit
or cost center and must be ‘shared out’ on an equitable basis.
(c) Behavior – costs are classified as being fixed, variable, semi-variable or stepped fixed.
Fixed costs: are costs that are not affected in total by the level of activity, but remain the same
Variable costs: are the costs that change in total in direct proportion to the level of activity.
Step costs: costs that are constant for a range of activity level, and then change, and are constant
again for another range.
If the steps are large, within a relevant range of activity, the cost can be taken as fixed.
If the steps are small and frequent as the activity level rises, the steps may be ignored and the cost may
be treated as variable cost.
Semi-variable costs:are those which have both fixed and variable element.
Product costs: are costs included in a stock valuation. The product cost is the cost of making, or
buying
Period costs: are costs that are not attributed to product costs, but instead are treated as a cost
of the time period when they arise.
Direct material 2
Direct labor 3
Direct expenses 1
Prime cost 6
Production overhead 1
Administration OH 1
Total costs 9
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1.2. Cost equations
The equation of a straight line is a linear function and is represented by the following equation:
Y= a + bx
y = a + bx
y = total costs
Cost graph
Cost and revenue$
Sale revenue
Total costs
Variable cost
Fixed costs
Output
Cost estimation
A number of methods exist for analyzing semi-variable costs into their fixed and variable elements. The
two main methods are:
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High-low method
Step 1 – select the highest and lowest activity levels, and their associated costs
Step 3 – find the fixed cost by substitution, using either the high or low activity level.
EXERCISE 1
Using high-low method to calculate the fixed and variable elements of the following costs:
Month units produced costs($)
July 340 2,260
August 300 2,160
September 380 2,320
October 420 2,400
November 400 2,300
December 360 2,266
Solution
Sometimes fixed costs are only fixed within certain levels of activity and increase in steps as activity
increases
The high low method can still be used to estimate fixed and variable costs.
Adjustments need to be made for the fixed costs based on the activity level under consideration
EXERCISE 2:
Variable cost per unit is constant within this activity range and there is a step up of 10% in the total fixed
costs when the activity level exceeds 5500units
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Solution:
Sometimes there may be changes in the variable cost per unit, and the high low method can still be used
to determine the fixed and variable elements of semi-variable costs. The variable cost per unit may
change because:
(b) Bulk discounts may be available for purchasing resources in large quantities.
EXERCISE 3:
For output volumes above 350 units the variable cost per unit falls by 10%. ( Note: this fall applies to all
units – not just the excess above 350)
Solution:
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3. Cost objects, cost units and cost centres
Analyzing costs
Including:
Cost objects: a cost object is any activity for which a separate measurement of cost is undertaken
Cost units: a cost unit is a unit of product or service in relation to which costs are ascertained.
4. Responsibility accounting
Responsibility accounting is based on identifying individual parts of a business, which are the responsibility
of a single manger.
A responsibility centre is an individual part of business whose manager has personal responsibility for
its performance.
(a) Cost centre—within an organization, this is a production or service location, a function, an activity or
an item of equipment whose costs may be accumulated and attributed to cost units.
The performance of a cost centre manager is judged on the extent to which cost targets have been
achieved
Cost centre managers need to have information about costs that are incurred and charged to their
cost centres.
(b) Revenue centre---within an organization, this is a centre or activity that earns sales revenue. And
whose manager is responsible for the revenue earned but not for the costs incurred.
(c) Profit centre—a part of the business whose manager is responsible and accountable for both costs
and revenue. The performance of a profit centre manager is measured in terms of the profit made by
the centre.
Data and information relating to both costs and revenues must be collected and allocated to the
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relevant profit centres
(d) Investment centre—a profit centre with additional responsibilities for investment and possibly also
for financing, and whose performance is measured by its return on capital employed (ROCE).
5. Exercise questions:
Which one of the following descriptions is consistent with the above diagram?
A. Annual total cost of factory power where the supplier sets a tariff based on a fixed charge plus a
constant unit cost for consumption which is subject to a maximum annual charge.
B. Total annual direct material cost where the supplier charges a constant amount per unit which
then reduces to a lower amount per unit after a certain level of purchases.
C. Total annual direct material cost where the supplier charges a constant amount per unit but when
purchases exceed a certain level a lower amount per unit applies to all purchases in the year.
D. Annual total cost of telephone services where the supplier makes a fixed charge and then a
constant unit rate for calls up to a certain level. This rate then reduces for all calls above this
level.
2. A supplier of telephone services charges a fixed line rental per period. The first 10 hours of telephone
calls by the customer are free, after that all calls are charged at a constant rate per minute up to a
maximum, thereafter all calls in the period are again free.
Which of the following graphs depicts the total cost to the customer of the telephone services in a
period?
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3. Up to a given level of activity in each period the purchase price per unit of a raw material is constant.
After that point a lower price per unit applies both to further units purchased and also retrospectively
to all units already purchased.
Which of the following graphs depicts the total cost of the raw materials for a period?
Which one of the following statements is consistent with the above chart?
A. Both selling price per unit and variable cost per unit are constant.
B. Selling price per unit is constant but variable cost per unit increases for sales over 4,000 units.
C. Variable cost per unit is constant but the selling price per unit increases for sales over 4,000
units.
D. Selling price per unit increases for sales over 4,000 units and there is an increase in the total
fixed costs at 4,000 units.
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5. A firm has to pay a $0.5 per unit royalty to the inventor of a device which it manufactures and sells.
A a cost centre
B a customer
C a manager
D a product
7. A cost is described as staying the same over a certain activity range and then increasing but remaining
stable over a revised activity range in the short term. What type of cost is this?
A A fixed cost
B A variable cost
C A semi-variable cost
D A stepped fixed cost
9. The following production and total cost information relates to a single product organization for the last
three months:
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A$54,200
B$55,000
C$59,000
D$60,200
10. A manufacturing company has four types of cost (identified as T1, T2 , T3 and T4). The total cost for
each type at two different production levels is:
Cost type Total cost for 125units Total cost for180 units
$ $
T1 1,000 1,260
T2 1,750 2,520
T3 2,475 2,826
T4 3,225 4,644
A T1 and T3
B T1 and T4
C T2 and T3
D T2 and T4
11. Reginald is the manager of production department M in a factory which has ten other production
departments. He receives monthly information that compares planned and actual expenditure for
department M. After department M, all production goes into other factory departments to be
completed prior to being dispatched to customers. Decisions involving capital expenditure in
department M are not taken by Reginald.
(i) Return on capital employed is a suitable measure of performance in both profit and investment
centres.
(ii) Cost centres are found in manufacturing organisations but not in service organizations.
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(iii) The manager of a revenue centre is responsible for both sales and costs in a part of an
organisation.
A (i)only
B (ii)only
C (iii)only
D None of them
SYLLABUS CONTENT
b) Correlation coefficient
c) Coefficient of determination
To estimate the relationship between two variables in the form of an equation, we can try to fit a straight
line through the points on the scatter-graph.
Advantage of scatter graph: all the points on the graph are taken into consideration, not just high and low
point
Disadvantage
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Not accurate
Regression analysis, like the high/low method, can be used to predict the linear relationship between
two variables
Y = a + bx
a = ∑y __ b∑x
nn
b= n∑xy - ∑x∑y
n∑x2 – (∑x) 2
EXERCISE 1
Solution:
2. Correlation coefficient
Correlation measures how strong the connection is between the two variables. When correlation is strong,
the estimated line of best fit should be more reliable.
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R =n∑xy- ∑x∑y
√(n∑x2 – (∑x)2)(n∑y2 – (∑y)2)
Interpretation:
3. Coefficient of determination
The coefficient of determination will show how much of the variations in total cost can be explained by
variations in activity level.
R2 = 0.92 or 92%
This is means that 92% of the variations in total costs is explained by variations in the level of activity.
The other 8% of variations in total costs are assumed to be due to random fluctuations.
4. Exercise question:
1. Regression analysis is being used to find the line of best fit (y = a + bx) from five pairs of data. The
calculations have produced the following information:
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What is the value of ‘a’ in the equation for the line of best fit (to the nearest whole number)?
A 146
B 152
C 210
D 245
2. Which of the following is NOT a feasible value for the correlation coefficient?
A+ 1.2
B+ 0.6
C+0
D– 0.6
3. An organisation is using linear regression analysis to establish an equation that shows a relationship
between advertising expenditure and sales. It will then use the equation to predict sales for given
levels of advertising expenditure. Data for the last five periods are as follows:
4. Which of the following correlation coefficients indicates the weakest relationship between two variables?
A + 1.0
B + 0.4
C – 0.6
D –1.0
5. A company uses regression analysis to establish a total cost equation for budgeting purposes, Data
for the past four months is as follows:
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1 57·5 1·25
2 37·5 1·00
3 45·0 1·50
4 60·0 2·00
200 5·75
The gradient of the regression line is 17·14.
What is the value of a?
A 25·36
B 48·56
C 74·64
D 101·45
6. The following statements have been made about linear regression analysis
SYLLABUS CONTENT
a) Purchasing materials
d) Holding costs
e) Ordering costs
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1. Purchasing materials
Stores/material
Buying department
using department
Goodsreceiving
Selected supplier
department.
Purchasing department
Receipt Supplier
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3. Physical inventory and book inventory
3.1 Perpetual inventory is the recording as they occur of receipts, issues and the
value
Inventory records are updated using stores ledger cards and bin cards
Bin cards also show a record of receipts, issues and balances of the quantity of an item of inventory
handled by stores
3.2 Stocktaking
Periodic stocktaking involves checking the balance of every item of inventory on the same date,
usually at the end of an accounting period.
Continuous stocktaking involves counting and valuing selected items of inventory on a rotating basis.
Specialist teams count and check certain items of inventory on each day. Each item is checked at
least once a year with valuable items being checked more frequently.
Summary
Periodic stocktaking Check balance of every item of inventory on the same date, usually at
the end of an accounting period
Continuous stocktaking Count and value selected items of inventory on a rotating basis.
Specialist teams count and check certain stock items on each day.
Perpetual inventory Record, as they occur, receipts, issues and the resulting balances of
individual items of inventory in either quantity or quantity and value
Slow –moving stock Those inventory items, which take a long time to be used up.
Obsolete stock Those items of inventory which have become out of date and are no
longer required
4. Valuation of Stock
(a) Specific identification - Specific costs are attributable to identified items of inventory.
(b) First-in-first-out (FIFO) - Assumes goods are sold in order of their receipt, i.e. first price in is the first
price out. Ending stock is always valued at the latest price.
(c) Last-in-first-out (LIFO)- Assumes goods are sold in the reverse order of their receipt, i.e. last price
- 36 -
in is the first price out. Ending stock is valued at the earliest price. (not allowed in IAS 2)
(d) Weighted average (AVCO) - The weighted average cost per unit of stock is measured by dividing
total cost of goods available for sale by total number of units available for sale. The weighted average
stock valuation method is further subdivided into:
Periodic average
Example
You are given the following information relating to the stock movement of J Beth for the month of August
20X9.
Date Description In its/cost price
20X9 Aug 1 Opening stock 800 units at $10 each
8 Purchases 600 units at $12 each
15 Sales 750 units
22 Sales 300 units "
28 Purchases 350 units at $11 each
31 Sales 200 units
Required:
Present the stock movement schedule, showing clearly the closing stock balance and the cost of goods
sold, using the following methods of stock valuation:
(a) FIFO
(b) LIFO
Answer:
FIFO: closing stock 5650 LIFO: 5150 WAC (continuous):5464 WAC(periodic) 5445
FIFO
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7200
15 750 10 50 10
7500 500
600 12
7200
22 50 10 350 12
500 4200
250 12
3000
28 350 11 350 12
3850 4200
350 11
3850
31 200 12 150 12
2400 1800
350 11
3850
LIFO
28 350 11 350 10
3850 3500
350 11
3850
- 38 -
31 200 11 350 10
2200 3500
150 11
1650
5. Inventory problem
- 39 -
6. How much to order?
The total costs associated with stocks include the following costs:
The main reason that an organization will hold inventory is in order to make sure that customer demands
are met as soon as possible.
Holding raw material inventory will prevent hold-ups in the production process of manufacturing
companies.
B. HOLDING COSTS
-cost of insurance.
Buffer inventory is a basic level of inventory held for emergencies and to prevent stock-outs from
occurring. It is also known as safety inventory
Holding cost can be distinguished between fixed holding costs and variable holding costs.
Fixed holding costs include the cost of storage space and the cost of insurance. Note that the
cost of storage space may be a stepped fixed cost if increased warehousing is needed when higher
volumes of inventory are held.
Variable holding costs include interest on capital tied up in inventory. The more inventories that
is held, the more capital that is tied up.
Holding costs are often stated as being valued at a certain percentage of the average inventory
held.
- 40 -
Note: stock-out costs are the costs associated with running out of inventory and they include loss
of sales, loss of customers (and customer goodwill) and reduced profits.
8. Ordering costs
Every time an order is placed to purchase materials an order cost is incurred. The costs associated
with placing orders are known as ordering costs and include administrative costs and delivery costs.
(a) Ordering stock: are incurred every time stock is purchased from a supplier. Order costs include:
9. Re-order quantity
(a) The re-order quantity is the amount of the item of stock to be ordered each time the re-order level
is reached.
(b) The re-order quantity will be the same amount each time an order is placed.
Formula
EXERCISE 1
Demand for a company’s product is about 600,000 units per annum. It costs $3 to keep one unit in
stock for one year. Each time an order is placed, administrative costs of $40 are incurred.
How many units should the company order at a time so as to minimize the costs of stock ordering plus
stock holding?
- 41 -
Solution
EXERCISE 2
A company uses 9,000 units of a component per annum. The component has a purchase price of $40
per unit and the cost of placing an order is $160. The annual holding cost of one component is equal
to 8% of its purchase price.
What is the Economic Order Quantity (to the nearest unit) of the component?
Solution
EXERCISE 3
W ltd. is a retailer of beer barrels. The company has an annual demand of 36,750 barrels. The barrels
cost $12 each. Fresh supplies can be obtained immediately, but ordering costs and the cost of carriage
inwards are $200 per order. The annual cost of holding one barrel in stock is estimated to be $1.20,
what are the total annual costs with EOQ?
- 42 -
Solution
Frequently discounts are offered for large quantity orders. Theses are often called bulk purchase discounts.
The problem to consider is that if the order quantity to obtain the bulk discount is larger than the EOQ, is
the discount worth taking?
EXERCISE CONTINUED
In the earlier EXERCISE of W ltd., suppose additionally that a 2% discount is available on orders of at
least 5,000 barrels and that a 2.5% discount is available if the order quantity is 7,500 barrels or above.
Would the least-cost order quantity still be 3,500 barrels?
Solution
The economic batch size is the quantity that minimizes the combined total of the costs of stockholding and
the cost of setting up the batch for manufacture.
EBQ=
- 43 -
Q = batch size
EXERCISE 4:
(b) Demand is 10000 units per annum; evenly spread over 50 working weeks
Solution
Buffer stock is a basic level of stock held for emergencies, to cover unexpected demand for the stock item.
Re-order level = maximum supply lead-time (in days or weeks) * maximum daily or weekly demand for the
item.
EXERCISE 5
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The daily demand for stock item is expected to be not less than 60 tones and not more than 100 tones.
The lead-time between placing an order and receiving delivery from the supplier will be between one and
three days. What should be the re-order level?
Solution
Minimum stock level = re-order level – (average demand for the item each day/ month× average length
of lead time in days/months)
Maximum stock level = re-order level + re-order quantity – (minimum usage per day * minimum lead
time per order)
EXERCISE 6
Calculate the re-order level, minimum stock level and maximum stock level from the following data.
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Solution
1. A Company determines its order quantity for a component using the Economic Order Quantity (EOQ)
model. What would be the effects on the EOQ and the total annual ordering cost of an increase in the
annual cost of holding one unit of the component in stock?
2. The demand for a product is 12,500 units for a three -month period. Each unit of product has a
purchase price of $15 and ordering costs are $20 per order placed. The annual holding cost of one
unit of product is 10% of its purchase price. What is the Economic Order Quantity (to the nearest unit)?
A 1,577
B 1,816
C 1,866
D 1,155
(ii) Safety stocks are the level of units maintained in case there is unexpected demand.
(iii) A reorder level can be established by looking at the maximum usage and the maximum lead-time.
- 46 -
4. A company uses the Economic Order Quantity (EOQ) model to establish reorder quantities. The
following information relates to the forthcoming period:
What are the total annual costs of stock (i.e. the total purchase cost plus total order cost plus total
holding cost)?
A $22,000 B $33,500
C $802,000 D $803,000
A 5,000 B 6,000
C 7,800 D 8,000
6. A company uses components at the rate of 600 units per month, which are bought in at a cost of $2.24
each from the supplier. It costs $8.75 each time to place an order, regardless of the quantity ordered.
The supplier offers a 5% discount on the purchase price for order quantities of 2000 items or more.
The current EOQ is 750 units. The total holding cost is 10% per annum of the value of inventory held.
What is the change in total cost to the company of moving to an order quantity of 2000 units?
- 47 -
Chapter 5. Accounting For Labor
SYLLABUS CONTENT
b) Time-based system
c) Piecework systems
d) Labor turnover
e) Labor efficiency
--- Those who are directly engaged in manufacturing products are direct labor employees.
--- Those who are not directly engaged in actual manufacturing work are indirect labor employees.
TIME-BASED SYSTEM
Total wages = (hours worked x basic rate of pay per hour) + (overtime hours worked x overtime premium
per hour )
PIECEWORK SYSTEMS
Wage earners are usually paid a basic rate of pay for each hour they work.
Time spent doing nothing is called idle time, when idle time appears to be excessive, measures might
be taken to improve the utilization of the work force, and in doing so improve productivity.
Overtime is time in excess of the basic hours for a period. Usually, overtime hours are paid at a higher
rate than the basic hourly rate.
A bonus is a payment in addition to a basic salary or wage, and is paid for either achieving or exceeding
certain targets.
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EXERCISE 1
A company pays a group of employees $9 per hour for a 37-hour week. Time worked in excess of 37 hours
is overtime, which is paid at time and one third. During one week, the work force works 407 hours in normal
time plus an additional 40 hours of overtime.
solution
All labor costs associated with indirect labor employees are indirect labor costs
Some labor costs associated with direct labor employees are treated as direct labor costs, but some are
treated as indirect labor costs.
For hours paid for but not engaged in direct labor operations, such as idle time and time spent on
training, the cost is usually treated as an indirect labor cost.
When direct labor employees work overtime hours, the overtime premium is usually an overhead cost
item. The only exception to this rule is when overtime is worked for a specific reason
Bonus payments to direct labor employees are usually be treated as aindirect labor cost
EXERCISE 2
Sky employs two types of labor: skilled workers, considered to be direct workers, and semi-skilled workers,
considered to be indirect workers. Skilled workers are paid $10 per hour and semi-skilled $6 per hour.
The skilled workers have worked 30 hours overtime this week, 10 hours on a specific order and 20 hours
on general overtime. Overtime is paid at a rate of time and a half.
The semi-skilled workers have worked 45 hours overtime, 15hours for a specific order at a customer’s
request and the rest for general purposes. Overtime again is paid at time and a half.
What would be the total overtime pay considered to be a direct cost for this week?
A $195 B $285
C $350 D $485
- 49 -
Solution
EXERCISE 3
Idle time 25 10
Training 15 6
There are 10 direct labor employees and 3 indirect labor employees, all of whom are paid for a 37-hour
week. All additional hours are paid on an overtime basis. Direct labor employees are paid a basic rate of
$8 per hour and indirect labor employees are paid a basic rate of $6 per hour. All overtime is worked to
meet the general requirements of production and is paid at time-and-a-half. (Overtime premium is 50% of
the basic rate of pay)
Solution
Direct labor employees indirect labor employees
Hours Hours
Basic Hrs (10 x 37) 370 (3 x 37) 111
Payroll Hrs390 118
Overtime 20 7
- 50 -
3. Labor turnover
Labor turnover is a measure of the proportion of people leaving relative to the average number of people
employed.
Labor turnover = no. of leavers who require replacement/average no. of employees *100%
EXERCISE 4
At 1 January a company employed 3,641 employees and at 31 December employees number were 3,735.
During the year 624 employees left the company. What was the labor turnover rate for the year?
Solution
624 x 100% = 16.9%
(3735 + 3641) / 2
4. Labor efficiency
Production volume ratio= expected hours to produce actual output (std hours) X 100%
Total hours available (budgeted)
EXERCISE 5
EXERCISE 6
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Efficiency ratio =? Capacity ratio =? Production volume ratio =?
Solution
Q5 Q6
Efficiency ratio 420 x 100% = 102% 225 x 100% = 90%
410 250
Capacity ratio 410 x 100% = 102.5% 250 x 100% = 125%
400 200
Production Volume ratio 420 x 100% = 105% 225 x 100% = 112.5%
400 200
5. Exercise question
2 An organization operates a piecework system of remuneration, but also guarantees its employees
80% of a time-based rate of pay, which is based on $20 per hour for an eight hour working day. Three
minutes is the standard time allowed per unit of output. Piecework is paid at the rate of $18 per standard
hour.
If an employee produces 200 units in eight hours on a particular day, what is the employee’s gross
pay for that day?
A $128
B $144
C $160
D$180
Labor grade No. of employees Rate per hour Individual hour worked
1 6 4 40
2 18 3.2 42
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3 4 2.8 40
4 1 1.6 44
Output and standard time during the same week were:
Component Output standard minutes
A 444 30
B 900 54
C 480 66
The normal working week is 38 hours, and overtime is paid a premium of 50% of the normal hourly rate.
A group incentive scheme is in operation. The time saved is expressed as a percentage of hours worked
and is shared between the groups as a proportion of the hours worked by each grade. The rate paid is
75% of the normal hourly rate.
SYLLABUS CONTENT
c) Overhead absorbed
d) Under/over absorbed
Overhead costs are costs that cannot be economically directly to cost units. Overheads are another
term for indirect costs.
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Overhead costs are charged to a cost centre, which might represent:
2. Absorption costing
Absorption costing is a method of costing in which the costs of an item are built up as the sum of direct
costs and a fair share of overhead costs, to obtain a full cost or a fully absorbed cost
Direct materials
Direct labor
Direct expenses
Direct cost
Production overhead
Total cost
(b) Service department (e.g. Material handling costs, Production control cost, Canteen cost)
e.g. stores department/ material handling department, maintenance and repairs department, production
control department
- 54 -
1.2 Apportionment of general overhead costs
The basis of apportionment used should be based on a rationale view of what is ‘fair’ in relation to the
item of cost. There are no rules for deciding what a fair basis for apportioning costs should be.
General cost examples:machine maintenance labor cost, power, light and heat, rent and rates, small
tools, insurance of machinery, insurance of building, deprecation of machinery etc.
EXERCISE 1
The overhead budget for the month together with data relating to cost centers is as follow; apportion
each of the costs given to the four groups of machines (Q, R, S, T) on a suitable basis.
Overhead budget
$
Supervision 7,525
Indirect workers 6,000
Holiday pay and national insurance 6,200
Tooling cost 9,400
Machine maintenance labor cost 4,500
Power 1,944
Small tools and supplies 1,171
Insurance of machine 185
Insurance of building 150
Rent and rates 2,500
Depreciation of machine 9,250
Total 48,825
Q R S T Total
Floor space 1,800 1,500 800 900 5,000
Kilowatt hrs 270k 66k 85k 65k 486k
Capital cost of machine$ 30k 20k 8k 16k 74k
Indirect workers (persons) 3 3 1 1 8
Total workers (persons) 19 24 12 7 62
Machine maintenance hrs 3k 2k 3k 1k 9k
Machine running hrs 30k 36k 19k 8k 93k
Tooling cost $ 3,500 4,300 1,000 600 9,400
Supervision cost $ 2,050 2,200 1,755 1,500 7,525
Small tools $ 491 441 66 173 1,171
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Solution
1. $ Basis Q R S T
Supervision 7525 Allocation 2050 2200 1755 1500
Indirect workers 6000 Indirect worker 2250 2250 750 750
Holiday pay & NI 6200 Total worker 1900 2400 1200 700
Tooling cost 9400 Allocation 3500 4300 1000 600
Maint. Labor cost4500 Maintenance Hrs 1500 1000 1500 500
Power 1944 kilo Hrs 1080 264 340 260
Small tools 1171 Allocation 491 441 66 173
Insurance of machine 185 Cost of machine 75 50 20 40
Insurance of building 150 Floor space 54 45 24 27
Rent & rates 2500 floor space 900 750 400 450
Depn. of machine 9250 Cost of machine 3750250010002000
48825 17550 16200 8075 7000
1.3 Apportioning service cost centre costs to production cost centers (Re-
apportionment)
When calculating unit costs under absorption costing principles each cost unit is charged with its direct
costs and an appropriate share of the organization’s total overheads (indirect costs). An appropriate share
means an amount that reflects the time and effort that has gone into producing the cost unit.
Service cost centres are those that exist to provide services to other cost centres in the organisation. They
do not work directly on producing the final product. Consequently, their costs must be re-apportioned to
production cost centres so that their overheads can be absorbed into the final product.
This is the simplest method and is ideal to use when service cost centres provide services to production
cost centres, but not to each other.
Example 1
A company’s overheads have been allocated and apportioned to its five cost centres as shown below.
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overhead ($)
In this situation, service cost centre overheads are simply ‘shared out’ on the basis of
usage. For example, production cost centre A should be charged with 40%, 75% and
30% respectively of cost centre C and D and E’s overhead costs. This would result in
the following re-apportionment.
This approach is best used where some service cost centres provide services to other service cost centres,
but these services are not reciprocated. Example 2 considers this situation. Cost centre C serves centres
D and E, but D and E do not reciprocate by serving C. In these circumstances the costs of the service cost
centre that serves most other service cost centres should be reapportioned first. We then ‘step down’ to
the service cost centre that provides the second most service, and so on.
Example 2
Data as Example 1 apart from usage of C, D and E’s services has changed.
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Usage of service cost centres is as follows:
Cost centre A B C D E
Cost centre C
re-apportionment4,000 5,000 (10,000) 800 200
($)
Cost centre D
re-apportionment 15,600 4,160(20,800)1,040
($)
Cost centre E
re-apportionment 1,5723,668(5,240)
($)
This approach is used where some service cost centres provide services to other service cost centres,
and the service is reciprocated. In Example 3, cost centre C serves centre D, and vice versa. In reality, an
organisation may choose to ignore this reciprocal service and re-apportion overheads by using the direct
or step down approach. In Example 3, the direct approach would involve re-apportioning C’s overhead on
the basis of 40/90 and 50/90 to A and B respectively and ignoring the reciprocal service to D. D’s overheads
would be similarly reapportioned on the basis of 75/95 and 20/95.
However, if we choose to fully reflect the reciprocal services between C and D, one of two methods are
possible – the repeated distribution approach or the algebraic approach. Both are methods of solving a
simultaneous equation and should give the same result. Example 3 demonstrates both methods. In the
exam, the examiner will indicate that he wants you to use one or either of these methods by asking for a
method that ‘fully reflects the reciprocal services involved’. Practically in the Paper F2 exam, where this
topic would be examined by two-mark questions, the focus will be on the algebraic approach as repeated
distribution would be too time consuming.
- 58 -
A. Repeated distribution approach
Example 3
Data as Example 1 apart from usage of C and D’s services has again changed.
Cost centre A B C D E
Apportioned
Cost centre E
re-apportionment 1,200 2,800 (4,000)
($) (note 1)
Cost centre C
re-apportionment 4,000 5,000 (10,000) 1,000
($) (note 2)
Cost centre D
re-apportionment($) 15,750 4,200 1,050 (21,000)
Cost centre C
re-apportionment($) 420 525 (1,050) 105
Cost centre D
re-apportionment 83 22 NIL (105)
(note 3)
Total overheads($) 101,453 112,547 NIL NIL NIL
Note 2 It doesn’t really matter which of the two remaining cost centres you start with.
Note 3 On the last reapportionment, D’s overheads are apportioned on the basis of 75/95 to A and 20/95
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to B. The reciprocal service to C is ignored, as, by now, it is not material.
B. Algebraic approach
Then
A = 80,000 + 0.40 C + 0.75 D + 0.30 E
B = 100,000 + 0.50 C + 0.20 D + 0.70 E
C = 10,000 + 0.05 D
D = 20,000 + 0.10 C
E = 4,000
Finally, plugging these values into the equations for A and B, the total overhead apportioned to each of the
production cost centres is:
These results, as they should be, are quite close to the repeated distribution approach.
Cost centre V W X Y
Apportioned and
Allocated overhead ($) 6,000 8,000 4,000 10,000
The company has calculated the following usage of X and Y’s services.
Cost centre V W X Y
Use of X’s services 60% 30% NIL 10%
Use of Y’s services 80% 20% NIL NIL
How much would cost centre V’s total overhead cost be if the company used the step-down approach to
re-apportion service cost centre overhead?
A $10,400
B $10,720
C $16,400
D $16,720
The correct answer is D ($6,000 + $4,000 × 0.6 + 0.8 × ($10,000 + 0.1 × $4,000))
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4. Absorption in cost units
The total amount of overheads incurred should be absorbed into the costs of the products on a basis
selected by the organization.
(a) Unit
An organization that uses absorption costing and has two or more production cost centers can choose
between:
5. Overhead absorbed:
EXERCISE 2
A company has three production departments. Its allocated and apportioned overheads for each
department are:
Dep. A: $480,000
Dep. B: $360,000
Dep. C: $300,000
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Hours worked and direct labor costs are as follows:
Overhead will be absorbed on a direct labor hour basis in department A, a machine hour basis in
department B and as a percentage of direct labor cost in department C.
2) What should be the full production cost of a job for which the following information applies?
Solution
20000
Production O / H
B (2 x $ 20) 40
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Full Production Cost 640
EXERCISE 3
A company uses a single factory-wide absorption rate, based on direct labor hours. Its budgeted
production overheads are $840,000 and budgeted direct labor hours are 52,500 hours.
During the year, it produces a batch of 100 units of product item 1234. The batch has direct material
costs of $500 and direct labor costs are $400. the batch takes 44 hours to make. What is the full
production cost for each unit in the batch?
Solution
6. Under/over absorbed:
The total amount of overhead costs absorbed into production costs might be exceed the actual
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overhead expenditure. When this happens, there is over-absorbed overhead. (Budget exceeds)
The total amount of overhead costs absorbed into production costs might be less than the actual
overhead expenditure. When this happens, there is under-absorbed overhead. (Budget less)
EXERCISE 4
A company uses a single factory-wide absorption rate. Budgeted and actual data are as follows:
Solution
Absorption rate = $540000 / 36000 = $15/LHr
$
O / H absorbed 37500 x $15 562500
Actual O / H 555000
Over absorbed O/H 7500
EXERCISE 5
In the year the machine shop incurred $5,400 of overhead and 1,050 machine hours were worked.
Calculate the predetermined absorption rate and the overhead under or over absorbed.
Solution
- Absorption rate = $60000 / 12000 = $5 /MHr
$
O / H absorbed 1050 x $5 5250
Actual O / H (incurred ) 5400
Under absorbed 150
(a) When overheads are over-absorbed, production is charged with more overhead costs than have
actually been incurred. The over-absorbed overhead is taken to the statement of profit or loss as an
addition to profits, to offset the excess charge to production.
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(b) When overheads are under-absorbed, production is charged with less than the overhead costs that
have actually been incurred. The under-absorbed overhead is taken to the statement of profit or loss
as a charge against profits, to make up for the under-charging of costs to production.
Cost ledger: a manufacturing organization might record its costs in a set of ledger accounts, called
the cost ledger.
Only accounts it contains are those that are relevant to costing. It means the ledger not contain
accounts for bank, debtors, Non-current assets
Cost control accounts, it is for recording the matching double entry whenever the entry would be to
an account not contained in the cost ledger.
- 65 -
7.4 For manufacturing overhead
Incurred: Dr production o/h absorption Dr: WIP over-absorbed Dr: production o/h
Cr cost control a/c Cr production o/h Cr: I/S
Under-absorbed: Dr: I/S
Cr: production o/h
8. Exercise questions
1. A company uses absorption costing with a predetermined hourly overhead absorption rate. The
following situations have both occurred:
(ii) Actual hours worked were less than the planned hours.
A Situation (i) would cause overheads to be over absorbed and situation (ii) would cause overheads
to be under absorbed.
B Situation (i) would cause overheads to be under absorbed and situation (ii) would cause overheads
to be over absorbed.
2. A manufacturing company uses a machine hour rate to absorb production overheads, which were
budgeted to be $130,500 for 9,000 machine hours. Actual overheads incurred were $128,480 and
8,800 machine hours were recorded.
3. A factory consists of two production cost centres (G and H) and two service cost centres (J and K).The
total overheads allocated and apportioned to each centre are as follows:
G H J K
The work done by the service cost centres can be represented as follows:
G H J K
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Percentage of service cost centre J to 30% 70% - -
The company apportions service cost centre costs to production cost centres using a method that fully
recognizes any work done by one service cost centre for another.
What are the total overheads for production cost centre G after the reapportionment of all service cost
centre costs?
A $36792
B $46792
C $56792
D $66792
SYLLABUS CONTENT
b) Contribution
In absorption costing, fixed manufacturing / production overheads are absorbed into cost units.
Stock is valued at absorption cost
In marginal costing, fixed manufacturing / production overheads are not absorbed into cost units.
Stock is valued at marginal / variable cost. All fixed overheads, including fixed production
overheads, are treated as period costs and are charged in the statement of profit or loss.
- 67 -
1. Contribution
2. Profit statement
Sales X
Less;
Variable production cost of sales
Opening stock (marginal production cost) X
Variable production cost incurred:
Direct materials X
Direct labor X
Direct expense X
Variable production overheads X
- 68 -
X
Less: closing stock (marginal production cost) (X)
X
Variable selling and distribution costs X
Total variable cost of sales (X)
Contribution X
Less: Fixed costs
Fixed production costs X
Fixed administration costs X
Fixed selling and distribution costs X
(X)
Profit X
EXERCISE 1
$
Selling price 10
Direct materials 3
Direct wages 2
Variable overhead 1
Fixed production overhead is $10,000 per month; Production volume is 5,000 units per month.
Show profit statements for the month if sales and production is 5,000 units under: 1) absorption
costing 2) marginal costing
Show profit statements for the month if sales are 4,800 units and production is 5,000 units under:
1) absorption costing 2) marginal costing
- 69 -
Solution
The difference in profit between the two costing methods is due to the deference in stock levels between
the beginning and the end of the period.
- If opening and closing stock levels are the same, AC profit = MC profit
- 70 -
4. Exercise questions
1. A company, which uses marginal costing, has a profit of $37,500 for a period. Opening stock was 100
units and closing stock was 350 units.
A $35,700
B $36,500
C $38,500
D $39,300
2. A company produces and sells a single product whose variable cost is $6 per unit.
Fixed costs have been absorbed over the normal level of activity of 200,000 units and have been
calculated as $2 per unit.
How much profit is made under marginal costing if the company sells 250,000 units?
A $500,000
B $600,000
C $900,000
D $1,000,000
- 71 -
Chapter 8. Job, Batch And Process Costing
SYLLABUS CONTENT
a) Job costing
b) Batch costing
c) Process costing
1. Job costing
With job costing, the costs of each job are recorded on job cost cards or job cost sheets, which records all
the costs for a single cost unit, i.e. for one job. When the job is finished, the cost sheet gives the total direct
cost and overhead.
EXERCISE 1
The following information is available for Job 007, which is being produced at the request of a customer:
In accordance with company policy, the following are chargeable to each job:
- 72 -
Solution
2. Batch costing
Where a business produces a product to meet a customer’s specification (as in job costing) but where
a number of similar items ( a batch) are made for each order; or where a batch of similar items are
made, and held in stock awaiting customers’ orders.
Batch costing is very common on the engineering component industry, footwear and clothing
manufacturing industries.
Cost per unit in batch = total production cost of batch / number of units in batch
EXERCISE QUESTIONS
1. A company operates a job costing system. Job 812 requires $60 of direct materials, $40 of direct
labour and $20 of direct expenses. Direct labour is paid $8 per hour. Production overheads are
absorbed at a rate of $16 per direct labour hour and non-production overheads are absorbed at a
rate of 60% of prime cost.
A $240
B $260
C $272
D $320
3. Process costing
Process costing applies when standardized goods are produced from a series of interconnected
operations.
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examples of industries using process costing
Oil refining
Textiles
Breweries
Normal loss is the amount of loss expected from the operation of a process. This expectation is based
on past experience, and this loss is considered to be unavoidable.
Solution procedures:
EXERCISE 2
A normal loss equal to 10% of input was expected. Actual output was 900 kg. suppose the normal loss
of 100kg should be sold as scrap for $9/kg.
Solution
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3.1.2 Process costing with abnormal losses and gains
A. Abnormal loss
The extent to which the actual loss exceeds the normal loss is referred to as the abnormal loss.
The abnormal loss units equal the difference between the actual and expected output.
EXERCISE 3
A normal loss equal to 10% of input was expected. Actual output was 850 kg. Losses are sold as scrap
for $9/kg
Solution
B. Abnormal gain
The extent to which the actual loss is less than the normal loss is referred to as an abnormal gain
EXERCISE 4
A normal loss equal to 10% of input was expected. Actual output was 920 kg.
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Solution
Completed product
work-in-process product
Once processing has started on a unit of output, to the extent that it remains in an uncompleted state it
can be expressed as a proportion of a completed unit.
EXERCISE 5
A manufacturer starts processing on 1 March. In the month of March he starts work on 20,000 units of
production. At the end of March there are 1,500 units still in process and it is estimated that each is two
thirds complete. Costs for the period total $19,500.
Calculate the value of the completed units and the work-in-process at 31 March.
Solution
It is unlikely that all inputs to production will take place at the same time.
For example, materials are frequently added at the beginning of a process, whereas labor may be
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applied throughout the process.
EXERCISE 6
A manufacturer starts processing on 1 March. In the month of March he starts work on 20,000 units of
production. At the end of March there are 1,500 units still in process
Addition info:
Total $ 19,500
Solution
Cost: opening stock values are added to current costs to provide an overall average cost.
Unit: no distinction is made between units in process at the start of the period and those new units added
during the period
Procedure:
Equivalent units:
All completed units (whether they were started in the current period or were started in previous period)
and the closing WIP work done.
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Costs to be accounted for:
Opening stock values are added to current costs to provide an overall average cost
EXERCISE 7
Work in process, 1 December (15,000 units, two-fifths complete) $10,250 (work-in-process value made
up of : materials $9,000 plus conversion costs $1,250).
Calculate the values of finished production for December and work-in-process at 31 December, using
weighted average method.
Solution
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B. The FIFO method
This method distinguishes between units completed in the period that from the opening work in progress
and those new items started and completed in the period
Procedure:
Equivalent units:
Cost from opening WIP (value at the beginning of the period add conversion cost added in this
period)
Cost of the finished goods which started and completed in this period
EXERCISE 8
Work in process, 1 December (15,000 units, two-fifths complete) $10,250 (work-in-process value made
up of : materials $9,000 plus conversion costs $1,250).
Calculate the values of finished production for December and work-in-process at 31 December, using
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FIFO method.
Solution
EXERCISE 9
BLT manufactures chemicals and has a normal loss of 15% of material input.
Solution :
. Process a/c
Kg $ kg $
Material 200 1000 Normal loss 30 -
Conversion 4100 Finished goods 160 4800
Abnormal 10 300
5100 5100
Cost / unit = (1000 + 4100) / 200 x 85% = 30
EXERCISE 10
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BLT manufactures chemicals and has a normal loss of 15% of material input.
EUs of output
Total Material Conversion
Finished units 160 160 160
Abnormal loss 10 10 4
Total EUS 170 170 164
Cost (200 x 5) 1000 4100
Cost / E.U. 5.88 25
Process a/c
Kg $ kg $
Material 200 1000 Normal loss 30 -
Conversion 4100 Finished goods 160 4941
Ab. Loss 10 159 = 10x5.88
200 5100 200 5100 +4x25
EXERCISE QUESTION
1. A company operates a process costing system using the first-in-first-out (FIFO) method of valuation.
No losses occur in the process. All materials are input at the commencement of the process.
Conversion costs are incurred evenly through the process. The following data relate to last period:
Costs arising:
Materials $51,000
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Conversion $193,170
1) What was the total number of units input during last period?
A12, 000
B13, 000
C15, 000
D17, 000
2) What was the value of the closing work in progress for last period?
A$21,330
B$21,690
C$22,530
D$22,890
2. Company uses process costing to establish the cost per unit of its output. The following information
was available for the last month:
Opening stock 300 units, 100% complete for materials and 70% complete for conversion costs
Closing stock 450 units, 100% complete for materials and 30% complete for conversion costs
A 9,505 units
B 9,715 units
C 9,775 units
D 9,985 units
The nature of process costing is that the process often produces more than one product.
Joint products: two or more products separated in the course of processing, each having a
sufficiently high saleable value to merit recognition as a main product.
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1.3.1 Treatment of by products
The proceeds from the sale, less any handling and selling expenses, be applied in reducing the cost of
the main products.
EXERCISE 11
Output from a process was 1,300 kilos of the main product and 100 kilos of a by-product. Sales of the
main product were 1,000 kilos realizing $6,000, sales of the by-product realized $160 but incurred $30
distribution cost. Process costs were $5,200
Solution
$ $
Main product sales 6000
Process Cost 5200
Less: By – Product NRV (130)
5070
Less: cl. Stock 300 x 5070/1300 (1170)
Cost of sale (3900)
Profit 2100
Methods:
Physical weight
Sales value at separation point
EXERCISE 12
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Solution
Trading result
$ $ $
Sales 700
Common cost 750
Less: closing stock –A : 20x4.17 83
- B: 50 x 1.67 83(163)
Cost of sales (584)
Profit 116
4. Exercise questions
Process F Process G
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C Abnormal loss Abnormal gain
D Abnormal loss Abnormal loss
2. In a process where there are no work-in-progress stocks, two joint products (J and K) are created.
Information (in units) relating to last month is as follows:
Joint production costs last month were $110,000 and these were apportioned to joint products based
on the number of units produced.
What was the joint production costs apportioned to product J for last month?
A $63,800
B $64,000
C $66,000
D $68,200
A company operates a process costing system using the first in first out (FIFO) method of valuation.
No losses occur in the process.
The cost per equivalent unit of production for last month was $12.
A $816
B $864
C $936
D $1,800
2) What was the total value of the units completed last month?
A $10,080
B $10,320
C $10,760
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D $11,000
4. Two products G and H are created from a joint process. G can be sold immediately after split-off. H
requires further processing before it is in a saleable condition. There are no opening stocks and no
work in progress. The following data are available for last period:
Using the physical unit method for apportioning joint production costs, what was the cost value of the
closing stock of product H for last period?
A $36,400
B $37,520
C $40,264
D $45,181
5. A company uses process costing to value its output. The following was recorded for the period:
What was the valuation of one unit of output to one decimal place?
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Chapter 9. Service and Alternative Costing
SYLLABUS CONTENT
Servicing costing
1. Servicing costing
A major problem in service industries is the selection of a suitable unit for measuring the service
It is also useful in service organizations to calculate many different types of cost per unit, in order to
control costs. For this reason, many organizations have more than one type of cost unit for the service
they provide.
All the same principles of costing should be used. This means that the total cost per unit (whatever the
unit happens to be) is still made up as:
$
Direct materials X
Direct labour X
Direct expenses X
Overheads Absorbed X
TOTAL COST XX
Often, though the only direct cost will be labour. Overheads will usually make up the bulk of the cost
and are likely to be absorbed using direct labour hours.
Whatever the cost unit is, the calculation of cost per unit is as follows:
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Exercise 1
H Ltd operates a haulage business with three vehicles. The following estimated cost and performance
data is available:
During week number 26 it is expected that all three vehicles will be used, 280 tones will be loaded and
a total of 3950 kilometres traveled ( including return journeys when empty) as shown in the following
tables;
Solution:
$/km $
Petrol 0.5
Repairs 0.3
Depreciation 1.00
1.8* 3950 7110
$/week
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1600
Loading costs ( $6*280) 1680
10390
Tone-km in week 26 ( see working) 66325
( costs averaged over the outward journeys, not the return, as these are necessary, but carry on tones)
Workings:
2. Alternative costing
The information required for internal reporting is more detailed, and as such the individual product costs
are necessary. The full absorption cost is not accurate enough for planning or control purposes. The costs
have become increasingly inaccurate over time due to the following factors:
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3. Reduced significance of labour
ABC involves the identification of the factors (cost drivers), which cause the costs of an organization’s
major activities. Support overheads are charged to products on the basis of their usage of the factor
causing the overheads.
The reasons:
the absorption costing approach was used when most organisations produced only a narrow range
of products and when overhead costs were only a small fraction of total costs. Direct labour and
direct material costs accounting for the largest proportion of the costs. The value of over-/under-
absorbed overhead was not too significant.
the absorption costing approach assume that all products consume all resources in proportion to
their production volumes, to allocate too great a proportion of overheads to high volume products
and too small a proportion of overheads to low volume products.
Step 2 Identify the factors which determine the size of the costs of an activity. These are known as cost
drivers.
For example:
For those costs that vary with production levels in the short term, ABC uses volume-related cost drivers
such as labour or machine hours.
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Step 3 Collect the costs of each activity into what are known as cost pools.
Cost pool is the point where costs of activities are collected—i.e. cost centres where cost are
incurred and accumulated.
Step 4 Charge support overheads to products on the basis of their usage of the activity. (Cost pool ÷ cost
driver). A product’s usage of an activity is measured by the number of the activity which is measured by
the number of the activity’s cost driver it generates.
2.1.2. Circumstances in which activity based costing would be an appropriate approach to product
costing.
Activity based costing can be used in almost any product-costing situation. It is most useful when:
Where overhead expenditure is not driven by volume of output, but by the complexity and diversity of
operations.
For multi-product companies ABC can give more accurate product costs by more accurately reflecting
the activities performed in producing the products.
The improved product costing should allow the identification of unprofitable products and services.
ABC cost driver rates can be useful in product design. If designers are aware of the activities that
cause overhead costs they can attempt to design these features out of products.
It gives a better understanding of the causation of overheads, which should help in the control of costs.
By controlling the activities that cause cost, managers can control overheads.
ABC cost driver rates are useful in budgeting. By forecasting driver activity, managers are then able to
forecast overhead expenditure
A. Allocation of overheads
Traditional absorption costing allocates overheads to production departments. This will result in many
reapportionments of service department costs to ensure that all overheads are allocated to production
departments.
ABC system assigns overheads to each major activity. As the costs of these activities are assigned
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directly to products through cost driver rates, reapportionment of service department costs is avoided.
B. Absorption of overheads
ABC uses many cost drivers as absorption bases. (Number of orders, number of dispatches)
Target costing involves setting a target cost by subtracting a desired profit margin from a competitive
market price. A target cost may be less than the planned initial cost but it is expected to be achieved by
the time a product reaches its maturity stage of the product life cycle.
Determined the target price which customers will be prepared to pay for the product.
Deduct a target profit margin from the target price to determine the target cost
If estimated actual cost exceeds the target cost investigate ways of driving down the actual cost to the
target cost.
Upon deciding the target cost, departments need to discuss the problem in achieving the target costs. In
any case, the target cost will need to be achieved.
For existing products, the deviation in cost can be ascertained by analyzing the ‘cost gap’ before corrective
action is taken. It is important to carry out continuous cost reduction exercises to achieve the target costs.
2.2.2. Difference between Target Costing and Traditional Cost Reduction method:
Traditional Costing
Begins with market research into customer requirements followed by product specification. The companies
engage in product design and engineering and obtain prices from supplier. Engineers and the designer
will determine the product design. If the cost is too high then they will modify the design. The profit margin
will be determined by the difference between the expected selling price and the expected costs. However,
another method that is commonly used is where the cost is determined and the profit is mark-up on the
cost to determine the selling price.
Target Costing
The initial step in market research is to determine the customer requirements and product specifications,
which is similar to traditional costing. The next step is to determine the selling price and the target volume.
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Then the company determines the target profit it wants to achieve. The target cost will be the difference
between the selling price and the anticipated profits. Once the target cost been identified, value
engineering process takes place whether the target cost can be achieved. In this approach, suppliers are
also required to find ways to reduce costs as they play a critical role in making target costing viable.
Life cycle costing estimates and accumulated costs over a product’s entire life cycle in order to determine
whether the profit earned during the manufacturing phase will cover the costs incurred during the pre- and
post-manufacturing stages.
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2.3.1. Four stages of the product life cycle
Introduction. This refers to the bringing in and the bringing on of a new product. This is usually the
culmination of a period of market research and product research and development; the point at which
the product or service first comes to market. Sales are usually low and costs are high due to launch
expenses and design changes.
Once market research has assessed emerging customers’ needs and ideas are generated for new
products, the scientists and engineers will design the technical aspects of the products. Product
development takes place where the company creates features critical to customer satisfaction and
design prototypes, production processes and any special tooling required. Because 80% to 85% of a
product’s total life costs are committed at this stage, decisions made are critical because an additional
dollar spent on activities at this stage can save at least $8 to $10 on manufacturing and post-
manufacturing costs.
Growth. This is where the product takes off and its true potential begins to become apparent. Sales
rise quickly for successful products, unit costs start to decline as the firm gains experience of the
product.
Maturity. The product is now a familiar part of the market. Unit costs are low and profits are generally
high. Competition is now strong. The market generally reaches saturation during this phase and sales
growth stops. The product may be modified or improved as a means of sustaining demand.
Decline. Eventually sales begin to decline and there is over-capacity amongst suppliers. Falling sales
volume and reduced prices will eventually lead to losses and withdrawal of the product.
A. Aids decision makers to analyze critically and understand what creates the costs of product and
projects. By having an integrated perspective of costs, managers can see the big picture and manage
costs in a comprehensive fashion. For e.g., poor decisions in the design stage may lead to much
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higher costs in manufacturing and post sale service stage. A total-life-cycle-costing exercise will
enable the organization to reconsider some of these costs at the R&D stage.
B. Enhances cost control and cost reduction techniques since the organization will know the amount of
costs and at what stages these costs are committed and incurred. For e.g., some 80% to 85% of the
product’s total life costs are committed by decisions made in the R&D stage.
C. Enhance the decision making process of accepting new products or projects. A life-cycle costing
exercise enables an organization to appraise the profitability over the whole life of the product or
project than a period of time. Thus products and projects that are loss-making initially but profitable in
the long run will be accepted.
D. It also enables management to focus marketing and promotion when required- at certain critical points
of the life cycle.
Traditional management accounting control procedures have focused primarily on the manufacturing stage
of a product’s life cycle. Pre-manufacturing costs, such as research and development, design. Post-
manufacturing cost, such as disposal cost are treated period costs. Therefore they are not included in the
product cost calculations.
Total quality management (TQM) is the continuous improvement in quality, productivity and effectiveness
obtained by establishing management responsibility for processes as well as outputs. In this, every
process has an identified owner and every person in an entity operates within a process and contributes
to its improvement.
One of the basic principles of TQM is that the cost of preventing mistakes is deemed to be less than the
cost of correcting them once they occur. The aim should be therefore to get things right first time.
The process:
- Establishing standards of quality for a product or service.
- Establishing procedures or production methods.
- Monitoring actual quality.
- Taking control action when actual quality falls below standard.
The requirements of quality
Mark Lee Inman listed of quality ‘eight requirement in his article in the May 1995 ACCA Students’
Newsletter
1) Accept that the only thing that matters is the customer
2) Recognize the importance of the customers-supplier relationship, where customers include
internal customers; passing sub-standard material down to another division is not satisfactory.
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3) Move away from relying on inspecting to a predetermined level of quality and move towards
preventing the cause of the defect in the first place
4) Each employee or group of employees must be personally responsible for defect-free production
or service in their domain.
5) There must be a move away from ‘acceptable’ quality levels. Any level of defects is unacceptable
6) All departments should try obsessively to get things right first time; this applies to misdirected
telephone calls and typing errors as much as to production.
7) Quality certification programmers should be introduced
8) The cost of poor quality should be emphasized: good quality generates savings
Prevention costs - are the costs incurred in preventing the production of products that do not conform
to specification.
They include the cost of preventive maintenance, quality, training and the extra cost of acquiring higher
quality materials.
Appraisal costs - are the costs incurred to ensure that materials and products meet quality standards.
They include costs of inspecting purchased parts, work in progress and finished goods, quality audit and
filed test.
Internal failure costs - are costs arising within the organization of failure to achieve the quality
specified. They are discovered before the product is delivered and include ‘down time’ and scrap costs,
repair, stoppage caused by defects
External failure costs - are costs incurred when the products or services fail to conform to
requirements or satisfy customers’ needs after they have been delivered.
They include the costs of handling customer complaints, warranty replacement, repair of returned product
etc. Costs within this category can have a dramatic impact on future sales.
3. Exercise questions
1. A hotel calculates as number of statistics including average cost per occupied bed per day. The
following information is provided for a 30- day period.
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Total cost of laundering in period $22500
The average cost per occupied bed per day for the period is:
A $9.9 B $9.88
C $7.2 D $8.17
2. The following statements have been made about activity based costing:
i. ABC recognizes that complexity of manufacturing as increased by using multiple cost drivers
ii. ABC focuses attention on the nature of cost behavior and attempts to provide meaningful product
costs.
iii. The determination and use of cost drivers helps to measure and improve the efficiency and
effectiveness of support departments
iv. ABC works well with the modern manufacturing method just-in-time (JIT)
3. Which of the following organizations should not be advised to use service costing?
A Hotel
B Distribution service
C Clothing manufacturer
D Training firm
4. Which one of the following ideas is NOT usually associated with a TQM environment?
A Continuous improvement
B Right first time
C Reduced customer service
D Zero defect
PART C BUDGETING
SYLLABUS CONTENT
b) Time series
c) Moving average
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1. The planning and control cycle
Step 1
Identify objectives
Step 3
Evaluate each strategy
Planning
Process
Choose alternative courses of action Step 4
Control
Process
Respond to divergences from plan Step 7
2. Statistical techniques
Data used in forecasting may need to be adjusted to take account of any movements in prices that may
have occurred, usually as a result of inflation.
We remove the effects of price movements by adjusting figures to a common basis using index numbers.
Index numbers show how prices have changed compared with the price at a certain point in time, the
base period. The base period will have an index number of 100.
Step 1. Remove the effects of price movements by adjusting the data to a common basis, usually to the
price level of the base period.
Step 3 Adjust the forecast produced in step 2 to take account of price movements.
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Example
Using the average price level index, adjust the following costs so that they can be used for forecasting.
Solution
Year Cost Adjusted cost
$ $
2000 145000 X100/100 145000
2001 179200 X100/112 160000
2002 209100 X100/123 170000
2003 201600 X100/144 140000
2004 248000 X100/160 155000
An index is a measure, over time, of the average changes in the value (price or quantity) of a group of
items relative to the situation at some period in the past.
- A price index measures the change in the money value of a group of items over time.
- A quantity index ( or volume index ) measures the change in the non-monetary values of a group
of items over time.
The fixed base method, a base year is selected (index is 100), and all subsequent change are
measured against this base. Only used if the basic nature of the commodity is unchanged over time.
The chain base method, changes are calculated with respect to the value of the commodity in the
period immediately before. Used for if the basic nature of the commodity is changed over time.
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Example:
The price of commodity was $2.70 in the 20x0, $3.11 in 20x1, $3.42 in 20x2 and $3.83 in 20x3.
Construct both a chain base index and a fixed base index for the years 20x0 to 20x3 using 20x0 as
the base year.
Solution:
The chain base relatives show the rate of change in prices from year to year, whereas the fixed base
relatives show changes relative to prices in the base year.
This method of weighting involves multiplying each component value by its corresponding weight and
adding these products to form an aggregate. This is done for both the base period and the period in
question. Laspeyre, and Paasche indices are special cases
Use weights from the base period and are sometimes called base weighted indices.
A laspeyre price index uses quantities consumed in the base period as weights.
∑PnQ0
Laspeyre price indices = x100
∑P0Q0
A laspeyre quantity index uses prices from the base period as weights.
∑P0Qn
Laspeyre quantity indices = x100
∑P0Q0
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2.3.2 Paasche indices use current time period weights. In other words the weights are changed
A Paasche price index uses quantities consumed in the current period as weights.
∑PnQn
Paasche price index = x100
∑P0Qn
A Paasche quantity index uses prices from the current period as weights.
∑PnQn
Paasche quantity indices = x100
∑PnQ0
Example:
A baker has listed the crude material he used and their price, in 2013 and 2014, as follows.
Required:
Calculate the following quantity indices for 2014(with 2013 as the base year).
A Laspeyre index
A Paasche index
Laspeyre Paasche
Q0 P0 Qn Pn P0Q0 P0Qn PnQn PnQ0
Milk 4 0.9 5 1.2 3.6 4.5 6 4.8
Eggs 3 1.9 4 0.98 5.7 7.6 3.93 2.94
Flour 2 0.7 3 1 1.4 2.1 3 2
Sugar 5 1.1 4 1.14 5.5 4.4 4.56 5.7
16.2 18.6 17.49 15.44
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2.3.3 Fisher indices
This index is found by taking the geometric mean of the Laspeyre index and the Paasche index
There are four components: trend, seasonal variations, cyclical variations and random variations.
Examples:
The trend is the underlying long-term movement over time in the values of the data recorded.
Seasonal variations are short-term fluctuations in the recorded values, due to different circumstances,
which affect results at different times of the year, on different days of week, at different times of days or
whatever.
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Examples: sales of ice cream will be higher in summer than winter
It is fluctuations, which take place over a longer time period than seasonal variations. It may take several
years to complete the cycle.
These may be caused by unforeseen circumstances, such as a change in the government of the country,
a war etc. They are of non-recurring nature.
The principle is to eliminate the variations around the trend by averaging, leaving a line (which may or may
not be linear) through the centre of the data.
1. Find a one-year moving total, placing each total in the centre of the group of periods it represents. In
our example this will be a 4-point moving total, placed between the middle two numbers.
2. Divide each total by the number of periods to find the moving average. In our example this will mean
dividing by 4.
3. If the moving average is between actual periods, as in our example, we need to find the centered
moving average to enable comparison with the actual. This centered moving average is now the
TREND. Hence, a second two point moving total must be calculated It is important that each trend
figure relates to an actual period.
4. Note: if there is an even number of results (e.g. 4 quarters per annum), then Step 3 is necessary.
However, if there are an odd number of results (e.g. 5 days per week), then the second centered
moving average (step 3) is not necessary.
Example:
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3.6 Evaluating The Seasonal Variations
The seasonal variations may be expressed in absolute terms or proportional terms. This leads to two time
series models.
This is based upon the idea that each actual result is made up of two influences
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Now calculate the average 'Actual - Trend' for each quarter. This is a task that should be carried out by
drawing up a second working table (see below)
Our estimate of the seasonal or quarterly variation is almost complete, but there is one more important
step to take. Variances around the basic trend line should cancel each other out, and add up to zero. At
the moment, they do not. We therefore spread the total of the variations across the four quarters so
that the final total of the variations sum to zero.
An additive model has the important drawbacks that when there is a steeply rising or a steeply
declining trend, the moving average trend will either gets ahead of or fall behind the real trend.
The alternative is to use the multiplicative model whereby each actual figure is expressed as a proportion
of the trend
For example, if, in one particular period the underlying trend was known to be $10,000 and the seasonal
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variation in this period was given as +12%, then the actual result could be forecast as;
$10,000×(1+12%) = $11,200
The multiplicative seasonal variations are calculated in a similar manner, but the variations are proportions.
Instead of finding A - T, we find A/T, and then average the results as above. For example, for quarter 1, A/T
is 18/26.5= 0.68 in year 2, and 14/27.5 = 0.51 in year 3. The average of these is 0.6; the variations below
have been rounded to one decimal place for simplicity, so that the seasonal variations are approximately:
Quarter 1: 0.6
Quarter 2: 0.6
Quarter 3: 1.2
Quarter 4: 1.6
4. Forecasting
The model used in the analysis of the historical numbers should be used to perform the forecast.
The trend may be forecast by extrapolating the trend line on the time series graph.
Forecasting the quarterly sales in Year 4, using both the additive and then the multiplicative model is as
follows:
Additive Model
Quarter Forecast of Trend Seasonal Variation Forecast of Sales
(From graph)
1 30.5 -11 19.5
2 31.0 -12 19
3 31.5 6 37.5
4 32.0 16 48
Multiplicative Model
Quarter Forecast of Trend Seasonal Variation Forecast of Sales
(from graph)
1 30.5 0.6 18.3
2 31.0 0.6 18.6
3 31.5 1.2 37.8
4 32.0 1.6 51.2
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The accuracy of the forecasts will depend, to some extent, on the size of the residual variations which
have been ignored. Large residual variations will mean the forecasts are fairly inaccurate but small residual
variations should mean fairly accurate forecasts.
5. Forecasting problem
- the trend and seasonal variations cannot be guaranteed to continue in the future
There are a number of changes that make it difficult to forecast future events
- environmental changes
- technological changes
- technological advances
- social changes
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Chapter 11. Budgeting
SYLLABUS CONTENT
a) Basic knowledge
b) Functional budget
c) Master budget
e) Flexible budget
1. Budgeting
A budget is a quantified plan of action for a forthcoming accounting period. A budget is a plan of what
the organization is aiming to achieve and what is has set as a target, whereas a forecast is an estimate
of what is likely to occur in the future
1.1. The objectives of a budgetary planning and control system are as follows
(purposes)
To compel planning
To coordinate activities
The budget manual is a collection of instructions governing the responsibilities of persons and the
procedures, forms and records relating to the preparation and use of budgetary data.
E.g.: an explanation of the objectives of the budgetary process, organizational structures, principle budgets
etc.
The budget committee is the coordinating body in the preparation and administration of budgets. The
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coordination and administration of budgets is usually the responsibility of a budget committee.
The principal budget factor should be identified at the beginning of the budgetary process, and the
budget for this is prepared before all the others.
The first task in the budgetary process is to identify the principal budget factor. This is also known as
the key budget factor or limiting budget factor.
Therefore, the principal budget factor is the factor, which limits the activities of an organization.
Sales demand
Machine capacity
Once this factor is defined then the remainder of the budgets can be prepared. For example, if sales are
the principal budget factor then the production manager can only prepare his budget after the sales budget
is complete.
Management may not know what the limiting budget factor is until a draft budget has been attempted.
The first draft budget will therefore usually begin with the preparation of a draft sales budget.
2. Budget preparation
Functional budgets
Functional budgets (or departmental budget) are the budgets for the various functions and departments of
an organization. They include production budgets, marketing budgets, sales budgets, personnel budgets,
purchasing budgets and research and development budgets.
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2.1. The Sales Budget
We have already established that, for many organizations, the principal budget factor is sales volume.
The sales budget is therefore often the primary budget from which the majority of the other budgets
are derived.
Before the sales budget can be prepared a sales forecast has to be made.
EXERCISE 1
A company makes two products –x and y. sales for next year are budgeted to be 5000 units of x and
1000 units of y. planned selling prices are $95 and $130 per unit respectively
Solution
1. Total X Y
Sales unit 6000 5000 1000
@95 @130
Sales value $605000 $475000 $130000
Are simply the numbers of hours multiplied by the labor rate per hour
EXERCISE 2:
N ltd manufactures three products, the expected production levels for each product are shown below
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Product 1 product 2 product 3
Budgeted production in units 2700 4100 2800
Two types of labor are used in producing the three products. Standard times per unit and expected
wage rates for the forthcoming year are shown below:
Product 1 product 2 product 3
Hours per unit
Skilled labor 3 1 3
Semi-skilled labor 4 4 2
Skilled labor is to be paid at the rate of $9/hour and semi-skilled labor at the rate of $6/hour.
Required:
a) The number of hours of skilled labor required is? The cost of this labor is $?
b) The number of hours of semi-skilled labor required is? The cost of this labor is $?
Solution
Skilled Semi-skilled
Product 1 Hrs (3 x 2700) 8100 (4 x 2700) 10800
Product 2 Hrs (1 x 4100) 4100 (4 x 4100) 16400
Product 3 Hrs (3 x 2800) 8400 (2 x 2800) 5600
Labor budget (Hrs) 20600 32800
Labor rate per Hrs $9 $6
Labor budget ($) 185400 196800
If the principal budget factor were production capacity then the production budget would be the first to
be prepared. To assess whether production is the principal budget factor, the production capacity
available must be determined, taking account of a number of factors.
Available labor, including idle time, overtime and standard output rates per hour
Maximum machine hours available, including expected idle time and expected output rates per
machine hour
It is, however, normally sales volume that is the constraint and therefore the production budget is usually
prepared after the sales budget and the finished goods inventory budget.
The production budget will show the quantities and costs for each product and will tie in with the sales
and inventory budgets. This coordinating process is likely to show any shortfalls or excesses in capacity
at various times over the budget period.
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If there is likely to be a shortfall then consideration should be given to how this can be avoided.
Possible options include the following.
A significant shortfall means that production capacity is, in fact, the limiting factor.
If capacity exceeds sales volume for a length of time the consideration should be given to product
diversification, a reduction in selling price and so on.
EXERCISE 3:
X ltd. manufactures two products, S and T, which use the same raw materials, D and E. one units of S
uses 3 liters of D and 4 kilo of E. one unit of T uses 5 liters of D and 2 kilo of E. A liter of D is expected to
cost $3 and a kilo of E $7
Budgeted sales for 20x2 are 8000 units of Sand 6000 units of T; finished goods in inventory at 1 January
20x2 are 1500 units of S and 300 units of T, and the company plans to hold inventories of 600 units of
each product at 31 Dec 20x2
Inventories of raw material are 6000 liters of D and 2800 kilo of E at 1 Jan, and the company plans to hold
5000 liters and 3500 kilo respectively at 31 Dec 20x2.
The warehouse and stores managers have suggested that a provision should be made for damages and
deterioration of items held in store, as follows
SOLUTION
To calculate material purchase requirements. It is first of all necessary to calculate the budgeted
production volumes and material usage requirements
Product S Product T
Units Units Units Units
Sales 8000 6000
Provision for loss 50 100
Closing inventory 600 600
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Less: Opening inventory (1500 ) (300)
(De)/increase in inventory (900) 300
Production budget 7150 6400
Material D Material E
Liters Liters kg kg
Usage requirements
To produce 7150 units of S 21450 28600
To produce 6400 units of T 32000 12800
Usage budget 53450 41400
Provision for losses 500 200
53950 41600
Closing inventory 5000 3500
Less: Opening inventory (6000) (2800)
(De)/increase in inventory (1000) 700
Material purchases budget 52950 42300
Material D Material E
Cost pr unit $3 per liter $7 per kg
Cost of material purchases $158850 $296100
Total purchases cost $454950
A non-current asset is an asset which is acquired and retained in the business with a view to ensure
profits and not merely turning into cash. It is normally used over more than one accounting period.
Non-current assets are to be distinguished from inventories, which we buy or make in order to sell.
Inventories are current assets and a part of the working capital of a business, along with cash and
amounts owned to us by customers.
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Depreciation charges are expenses in the income statement.
Capital expenditure on non-current assets results in the appearance of a non-current asset in the
balance sheet of the business.
(a) For the purpose of the trade of the business. This includes expenditure classified as selling and
distribution expenses, administration expenses and finance charges.
Nearly all but the smallest organizations keep an asset register. This is a listing of all non-current assets
owned by the organization. An asset register is part of the internal control system of an organization
and its main purpose is to ensure the proper monitoring and control of the organization’s non-current
assets. Most asset registers will be computerized.
Authorization
Capital expenditure over a certain amount must normally be authorized by directors of a company and
major projects will be noted in the minutes of board meetings. Generally a document called a capital
expenditure authorization form will be used.
A disposal over a certain amount must also be authorized, with the reason for disposal being specified.
The reason will generally be that the asset has become obsolete or worn out.
The asset register must be reconciled to the nominal ledger to make sure that all additions, disposal
and charges have been posted.
The capital expenditure budget is essentially a non-current assets purchase budget, and it will form
part of the longer-term plan of a business enterprise. A detailed capital expenditure budget should be
prepared for the budget period but additional budgets should be drawn up for both the medium and
long term.
As a part of the overall budget coordination process, the capital expenditure budget must be reviewed
in relation to the other budgets.
The costs which should be used for decision making are often referred to as relevant costs. Relevant
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costing is also used in long-term decision making and investment decisions which we will look at in the
next chapter.
Differential costs are the differences in total costs or revenues between two alternatives
Opportunity cost is the value of a benefit sacrificed in favor of an alternative course of action. It may
involve incurring a cost or losing revenue that could be obtained from an alternative course of action
avoidable and unavoidable costs :If a cost can be avoided, it is a relevant costs, because a decision
can be taken that will prevent the cost from occurring. If a cost is unavoidable, it cannot be relevant
to a decision, because it will be incurred anyway.
Directly attributable fixed costs are relevant costs, general fixed overheads are not
When all the functional budgets have been prepared, they are summarised and consolidated into a master
budget which consists of the budgeted income statement, budgeted statement of financial position and
cash budget and which provides the overall picture of the planned performance for the budget period.
A cash budget is a detailed budget of cash inflows and outflows incorporating both revenue and capital
items.
Example
The following is the forecast of sales and expenditure from July 2009 to January 2010 for ABC Co..
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November 75,000 6,000 3,600 9,000
December 63,000 4,200 3,600 9,600
January 66,000 6,000 3,600 9,600
Additional data:
1. Gross selling prices are calculated by adding 25% to the purchase price of goods.Sufficient goods are
purchased and delivered each month to enable all the following month’s sales to be made from these
purchases.
2. Normal credit terms for purchases are payment in the month after the month of delivery.
3. General expenses are paid one month after they are incurred.
5. Salaries and postages are paid in the month in which they are incurred.
6. 60% of sales are made for cash. 40% of sales are made to retailers after allowing a trade discount of
10% of the selling price. These sales are paid for on average two months after delivery.
Required:
(a) Prepare monthly cash forecasts for the months October, November and December 2009.
(15 marks)
(b) Define a cash budget and its uses to the management. (5 marks)
(Total : 20 marks)
Answer:
(a)Cash budget for October – December 2009
October November December
Balance b/d 60000 21000 11760
Add: Amount Receivable during the month
Cash Sales 48600 45000 37800*
Debtors 16200 23760 29160
Total amount available of payment 124800 89760 79320
Less: Amount Payable during the month
Creditors for goods 64800 60000 50,400
General expenses 4200 5400 6000
Rates 24000
Postages 3600 3600 3600
Salaries 7200 9000 9600
Total Payment 103800 78000 69600
Closing Balance 21000 11760 91320
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(b) Expected Revenues and expected expenditures.
(i) Management is able to foresee surplus funds in certain periods; such funds may then be
invested profitably elsewhere
(ii) Management is able to foresee deficiency or short fall in certain months, loans and
overdraft facilities may be arranged in advance to cover these particular months
(iv) The management has a time frame to arrange for loans etc.
A. Cash may be obtained from a transaction, which has nothing to do with profit or loss. For example:
an issue of shares or loan stock.
D. Profit is sales minus the cost of sales. Operating cash flow is the difference between cash received
and cash paid from trading.
Cash forecasting is vital to ensure that sufficient funds will be available when they are needed to
sustain the activities of an enterprise, at an acceptable cost.
Cash flow forecasts provide an early warning of liquidity problems and funding needs.
A company must know when it might need to borrow and for how long, not just what amount of funds
could be required.
Banks often expect business customers to provide cash forecasts as a condition of lending.
A. Fixed budget
A fixed budget is a financial expression of a plan of action based upon a single activity level.
B. Flexible budgets
A flexible budget is a budget, which, by recognizing different cost behaviour patterns, is designed to
change as volumes of output change.
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It recognizes that different costs behave in different ways with respect to volume.
It improves the quality of control information as it facilitates a comparison of like with like. Variances
calculated against a flexed budget will give more meaningful control information than those against
a fixed budget.
It allows managers to forecast revenues, costs and profits at different activity levels and forces
them to think about cost behaviour.
a fixed budget will not change with the level of activity. A flexible budget will change by adjusting
expected total costs for the level of production achieved.
Fixed budgets are useful at the planning stage as they provide a common ground for the
preparation of all the many types of budget.
A flexible budget may be needed at the planning stage to complement the master budget. During
the period the flexible budget may then be updated to the actual level of activity and the results
compared. So it can assist management control by providing more dynamic and comparable
information.
Flower budgeted to sell 200 units and produced the following budget
$ $
Sales 71400
Variable costs
Labor 31600
Material 12600
44200
Contribution 27200
Fixed costs 18900
Profit 8300
Actual sales turned out to be 230 units, which were sold for $69000. Actual expenditure on labor was
$27000 and on material $24000. Fixed costs totaled $10000
Required: prepare a flexible budget that will be useful for management control purposes.
Solution
Budget Budget flexed budget actual variance
200 units per unit 230 units 230 units
$ $ $ $ $
Sales 71400 357 82110 69000 13110 A
Variable costs
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Labor 31600 158 36340 27000 9340 F
Material 12600 63 14490 24000 9510 A
Contribution 27200 136 31280 18000 13280 A
Fixed costs 18900 18900 10000 8900 F
Profit 8300 12380 8000 4380 A
4. Spreadsheet
A spreadsheet is an electronic piece of paper divided into rows and columns. The intersection of a row
and a column is known as a cell.
--- Text
--- Values
--- Formulae
A. Advantages of spreadsheets
Spreadsheets make the calculation and manipulation of data easier and quicker
B. Disadvantages of spreadsheets
Data can be accidentally changed (or deleted) without the user being aware of this occurring.
Errors in design, particularly in the use of formulae, can produce invalid output.
Due to the complexity of the model, these design errors may be difficult to locate.
Security issues
5. Budgetary control
Most variable costs within a department are thought to be controllable in the short term because
managers can influence the efficiency with which resources are used, even if they cannot do anything
to raise or lower price levels.
A cost which is not controllable by a junior manager or supervisor might be controllable by a senior
manager.
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A cost which is not controllable by a manager in one department may be controllable by a manager
in another department.
Some of costs are non-controllable, such as increases in expenditure items due to inflation.
Budgets are one important way of influencing the behavioral of managers within an organization. It is
very easy for the budgetary process to cause dysfunctional activity. For example, if junior management
believe that a budget imposed upon them is unattainable, their aim may well be to ensure that the budget
is not achieved, thereby proving themselves to be correct. This needs to be avoided, and therefore an
understanding of the behavioral aspects is necessary.
6.1 Motivation
Motivation is the need to achieve a selected target or objective and the resulting drive and
determination that influence actions directed towards the selected target.
– If a budget or target is set at a too easy a level it is unlikely to encourage budget holders to achieve
their full potential. Although they may achieve the target set, this may not be their best possible
performance.
– On the other hand a budget that is set at a very challenging level may be seen as too difficult and
dissuade budget holders from trying at all, resulting in very poor actual performance.
– Ideally the targets included in budgets should fall between the two extremes. They should be
challenging enough to encourage budget holders to work hard in order to achieve them, whilst not
being seen as too difficult, so as to avoid demotivation.
Targets will assist motivation and appraisal if they are at the right level. Not too difficult, as this will
demotivate staff, not too easy, as managers are unlikely to strive for optimal performance.
A budget set to maximize performance is likely to create an adverse variance. This will need to be
managed carefully and central management in their own planning must accept that the budget is unlikely
to be achieved.
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Targets should be:
Communicated in advance
Participative/bottom-up budget is a budget system in which all budget holders are given the opportunity
to participate in setting their own budgets.
In this approach, budgets are developed by lower-level managers who then submit the budgets to their
superiors.
Budget holders have experience of the day-to-day running of the business. Their knowledge can help
to ensure that budget targets are realistic.
Having a detailed knowledge of day-to-day working practices and problems,budget holders are often
best placed to suggest innovations to processes.
Input to target setting encourages greater commitment to budgets as the budget are then perceived
to be fair. This lead to improved goal congruence.
As well as communication, participant itself can motivate budget holders; they may feel their job is
more important, which fosters self-esteem.
Budget holders may be less resistant to change since they have had a hand in the decision-making
process.
Senior management may lose some control of the business caused by delegating decision-making to
local managers.
Junior managers may be less familiar with the company’s strategic plan and therefore may make
decisions that are not in line with company strategy.
Junior managers may take the opportunity to build ‘slack’ (padding) into their budgets, resulting in
reduced profitability.
Depending upon the relative abilities and experience of senior and junior managers participation could
be argued to produce poor quality decisions.
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– It could slow down budget preparation.
A top down approach to budgeting involves preparation of budgets by senior managers without giving
the ultimate budget holder an opportunity to participate in the budgeting process. These budgets are then
passed down to (imposed upon) budget holders.
It should lead to tactical decisions that are in line with the overall strategic plan (goal congruence).
It reduces the opportunity for junior managers to build ‘slack’ (padding) into budgets.
Depending upon the abilities and experience of senior and junior managers it could be argued to
produce better quality decisions.
Disadvantages:
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Chapter 12. Methods of project appraisal
SYLLABUS CONTENT
c) NPV
d) IRR
The payback period is the time taken for the initial investment to be recovered in the cash inflows from the
project.
(c) Its use will tend to minimize the effects of risk and help liquidity, because greater weight is given to
earlier cash flows, which can probably be predicted more accurately than distant cash flows.
(c) It ignore any cash flows that occur after the project has paid for itself
A more scientific method of investment appraisal is the use of discounted cash flow (DCF) technique.
2. Interest
Simple Interest
Compound Interest
An effective annual rate of interest is the corresponding annual rate when interest is compounded at
intervals shorter than a year.
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Interest may be compounded daily, weekly, monthly or quarterly.
For example, $10000 invested for 5 years at an interest rate of 2% per month will have a final value of
$10000 x (1+ 0.02)60 = $32810. notice that n relates to the number of periods ( 5years x 12 months) that r
is compounded
The non-annual compounding interest rate can be converted into an effective annual rate of interest. This
is also known as the APR (annual percentage rate) which lenders such as banks and credit companies
are required to disclose.
Formula
(a) 1.5% per month, compound(b) 4.5% per quarter, compound(c) 9% per half year, compound
Solution
A nominal rate of interest is an interest rate expressed as a per annum figure although the interest is
compounded over a period of less than one year. The corresponding effective rate of interest is the annual
percentage rate (APR) sometimes called the compound annual rate, CAR
Example:
A building society may offer investors 10% per annum interest payable half-yearly. If the 10% is a nominal
rate of interest, the building society would in fact pay 5% every six months, compounded so that the
effective annual rate of interest would be
Similarly, if a bank offers depositors a nominal 12% per annum, with interest payable quarterly, the effective
rate of interest would be 3% compound every three months, which is
Summary
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---- The nominal rate is the interest rate expressed as a per annum figure, e.g. 12% pa nominal even
though interest may be compounded over periods of less than one year
---- Equivalent annual rate (the rate per day or per month adjusted to give an annual rate ) = effective
annual rate
---- Effective annual rate= annual percentage rate (APR) = compound annual rate (CAR)
The value of an investment after several years which earns compound interest is:
S=P(1+r)^n
Where
Nominal rates of interest are rates of interest expressed in money terms. For example, if interest paid
per annum on a loan of $1,000 is $150, the rate of interest would be 15%. The nominal rate of interest
might also be referred to as the money rate of interest, or the actual money yield on an investment.
The real rate of interest is a measure of the increase in the real wealth, expressed in terms of buying
power, of the investor or lender. Real rates of interest are lower than nominal rates when there is price
inflation.
DSF can be used in either of two ways: the net present value method (PV) or the internal rate of return
(IRR).
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(b) Calculate the present value of future cash benefits from the project
(c) Compare the present value of costs with the present value of benefits
(d) NPV is positive or negative
Calculation:
3.1.1 Simple PV
3.1.2 Annuity
Annuities are an annual cash payment or receipt which is the same amount every year for a number
of years.
What is the present value of $2000 costs incurred each year from years 3 to 6 when the cost of capital is
5%
Solution
We need to take the annuity factor for years 1 to 6 and deduct the annuity factor for years 1 to 2. This will
give us a factor for years 3 to 6 only
3.1.3 Perpetuity
An investment will produce an annual return of the $1500 in perpetuity with the first receipt starting in 3
years’ time. What is the present value of the perpetuity discounted at 8%?
Solution
Step 1 calculate the future value of the income one year before the first receipt is due (year 2)
$1500/0.08=$18750
PV = $18750 x 0.857=$16068.75
M has recently won a competition where he has the choice between receiving $5000 now
or an annual amount forever starting now (i.e. a level perpetuity starting immediately). The
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interest rate is 8% per annum.
Adv. of NPV:
(c) It is based on cash flows which are less subjective than profit
Disadvantage:
(b) For simplicity, cash flows are sometimes all assumed to occur at year ends: this assumption may
be unrealistic
The internal rate of return technique uses a trial and error method to discover the discount rate which
produces the NPV of zero. This discount rate will be the return forecast for the project.
If a project earns a higher rate of return than the cost of capital, it will be worth undertaking (and its
NPV would be positive). If it earns a lower rate of return than the cost of capital, it is not worthwhile
(and its NPV would be negative).
IRR=A+[a/(a-b) ×(B-A)]
Where
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Adv. of the IRR:
(a) It takes into account the time value of money, unlike other approaches such as payback
(b) Results are expressed as a simple percentage, and are more easily understood
Disadvantage:
(a) Projects with unconventional cash flows can produce negative or multiple IRRs
(b) IRR may be confused with ARR or ROCE, since all give answers in percentage terms
(c) It may give conflicting recommendations with mutually exclusive projects because the result is
given in relative terms (percentage)
Interest rate of return is an extrapolation based on cash flow analysis. It takes account of the time value
of money.
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PART C EXERCISE QUESTIONS
B A monthly budget which is changed to reflect the number of days in the month.
C A budget which shows sales revenue and costs at different levels of activity.
DA budget that is updated halfway through the year to incorporate the actual results for the first half of
the year.
Statement (1): An important task of a budget committee is to ensure that budgets are properly
coordinated.
Statement (2): A budget manual is the document produced at the end of the budget setting process.
3 A company manufactures and sells one product which requires 8 kg of raw material in its
manufacture. The budgeted data relating to the next period are as follows:
Units
Sales 19,000
Opening inventory of finished goods 4,000
Closing inventory of finished goods 3,000
Kg
Opening inventory of raw materials 50,000
Closing inventory of raw materials 53,000
What is the budgeted raw material purchases for next period (in kg)?
A 141,000 B 147,000
C 157,000 D 163,000
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C A factor which limits the activities of an organisation.
6 Six years ago material M cost $10 per kg and the price index most appropriate to the cost of
material M was 130. The same index show stands at 510
What is the best estimate of the current cost of material M per kg?
A $2.55
B $29.23
C $39.23
D $51.00
i. Trend
ii. Seasonal variation
iii. Cyclical variation
A i and ii
B i and iii
C ii and iii
D i, ii and iii
9 Under which of the following circumstances would a multiplicative model be preferred to an additive
model in time series analysis?
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C When a model easily understood by non- accountants is required
11 Which one of the following steps of the planning and control cycle is part of the control process?
D Identify objectives
12 Which one of the following would probably not be contained in a budget manual?
B Specimen reports
13 Which one of the following tasks would usually be carried out first in the budgetary planning
process?
A Marketing budget
B Sales budget
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C Cash budget
D purchasing budget
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PART D STANDARD COSTING
SYLLABUS CONTENT
d) Variable OH variances
e) Fixed OH variances
f) Sales variances
h) Reconciliation
1. Standard costing
Standard costing is a method of cost accounting which incorporates standard costs and variances into the
ledger accounts. The principal purpose of running a standard costing system is as follows
In order to prepare budgets we need to know what an individual unit of a product or service is expected
to cost.
Standard costs represent ‘target’ costs and they are therefore useful for planning, control and
motivation.
As well as being the basis for preparing budgets, standard costs are also essential for calculating
and analyzing variances.
Variances provide ’feedback’ to management indicating how well. Or otherwise, the company is
doing.
Standard costs also provide an easier method of accounting since it enables simplified records to be
kept.
A standard cost may be computed on either a marginal cost basis, including only variable costs, or
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under absorption costing.
Basic standard – a standard established for use over a long period form, which a current standard
can be developed.
Current standard – Standards established for use over a short period of time, related to current
conditions.
Ideal standard – a standard which can be attained under the most favourable conditions, with
no allowance for normal losses, waste and machine downtime.
Attainable standard – a standard, which can be attained if a standard unit of work is carried out
efficiently, a machine properly operated or materials properly used. Allowances are made for
normal losses, waste and machine downtime.
2. Variances
A. A variance is the difference between planned, budgeted, or standard cost and the actual cost incurred.
When actual results are better than expected results, it is a favourable variance (F).
When actual results are worse than expected results, it is an adverse variance (A).
B. Variance analysis uses standard costs for budgetary control purposes; the standard is compared to
the actual result - the difference being the variance. The analysis provides the following information:
Variances are calculated separately for each cost element in order that a detailed knowledge of where
the budget is (and is not) being achieved is built up.
The total of all variances will provide reconciliation between Budgeted and Actual Profit (or
Contribution or cost).
Managers may be provided regular feedback of how they are achieving against budget.
Material price variance = Actual materials bought should cost - Did cost
Material usage variance = (Actual output produced should use -Did use) × Standard price
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2.2 Direct labor cost variances
Labor rate variance = Actual hours worked should cost- Did cost
Labor efficiency variance = (Actual output produced should take- Did take) ×Standard rate
Variable overhead expenditure variance = Actual hours worked should cost - Did cost
Variable overhead efficiency variance = (Actual output produced should take - Did take )×
standard rate
Fixed overhead volume variance = (Budget production volume in standard hours - Actual production
volume in standard hours) × standard fixed overhead rate
Efficiency variance = (standard hrs worked for actual production - actual hrs worked) × absorption rate
Sales price variances = Actual sales units × ( Budget price - Actual price)
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2.5.2 Sales volume variances
(Budget sales units - Actual sales units) × standard profit per unit (Absorption costing)
2.6.1 Total efficiency variance = (standard paid hrs- actual paid hrs) × hour rate
2.6.2 Productive efficiency variance = (standard productive hrs - actual productive hrs) ×
2.6.3 Idle time variance = (expected idle time - actual idle time) × adjusted hour rate
Overhead expenditure variances ought to be traced to the individual cost centres where the variances
occurred
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2.8 Interrelationships between variances
1. Reliability of the figures. Firstly we need to be certain that the figures are accurate. Mistakes in
calculating budget figures or in recording actual costs and revenues could lead to variances being
reported where no problem actually occurs.
2. Materiality. The size of the variance might indicate the scale of the problem and the potential benefits
from correcting the problem.
3. Possible interdependence of variances. Sometimes a variance in one area will be related to a variance
in another. For example, a favourable raw material price variance from buying lower grade material
may cause an adverse labour variance because of difficulties in working the lower grade material.
These two variances would need to be considered jointly before making an investigation decision.
4. The inherent variability of the cost or revenue. Some costs are by nature quite volatile (for example oil
prices) and variances would not be surprising. Other costs such as labour are far more stable and
even a small variance may indicate a problem.
5. Adverse or favourable. Adverse variances tend to attract most attention as they indicate problems;
however, there is an argument for investigating favourable variances so that we can learn from our
successes.
6. Trends in variances. One adverse variance may be caused by a random event. A series of adverse
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variances usually indicates that the process is out of control.
7. Controllability/probability of being able to correct. If a cost or revenue is outside our control (e.g. world
market price of a raw material) then there is little point in investigating its cause.
8. Costs and benefits of correction. If the cost of correcting the problem is likely to be higher than the
benefit then there is little point in investigating.
A. Reconcile the standard cost of actual production with its actual cost
$
Standard costs of actual production X
Variance (plus ‘A’, less ‘F’) X
Actual costs X
B. Reconcile the actual cost with the standard cost of actual production
$
Actual costs X
Variance (plus ‘F’, less ‘A’) X
Standard costs of actual production X
3. Operating statements
Cost variances F A
$ $
Material price
Material usage
Labor rate
Labor efficiency
Labor idle time
Variable overhead expenditure
Variable overhead efficiency
Fixed overhead expenditure
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Fixed overhead efficiency
Fixed overhead capacity
$ $
Budgeted profit XXX
Sales variances: price XX
Volume XX XX
Actual sales XX
4. Exercise questions
The standard direct material cost for a product is $50 per unit (12·5 kg at $4 per kg). Last month the
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actual amount paid for 45,600 kg of material purchased and used was $173,280 and the direct
material usage variance was $15,200 adverse.
A $8,800 Adverse
B $8,800 Favourable
C $9,120 Adverse
D $9,120 Favourable
A 3,344 units
B 3,520 units
C 3,952 units
D 4,160 units
2.A company uses standard absorption costing. The following data relate to last month:
Budget Actual
Standard Actual
$ $
What was the adverse sales volume profit variance last month?
A $1,000
B $1,100
C $1,200
D $1,300
3.Last month 27,000 direct labour hours were worked at an actual cost of $236,385 and the standard
direct labour hours of production were 29,880. The standard direct labour cost per hour was $8·50.
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4.A company’s budgeted sales for last month were 10,000 units with a standard selling price of $20 per
unit and a contribution to sales ratio of 40%. Last month actual sales of 10,500 units with total
revenue of $204,750 were achieved.
What were the sales price and sales volume contribution variances?
5.A company operates a standard absorption costing system. The standard fixed production overhead
rate is $15 per hour.
A $7,500 adverse
B $7,500 favourable
C $10,500 adverse
D $10,500 favourable
A company operating a standard costing system has the following direct labour standards per unit for
one of its products:
Last month when 2,195 units of the product were manufactured, the actual direct labour cost for the
9,200 hours worked was $110,750.
1) What was the direct labour rate variance for last month?
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2) What was the direct labour efficiency variance for last month?
A $4,250 favourable
B $4,250 adverse
C $5,250 favourable
D $5,250 adverse
A company has a budgeted material cost of $125,000 for the production of 25,000 units per month.
Each unit is budgeted to use 2 kg of material. The standard cost of material is $2·50 per kg.
Actual materials in the month cost $136,000 for 27,000 units and 53,000 kg were purchased and
used.
A $1,000
B $3,500
C $7,500
D $11,000
A $2,500
B $4,000
C $7,500
D $10,000
8.Sepsi is a cola drink manufacturer. The liquid content of one bottle of cola is 4 liters. During the filling
process there is a 25% loss of cola input due to spillage and evaporation. The standard price of the cola
is $2 per litre. The standard cost of the cola per bottle is:
A $3.00
B $5.00
C $8.00
D $10.66
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B An hour during which only Standard units
D An hour during which only standard hourly rates are paid to labour
A The difference between the budgeted value of the fixed overheads and the standard fixed overheads
absorbed by actual production
B The difference between the standard fixed overhead cost specified for the production achieved, and
the actual fixed overhead cost incurred
D The difference between the standard fixed overhead cost specified in the original budget and the same
volume of fixed overheads, but at the actual prices incurred
Budget Actual
A $896 A
B $896 F
C $1,120 A
D $1,120 F
12.Which of the following would help to explain an adverse direct material price variance?
(ii) A reduction in the level of purchases meant that expected bulk discounts
(iii) The standard price per unit of direct material was unrealistically high
A All of them
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PART E PERFORMANCE
SYLLABUS CONTENT
b) Financial measurement
c) Non-financial measurement
A Mission Statement describes the organisation’s basic function in society. What is it trying to accomplish?
The elements of a Mission Statement might include:
Strategy: It may specify the business that the organisation is in, the product and service areas it is
going to operate and the necessary competences that need to be present.
Values and Culture: It may state the beliefs, ethical standpoints and principles under which activity is
to be carried out, it should guide all employees at all levels to work collectively towards the achievement
of the corporate mission – ‘a guiding light’.
It may attempt to incorporate several of the stakeholders (for example, shareholders, customers,
employees), and increasingly, the environment.
Although the mission statement might be seen as a set of abstract principles, it can play an important role
in the planning process.
Implementation
The Mission Statement can play an important part in the planning process by providing:
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a focus on strategies
The wording of the statement may be rather vague and abstract and therefore provide limited
assistance in developing strategies
The content of the statement may provide the management with non-congruent goals. For example,
maximizing shareholder wealth may conflict with any ethical statements made in the mission
The potential for inconsistent goal setting can occur between departments, differing managerial levels
and over time
The mission statement is occasionally regarded by employees as ‘political window dressing’ and does
not in their view reflect actual company strategy and the actions of management – this may result in
adverse behavioural consequences
Critical success factors (CSF’s) are performance requirements that must be achieved if an organisation
is to be successful and outperform its competition.
A. As long ago as 1955 management reporting system and found that it produced reports on the following
factors.
Profitability
Market share
Productivity
Product leadership
Personnel development
Employee attitudes
Public responsibility
Critical success factors can be set and used by identifying objectives and goals, determining which factors
are critical for accomplishing each objective and them determining a small number of performance
measures for each factor.
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3. The problem of short-termism
Short-termism is when there is a bias towards short-term rather than long-term performance. It is often
due to the fact that managers’ performance is measured on short-term results.
Organisations often have to make a trade-off between short-term and long-term objectives. Decisions
which involve the short-term action include following:
Postponing or abandoning capital expenditure projects, this would eventually undermine to growth
and profits, in order to protect short term cash flow and profit.
Cutting R&D expenditure to save operating costs, and so reducing the prospects for future product
development.
Reducing the level of customers service, to save operating costs (but sacrificing goodwill)
Cutting training costs or recruitment (so the company might be faced with skills shortages)
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Changes in cost structures, the competitive environment and the manufacturing environment have lead to
an increased use of NFIs.
Categories Of Ratios
These ratios are concerned with the effectiveness of the firm in generating profit. A very popular means of
assessing a firm is to assess the amount of wealth generated for the amount of wealth invested.
Shareholders' funds
Sales × 100%
Capital employed
Sales
--- Gearing
Capital gearing is concerned with the relative sizes of the funds provided by shareholders, on the one
hand, and by loan creditors on the other. This is an important issue in business finance, about which there
are various theories and a body of empirical evidence.
Loan financing tends to be cheaper than equity financing. However, loan financing exposes the
shareholders to greater risk than does equity financing. Ratios in this area tend to be concerned with the
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level of capital gearing.
Interest
Liquidity ratios are a guide to the risk of cash flow problems and insolvency. If a company suddenly finds
that it is unable to renew its short term liabilities (for instance if the bank suspends its overdraft facilities)
there will be a danger of insolvency unless the company is able to turn enough of its current assets into
cash quickly.
Current ratio
= Current Assets
Current Liabilities
A simple measure of how much of the total current assets is financed by current liabilities. If, for example
the measure is 2:1 this means that only a limited amount of the assets are funded by the current liabilities.
Quick Ratio (acid test)
= Current Assets minus inventory
Current liabilities
A measure of how well current liabilities are covered by liquid assets. A measure of 1:1 means that we are
able to meet our existing liabilities if they all fall due at once.
--- Working Capital/Activity
Ratios in this area attempt to appraise the efficiency of management in various areas. The following first
three ratios considered tell us something about the management's efficiency in controlling the main
elements of working capital - inventory, receivables and payables. Thus they help in the interpretation of
liquidity ratios dealt with earlier.
Inventory days
Average inventory × 365
Cost of sale
It is a calculation of the number of days inventory is held for.
Receivables days
Average receivables ×365
Sales
It is a rough measure of the average length of time it takes for a company’s receivables to pay what they
owe. If the period is increasing year on year, this is indicative of a poorly managed credit control function.
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Payables days
Average payables ×365
Cost of sale/purchase
*Note: if purchase figure is not given, Cost of sales can be used as an approximation.
It provides a rough measure of the average length of time it takes a company to pay what it owes. An
increase is often a sign of lack of long-term finance or poor management of current assets, resulting in
the use of extended credit from suppliers, increased bank overdraft and so on.
Traditionally, financial measures are a dominant measure of performance. However, as the competitive
environment increasingly demands management’s understanding of and involvement in operating
decisions, non-financial performance measures take on a larger role in performance measurement.
The following table provides some examples of performance appraisal measures that might be used in
conjunction with non-financial objectives:
Measures
Market Share Market share in terms of percentages its product serves
Innovation Number of patents, copyrights, spending on R and D
Growth Growth in turnover, profits, employees, assets
Productivity Number of units by shift and hours, labour hours per unit, etc.
Quality Number of claims, number of returned goods, warranty expense
Social Aspects Amount spent in social areas (quantifying this might be a problem)
The use of non-financial indicators might be considered to be better than quantitative measures as the
non-financial indicators directly measure an entity’s performance in the activities that create shareholder
wealth, such as manufacturing and delivering quality goods and services and providing service for the
customer. Also, they measure productivity directly; non-financial indicators may better predict the direction
of future cash flows. For example, the long-term financial viability of some industries rests largely on their
ability to keep promises of improved product quality at a competitive price.
Perhaps the most important reason for the use of non-financial performance measures is that they
give early warning signals of problems. For this reason they are often referred to as ‘leading indicators’.
Financial performance measures are often described as ‘lagging indicators’, that is they tell the firm that
something has gone wrong after it has gone wrong. The use of non-financial performance measures gives
a firm a chance of correcting problems before they go too far. For example, a firm might be able to cure a
quality problem revealed by a high level of customer complaints before it has a damaging effect on sales
and profits.
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Virtually all companies face increasingly competitive market places. In the face of global competition
non-financial issues such as product quality, customer service, delivery, reliability and innovation have
become crucial elements of competitive strategy. None of these variables are directly measurable in
financial terms.
Non-financial performance measures may be more understandable and relevant for non-financial staff.
Financial measures in isolation can potentially be manipulated by managers. Using a range of financial
and non-financial measures makes it more difficult for managers to hide bad performance.
Economy is an input measure and is normally based around the expenditure of the organisation.
Effectiveness is an output measure and looks at what the organisation achieves in terms of its
objectives. Effectiveness is achieving established objectives.
Efficiency is a combination of the above two measures. It considers output in relation to input.
General Ideas
Short-termism is a major problem of performance measurement, which arises when managers are
judged by criteria (e.g. ROI, RI), which do not measure the long-term effects of the decision.
External considerations
A. Stakeholders
Different stakeholders will have different objectives and companies may deal with this by having a
range of performance measures.
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Performance required by different stakeholders may conflict, and therefore the company may adopt
an approach of satisfactory performance in each area rather than optimizing profit at the expense of
other objectives.
B. Economic environment
Economic growth
Inflation
Interest rates
Exchange rates
C. Competition
Performance management must consider information on competitors’ prices and cost structures and
identify which features of an organization’s products add most value. Management accounting information
has to be produced speedily and be up-to-date so that managers can react quickly and effectively to
changing market conditions.
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Chapter 15. Applications of performance measurement
SYLLABUS CONTENT
g) benchmarking
In a customer-focused organization, basic measures for sales can be supplemented by a host of others
including customer rejects/returns: total sales.
environments
In a contract environment each job undertaken is unique. There are a number of implications for
performance measurement:
Suppliers may be different for each contract, making it harder to set standards for quality, speed of
delivery and so on.
Customer satisfaction measures are particular important in this environment (payment might depend
contractually upon customer satisfaction).
Because each contract will be different the organization will have to be extremely flexible. Measures
of success in adapting to new requirements and employee skills will provide a key indicator.
It is likely that the contract will need to be completed within a certain time and therefore an ongoing
check must be kept of performance in relation to the deadline.
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Performance measurement in manufacturing is increasingly using non-financial measures
Intangibility.
Simultaneity.
The production and consumption of service are simultaneous, and therefore it cannot be inspected for
quality in advance.
Heterogeneity.
Many service organizations face the problem of achieving consistency in the quality of its output.
Perishability.
Many services are perishable. The services of a dentist are purchased only for the duration of an
appointment.
3.2 Performance measures covering the following six have been suggested for
service organizations
Competitive performance--- focuses on factors such as sales growth, market share and ability to
obtain new business
Financial performance--- like any other business, a service business needs to plan, and its short-term
plans can be drawn up in the form of a budget
Quality of service--- Service quality is measured principally by qualitative measures, although some
quantitative measures are used by some business.
The following table shows the measures used to assess 4 quality factors and the means of obtaining
the information by British Airports Authority (BAA) a transport facility service provider
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Friendliness Staff attitude and helpfulness Customer survey and
management inspection
Innovation--- can be measured in terms of how much it costs to develop a new service, how effective
the process is , and how quickly it can develop new service.
NPMOs include private sector organizations such as charities and churches and much of the public sector.
A major problem with many NPMOs, particular government bodies, is that it is difficult to define their
objectives.
Performance of NPMO is often judged in terms of inputs and outputs. This ties in with the “value for money”
criteria often used to assess NPMOs.
Lacks of profit measure --- Companies have profit as their bottom line measure. Not-for-profit
organizations are not motivated by a desire to maximize profit.
Multiple objectives
Multiple stakeholders in not-for-profit organisation give rise to multiple objectives so there is a need to
prioritizes/compromise.
Objectives may
Be difficult to define
For example
A museum may have the following objectives:
Educating the public.
Research.
Preservation and restoration.
One possible conflict here could arise if the decision to charge an entry fee were
considered. This would raise funds for research but discourage potential visitors.
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Measuring outputs
Financial constraints
Undertake cost and benefit analysis of projects in an effort to place a monetary value on the service
provision.
B. Judgment
Accept that performance measurement must to some extent be subjective. Judgments can be made
by experts in that particular NFP activity.
C. Comparisons
Facilitate regional benchmarking by introducing adjustment factors to compensate for know regional
disparities e.g. permit higher rates of pay in high wage locations; there is less of a problem with
confidentiality and so benchmarking is easier.
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5.2 The Purpose Of Performance Measurement Is To Control And Motivate The
Care must be taken when designing a performance measurement system to avoid dysfunctional behaviour
and demotivation.
Provide incentives to promote performance as a division with overall company objectives - goal
congruence
Only incorporate factors for which the manager (division) can be held responsible (accountable)-
motivation
Managers may be rewarded according to the overall performance of the company rather than their own
responsibility centre. This may help goal congruence but may not be motivating if poorly- performing
managers are rewarded in the same way as managers who are performing well.
Cost centre
Profit centre
Investment centre
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Advantages of ROI:
Advantages of RI
Both ROI and RI involve a cost of capital figure which must be estimated. The cost of capital is difficult
to calculate and is not known with certainty
Both ROI and RI measure divisional performance based on a single value. Most organizations these
days are of such a complex nature that a single figure is unlikely to be adequate for an investment
decision
6. Balanced scorecard
The Balanced Scorecard is an agreed set of measures that provides managers with a comprehensive,
balanced and timely view of an organisation's performance.
The Balanced Scorecard is a technique, which aims to allow managers to look at the business from 4
different perspectives by seeking to provide answers to the following 4 basic questions.
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6.1 Within each of these categories a company should seek to identify a series critical
CSFs - those things we absolutely must get right to succeed in relation to a given perspective.
NB the ultimate measure of corporate performance (for quoted companies) is the share price.
The balanced scorecard approach seeks to measure performance under a variety of headings of financial
success, customer satisfaction, process efficiency and organizational learning and growth.
Managers are unlikely to be able to distort the performance measure; bad performance is difficult to
hide if multiple performance measures are used.
Success in the four key areas should lead to the long-term success of the organisation.
It is flexible, what is measured can be changed over time to reflect changing priorities.
‘What gets measured gets done’, that is if managers know they are being appraised on various aspects
of performance they will pay attention to these areas, rather than simply paying lip service to them.
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6.3 Limitations of a balanced scorecard approach
Conflicting measures – some measures in the scorecard such as research funding and cost reduction
may naturally conflict. It is often difficult to determine the balance which will achieve the best results.
Selecting measures – not only do appropriate measures have to be devised but the number of
measures used must be agreed.
Expertise – non-financial managers have difficulty with the usual profit measures.
Interpretation – even a financial-trained manager may have difficulty in putting the figures into overall
perspectives.
7. Benchmarking
Internal benchmarking. This involves the comparison of different departments or divisions within an
organisation.
Data for this is easy to obtain and conditions are often comparable. Learning may be limited as
comparisons are only being made within the same company.
Competitive benchmarking. This involves comparing performance with that of direct competitors.
The potential for learning is improved but data may be difficult to obtain.
For commercial reasons firms are often unwilling to divulge information to direct competitors. The
growth of benchmarking clubs and trade associations has reduced the problems of competitive
benchmarking.
Functional benchmarking. Various functions in the business are compared with those recognised as
the best external practitioners of the function.
A manufacturing company could compare its invoice preparation time with that of a credit card
company, its delivery time with a firm of couriers etc. The potential for learning how to improve
performance is very high, but comparability problems sometimes exist. (This is sometimes referred to
as operational or generic benchmarking)
Strategic benchmarking. This involves comparison of performance with competitors at the strategic
level. Areas such as market share and return on capital employed could be considered. Such
comparisons are important in designing competitive strategy.
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7.2 Benefits of benchmarking
Its flexibility means that it can be used in both public and private sector and by people at different
levels of responsibility
Cross comparisons are more likely to expose radically different ways of doing things
It is an effective method of implementing change, people being involved in identifying and seeking out
different ways of doing things in their own areas.
It establishes a desire to achieve continuous improvement and helps develop a culture in which it is
easier to admit mistake and make changes
Employee resentfulness.
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Chapter 16. Cost management
SYLLABUS CONTENT
a) Cost reductions
b) Value analysis
Cost control – it is about regulating the costs of operating a business and keeping costs within acceptable
limits. This ought to lead to a reduction in excessive spending.
Cost reduction – it is a planned and positive approach to reducing expenditure and starts with an
assumption that current cost levels or planned cost levels are too high even though cost control might be
good and efficiency levels high. It aims to reduce expected actual cost levels to below current budgeted or
standard levels by purchasing new equipment, changing methods of working and so on..
A. Variety reduction
Examination of product range may show show that it is too extensive and that some of the products are
uneconomic because they are produced in small quantities. In general fewer varieties makes for easier
production, increase the scope for automation, and likely to reduce cost.
B. Improving efficiency
One way of reducing costs is to improve the efficiency of materials usage, the productivity of labour or the
efficiency of machinery or other equipment.
Changing work methods to eliminate unnecessary procedures and make better use of labour time.
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Improving the methods for achieving co-operation between groups or department.
Achieving a better balance between preventive maintenance and machine ‘down time’ for repairs.
C. Material costs
- Bulk purchase
D. Labour costs
Labour efficiency could be improved by changing working method (possibly by using an organisation and
methods (O&M) study or a work study).
Work Study-is a technique used in factories to determine the most efficient methods of
using labour, materials and machinery. Work-study can be subdivided into method study
and work measurement.
- Method study is the recording and analysis of existing methods of doing work and
comparing this with proposed methods in order to implement new and more
effective procedures.
Organization and methods (O&M) - is the systematic analysis of administrative and office
procedures in order to produce more efficient methods.
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b. Using JIT to reduce inventory holding cost.
Reassessing policies for offering early discount to credit customers (so as to improve working
capital position and less reliance on borrowing).
Value analysis is basically a form of cost reduction.i.e. a method of improving profitability by reducing
costs without necessarily increasing prices.
It is useful to distinguish two types of value – utility value and esteem value
Utility value is the value an item has because of the uses to which it can be put.
Esteem value is the value put on an item because of its beauty, craftsmanship etc.
Discover precisely why customers want an item, whether the item has any esteem value or utility
value. Only in this way can the manufacturer be certain that each function incorporated into the
product contributes some value to it.
Labour: can the cost be reduced by eliminating operations or changing production methods?
Other factors: can new, cheaper processes be found? Would a cheaper finish be acceptable?
C. The assessment in (2) may be carried out by middle management and , if so, it will require ratification
by top management before implementation.
D. Implementation of proposals.
E. Evaluate feedback from new proposals to establish the benefits from the change.
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1.2.2 The benefits of Value Analysis include:
2. Cost codes
Once costs have been classified, a coding system can be applied to make it easier to manage the cost
data, both in manual systems and in computerized systems.
Type of code
Composite codes
Numbers are given to items in ordinary numerical sequence, so that there is no obvious connection
between an item and its code.
These are an improvement on simple sequences codes, in that a digit (often the first one) indicates
the classification of an item.
Faceted codes
These are a refinement of group classification codes, in that each digit of the code gives information
about an item.
These incorporate some digit(s) which is (are) part of the description of the item being coded.
Hierarchical codes
This is a type of faceted code where each digit represents a classification, and each digit further to
the right represents a smaller subset than those to the left.
1. A code is usually briefer than a description, thereby saving clerical time in a manual system and
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storage space in a computerized system.
The overheads of a company are coded using 5 digit coding system, an extract from which is as follow
Which is the coding for the indirect labor cost incurred in service Dept. Y
A 31604
B 40602
C 41602
D 32605
Answer : C
1 Which of the following options describes the comparison of internal functions with those of the best
external practitioners of those functions, regardless of the industry?
A Competitive benchmarking
B Functional benchmarking
C Strategic benchmarking
D Internal benchmarking
20X7 20X8
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Capital employed 37,500 60,000
2) Using the figures in the question above, calculate the asset turnover for 20X8.
A 0.075 times
B 0.13 times
C 7.5 times
D 13.3 times
$’000 $’000
Non-current assets 31,250
Current assets
Inventory 35,000
Receivables 40,000
Cash 1,250
76,250
107,500
A 0.6875
B 0.7093
C 1.2708
D 2.0000
4 A government body uses measures based upon the ‘three Es' to the measure value for money generated
by a publicly funded hospital. It considers the most important performance measure to be `cost per
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successfully treated patient'.
5 The following statements have been made about: return on Investment and residual income.
(iv) Return on investment and residual income involve a cost of capital figure which is difficult to
calculate
A (iii) only
B (iv) only
C (i), (ii) and (iv) only
D (iii) and (iv) only
(2) Value analysis considers cost value, exchange value,use value and esteem value
Budgeting
1 .Vivi Co wishes to analyse the behaviour of its costs. The following information is available.
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2011 150 1,500,000 12,450,000
Required:
(a) Use the industry price index to restate ViviCo’s total costs for each year in terms of 2014 price levels.
(4 marks)
(b) Use the high low technique to estimate the fixed and variable elements of ViviCo’s total cost
expressed in 2014 price levels. (4 marks)
(c) Forecast ViviCo’s total cost for 2015 when output is forecast to be 2,000,000 units and the industry
price index is expected to rise to 95.(2 marks) (10 marks)
Standard costing
1.Moonearth Ltd, which manufactures a single product, uses standard absorption costing. A summary of
the standard product cost is as follows:
$/ per unit
Direct materials 15
Direct labour 20
Fixed overheads 12
Budgeted and actual productions for last month were 10,000 units and 9,000 units respectively. The
actual costs incurred were:
Required:
(a) Prepare a statement that reconciles the standard cost of actual production with its actual cost for last
month and highlights the total variance for each of the three elements of cost. (4 marks)
Last month 24,000 litres of direct material were purchased and used by the company. The standard
allows for2·5 litres of the material, at $6 per litre, to be used in each unit of product.
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(b) Provide an appropriate breakdown of the total direct materials cost variance included in your
statement in (a). (3 marks)
(10 marks)
Performance
1.Sunny Co operates a public bus service in a large city. Recently its bus service has been criticised for
its poor level of efficiency. The managers of Sunny Co have decided to undertake a benchmarking exercise
to assess the efficiency of the bus service and have collected the following information.
Bus Operators – Industry average statistics for the year ended 31 December 2013
Return on sales 8%
Average fuel consumption per passenger kilometre* 0·005 litres per passenger km
The management accountant of Sunny Co has collected the following information for the year ending 31
December 2013.
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Total number of passenger kilometres travelled 39,000,000 passenger kilometres
Fatalities 1
Required:
(a) Calculate the following ratios and other statistics for Sunny Co for the year ended 31 December 2013.
(b) ‘Benchmarking involves the establishment, through data gathering, of targets and comparators from
which an organization’s relative level of performance can be measured. By the adoption of the best
practices identified, performance may be improved.’
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F2 exercise questions Answers
Session 1
1B 2C 3 B 4D
Session 2
Session 3
1A 2A 3B 4B 5A 6B
Session 4
1A 2D 3D 4C 5D 6C 7C 8C
Session 5
1B 2D 3ABA
Session 6
1B 2D 3A 4A 5B 6A 7A 8A
Session 7
1C 2B 3B 4B
Session 8
Session 9
1 B 2C 3C 4C
Part C
Session 13
Part E
1B 2 A C 3A 4C 5C 6B 7D
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