Ex PF2

Notes
ACCA Paper F2
Management Accounting
For exams in 2010
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ACCA F2 Management Accounting
Contents
About ExPress Notes 3
1. The Nature and Purpose of Cost and 7

2. Cost Classification, Behaviour and Purpose 10
Business Mathematics and Computer
3. 12
Spreadsheets
4. Cost Accounting Techniques 14
5. Budgeting and Standard Costing 23
6. Short-term decision-making techniques 35
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Chapter 1
The Nature and Purpose of Cost and

The Characteristics of Good Information
The qualities of good information can be summarized in the word “ACCURATE”:
 Accurate,
 Complete,
 Cost-beneficial,
 User-targeted,
 Relevant,
 Authoritative,
 Timely and
 Easy to use
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“Responsibility” centres
Cost Centres Revenue Centres Profit Centres Investment Centres
Cost centres: Responsible for current expenses only
Revenue centres: Responsible for revenues, but not current expenses other than marketing
expenses
Profit centres: Responsible for revenues and current expenses
Investment centres: Responsible for revenues, current expenses and capital expenditure
KEY KNOWLEDGE
The process of identification, measurement, accumulation, analysis, preparation,

interpretation and reporting of information used by management to set targets, plan
resource allocation, evaluate investment choices and monitor/control the operating
performance and the orderly conduct of the business.
Differences in purpose and scope, compared to Financial Accounting
 Aimed at internal users (as opposed to financial accounting, which is aimed at

external stakeholders)
 Focused on present and future performance (as opposed to financial accounting,
which reports past performance)
 Not required by law and not regulated by accounting frameworks (as opposed to
financial accounting, which is a legal requirement and is regulated by accounting
frameworks)
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 Focused on specific areas or activities (as opposed to financial accounting, which

provides a holistic view of company’s performance)
 Employs non-financial indicators as well financial, while financial accounting uses
only financial measures.
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Chapter 2
Cost Classification, Behaviour and

Purpose
In financial accounting, it is a convention to break down costs into:
KEY KNOWLEDGE
Production vs. Non-Production costs
Production costs: These are costs (both direct and indirect, also variable and fixed) which
relate to the production of goods; this is also referred to as manufacturing or factory cost. It
is these costs, accumulated, which provide the value at which goods are placed in inventory
(prior to sale) and form the “cost of goods” value when sold.
Non-production costs: These are expenses that are incurred independent of production and
include administrative, selling, distribution and finance costs. These costs can have the
character of “period” costs, as they relate to the period of time in which they occur.
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KEY KNOWLEDGE
Direct vs. Indirect costs
Direct costs: are costs that can be directly attributable to a product.
Indirect costs: these are costs that cannot be directly attributable to a product.
KEY KNOWLEDGE
Fixed vs. Variable costs
Fixed costs: are costs that remain constant regardless of the volume of production. A variety
of indirect costs are fixed.
Variable costs: vary in proportion with the volume produced. Direct costs are by their nature
variable in behaviour.
“Although a variable cost increases with the level of activity, the variable cost per unit
remains fixed, while a fixed cost per unit falls with a rise in the level of activity.”
Other types of costs:
Mixed costs: these are costs that contain a fixed and a variable element.
Step costs: costs that remain fixed within a defined range of production, but at a certain
level of output increase in a significant way to a new (fixed) level.
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Chapter 3
Business Mathematics and

Computer Spreadsheets
Expected Value
This is the average of possible outcomes weighted by the probability of each outcome.
Expected
Profit/(Loss) Probability Value
340 10% 34.0

766 20% 153.2
278 50% 139.0
450 18% 81.0
-230 2% -4.6
100% 402.6
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Regression analysis
This is a statistical tool used to describe the relationship between two sets of variables.
The correlation coefficient – denoted by r -- measures the strength of the linear association
between the variables. The range for r is: -1 < r < +1
The coefficient of determination measures the degree to which the variation in the
dependent variable can be explained by the independent variable (x). It is denoted as r 2 and
its range is: 0 < r2 < 1
The use of spreadsheets is a basic skill that all accountants should possess.
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Chapter 4
Cost Accounting Techniques
Materials
The ordering, receiving and issuing of materials from inventory must be controlled according
to procedures and documented at all stages with forms appropriate to the purpose.
The controls and procedures are designed to monitor inventory movements so as to

minimise discrepancies and losses and theft.
Economic Order Quantity
This is a method which seeks to minimize the costs associated with holding inventory.
To determine the total costs, the following data is required:
Q = order quantity
D = quantity of product demanded annually
P = purchase cost for one unit
C = fixed cost per order (not incl. the purchase price)
H = cost of holding one unit for one year
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The total cost function is as follows:
Total cost = Purchase cost + Ordering cost + Holding cost
which can be expressed algebraically as follows:
TC = PxD + C x D/Q + H x Q/2
It is this total cost function which must be minimized.
Recognizing that:
 PD does not vary;
 Ordering costs rise the more frequently one places (during the year); and
 Holding costs rise the fewer times one places orders (due to larger quantities being
ordered each time),
It follows that there is a trade-off between the Ordering and the Holding costs.
The optimal order quantity (Q*) is found where the Ordering and Holding costs equal each
other, i.e.
C x D/Q = H x Q/2
Rearranging the above and solving for Q results in
Labour
Direct labour refers to work which is directly involved in the manufacture of a product.
Indirect labour (e.g. the supervisor’s salary or that of a security guard) forms part of
overhead costs.
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Absorption Costing
This is one method which seeks to make the link between overheads and (product) cost
units. The diagram below provides a useful roadmap.
Total Production Costs
Direct Costs Indirect costs (overheads)
2. Allocate/Apportion to Cost Centers
Production A Production B Service C
1. Allocate
3. Reapportion from
Service to Production
Production A Production B
4. Absorb
Cost Unit
The focus (above) is production. Overhead costs that are not incurred at the time of
production do not find their way into inventory.
It is useful to think of production costs as being those that end up as part of the inventory
(valuation) while other (non-production) costs are incurred outside, and normally after the
product leaves inventory.
Contribution
Contribution is defined as the difference between Sales revenue and the marginal cost of
sales, or
Contribution = Sales – Variable costs (both production and non-production)
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Marginal costing
A marginal approach to costing focuses on the variable (marginal) costs generated in a

business and considers fixed costs as period costs. This allows the company to be able to
quantify the amount by which its costs rise, if it produces/sells an additional unit of output.
Example
Below is data on a manufacturing company.
Selling price (per unit): 120
Cost card (per unit):

Direct materials 45
Direct labour 18
Variable production O/Hs 9
Total variable costs 72
There is a variable selling cost of $2 per unit
Year 1 Year 2
(units) (units)
Budget (normal) production 1,100 1,100
Actual Production 1,000 1,100

Actual Sales 950 1,150
Actual fixed production O/Hs $16,500 $16,500

Actual SGA costs $ 7,000 $ 7,000
Based on the above data, a profit and loss statement for the Years 1 and 2 is shown on the
next page.
Assume that the beginning inventory is zero.
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Profit/Loss (Marginal costing)
Year 1 Year 2
$ $
Sales (950/1,150 units) 114,000 138,000
Less: Variable cost of sales
Opening inventory 0 3,600
Production costs:
o Variable
(1,000 x $72) 72,000
(1,100 X $72) 79,200
Less: closing inventory

(50 x $72) (3,600) 0
(68,400) (82,800)
Less: Variable selling costs
(950 x $2) (1,900)
(1,150 x $2) (2,300)
Contribution 43,700 52,900
Less: Fixed production O/Hs (16,500) (16,500)

Less: SGA costs (7,000) (7,000)
Profit 20,200 29,400
Inventory is valued at variable production costs.
Absorption Costing
This method argues that focusing on marginal costs is potentially misleading in the longer
run because fixed production costs have also to be covered. Accounting conventions require
that fixed production costs be reflected in each unit produced.
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Revised cost card (Absorption costing)

Direct materials 45
Direct labour 18
Fixed production O/Hs 15
Total production costs 87
Profit/Loss (Absorption costing)
Year 1 Year 2
$ $
Sales (950/1,150 units) 114,000 138,000
Less: Variable cost of sales
Opening inventory 0 4,350
Production costs:
o Variable
(1,000 x $72) 72,000
(1,100 X $72) 79,200
o Fixed
(1,000 x $15) 15,000
(1,100 X $15) 16,500
Less: closing inventory

(50 x $87) (4,350) 0
Over/(under) absorption 1,500 0

(84,150) (100,050)
Gross Profit 29,850 37,950
Less: Variable selling costs

(950 x $2) 1,900
(1,150 x $2) 2,300
Less: SGA costs 7,000 (8,900) 7,000 (9,300)
Profit 20,950 28,650
Inventory is valued at the full production costs.
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Summary of Absorption costing and Marginal costing formats
Absorption Costing Marginal Costing
Revenue
Less: Cost of Sales
Variable/Fixed Variable production/

production costs non-production costs
Gross profit Contribution
Less: Expenses
Variable/Fixed Fixed production/

non-production costs non-production costs
Net Profit
Job costing / Batch costing
This refers to the calculation of costs associated with a specific job or customer order. This
is appropriate in situations where each product or service is distinct, and possibly unique, in
its delivery.
Batch costing is similar to job costing; the distinction lies in the identification of costs with
specific batches, which are numbered (separately identified) for this purpose.
Process Costing
Process costing is a technique that applies to the mass production of a large number of
identical products, moving through a series of processing stages. The accumulated costs of
production can be averaged over the number of items produced.
The average cost is determined by the following formula:
Average cost per unit = Total cost of inputs – Scrap value of rejected units
No. of units of input – Normal loss
The total cost of inputs refers to labour, materials and overhead costs of production. If
losses occur along the way that necessitate the scrapping of defective units, then to the
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extent that these items fetch a scrap value, then that (scrap) value will reduce the total
costs.
Similarly, an accounting is made of the number of units introduced into a process with the
expectation that a normal loss will be incurred. The number of good units emerging from a
process will therefore be the number of units entering it, minus the expected number lost in
processing.
Abnormal gains and losses are accounted for as an adjustment to the accounts using the
same value as the “good” output (deducted in the case of loss and added in the case of
gains).
Equivalent units (EU)
This refers to the way in which partially-completed output (“work-in-progress” or WIP) is

expressed. If an unfinished unit of product contains 35% of the labour and materials costs
of a complete unit, then the unit has a degree of completion of 35% in terms of value. It is
therefore considered to have an EU of 35%, which is normally expressed in monetary terms.
Weighted average method
The weighted average method makes no distinction between units that were started (but
not finished) in a previous process and those started in the current process. Since all the
units, when completed, are visually identical, processing costs are averaged over all the
units.
First-In-First-Out (FIFO) method
The FIFO method does make a distinction between units that were started in a previous
process and those begun in a current process. FIFO costing separates the costs that were
incurred in the previous period from costs of the current period.
Joint products / By-products
Joint products are two or more products that share a common processing path until the
point of separation. Until they go their own (separate) ways, the costs of production during
the joint processing cannot be physically distinguished.
There are different methods used to apportion common costs to such products at the point
of separation:
 Market value (based on expected sales price)
 Number of units (litres, tons, or some other objective physical measurement)
 Net realizable value = Final sales value – Incremental processing costs
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By-products are goods which are incidental to the production process and which generate
cash from sales, though the amount is modest in comparison to the overall revenues of the
firm. The cash received for by-products can be viewed as a bonus that reduces production
costs.
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Chapter 5
Budgeting and Standard Costing
Budgeting: definition and purpose
Quantitative plan for the future, used to:
a) Communicate b) Motivate b) Control b) Evaluate

Objectives Employees Activities Performance
The master budget process

 Annual frequency, preferably revised on a regular basis (rolling budget)
 Based on organization’s objectives, expressed in financial, quantitative and
qualitative measures
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The operating budget sequence

 Sales budget
 Production budget
 Ending inventory budget
 Direct materials budget, Direct labour budget, Factory overhead budget
 Cost of Sales budget
 R&D budget, Marketing budget, Distribution budget, Customer service budget, Admin
budget
 Pro-forma income statement
The financial budget sequence

 Capital budget
 Cash budget
 Pro-forma balance-sheet and pro-forma statement of cash-flows
Operating budgets
These are budgets that quantify the revenues and costs relating to a company’s activities at
a disaggregated level, meaning that there is direct input from department and functional
levels. They require both volume (e.g. units of output, quantities, hours, etc.) and price
specifications. Operating budgets are modelled on what will emerge as the company’s
income statement. Examples include:
 Sales budget
 Production budget
 Direct material usage
 Direct material purchases
 Direct labour budget
 Factory overhead budget
 Selling & distribution budget
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 Administrative expenses budget
The “disaggregation” of budgets referred to above allows the practice of “responsibility”

accounting.
Principal budget factor
When a budget is prepared, management must identify any factors that will prevent the
company from surpassing a certain level of activity.
A bank, for example, may be constrained from developing an extensive branch network
owing to the scarcity of suitably-skilled professional staff; or production may be constrained
by the built capacity of the plant or by the level of demand for a company’s products. In
each of these cases, there is a limiting factor at work.
Fixed vs. flexible budgets
Traditional budgets tended to be rigid, i.e. they were not subject to modification during the
period to which they referred.
Example
A producer of office equipment has a budget for the coming year:
Output: 1,000 units

Costs:
Materials 75,000
Labour 200,000
Fixed O/Hs 100,000
Total 375,000
After 3 months, the company observes that sales are running ca. 20% higher than originally
projected and it has therefore increased its production by a similar amount. In order to look
back at what its budget would have been had the actual (higher) level of activity been
anticipated, management can prepare a “flexed” budget; this is effectively a re-calibration of
the original budget. It allows management to re-focus their efforts without losing time
tracking “artificial” spending excesses according to the original budget.
Output: 1,200 units

Costs:
Materials 90,000
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Labour 225,000
Fixed O/Hs 100,000
Total 415,000
Prepare a flexed budget for an output level of 1,075 units.
Based on the data (below), the
 variable cost of labour is $125 per unit, and the

 fixed cost of labour is $75,000
Output: 1000 1200
Mats 75,000 90,000
Labour 200,000 225,000
Fix 100,000 100,000
Total 375,000 415,000
Therefore the cost of labour at output of 1,075 units is $209,375.
Absorption Costing
This method argues that focusing on marginal costs is potentially misleading in the longer
run because fixed production costs have also to be covered. Accounting conventions require
that fixed production costs be reflected in each unit produced.
Fixed Overhead Absorption Rate (FOAR) = Budgeted production O/H

Budgeted level of production
Year 1 Year 2
(units) (units)
Budget (normal) production 1,100 1,100
Actual fixed production O/Hs $16,500 $16,500
Fixed Overhead Absorption Rate (FOAR) = $15 ($16,500/1,100)
Cost card (Absorption costing)
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Direct materials 45
Direct labour 18
Fixed production O/Hs 15
Total production costs 87
Having established the OAR, we now have a basis on which the production department can
keep track of the fixed overheads being generated as the manufacturing process proceeds.
Actual output (units) x OAR = Fixed O/H absorbed
Basic variance analysis
The following data is from a manufacturing company
Budget
Production: 1,100 units
Sales: 1,000 units
Sales Price: $120 / unit
Actual results
Production: 1,000 units
Sales: 950 units
Materials: 4,900 kg, $45,025
Labour: 3,100 hrs, $19,050
Variable O/Hs: $9,250
Fixed O/Hs: $17,000
Sales price: $115 / unit
Cost card (per unit)

Materials (5kgs x $9 per kg) 45
Labour (3hrs x $6 per hr) 18
Variable O/Hs (3 hrs x $3 per hr) 9
Fixed O/Hs (3 hrs x $5 per hr) 15
87
Variance calculations
Sales volume variance (Absorption costing)
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 Budgeted sales volume 1,000
 Actual sales volume 950
Sales volume variance 50 (A)

@ standard margin ($120-$87) $1,650 (A)
Sales volume variance (Marginal costing)
 Budgeted sales volume 1,000
 Actual sales volume 950
Sales volume variance 50 (A)

@ standard contribution ($120-$72) $2,400 (A)
Sales price variance
 950 units should have sold @$120 114,000
 Actual revenues (950 units x $115) 109,250
Sales price variance 4,750 (A)
Material variances
(i) Material price variance
 Materials used (4,900 kg) should have cost @ $9 44,100
 Materials (4,900 kg) did cost 45,025
Materials price variance $925 (A)
(ii) Material usage variance
 1,000 units should have used @ 5 kg 5,000 kg
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 1,000 units did use 4,900 kg
Materials usage variance 100 kg (F)

@ standard $9 $900 (F)
Materials total variance: $ 25 (A)
Labour variances
(i) Labour rate variance
 Labour (3,100 hrs) should have cost @ $6 18,600
 Labour (3,100 hrs) did cost 19,050
Labour rate variance $450 (A)
(ii) Labour efficiency variance
 1,000 units should have taken @ 3 hrs 3,000 hrs
 1,000 units did take 3,100 hrs
Labour efficiency variance 100 hrs (A)

@ standard $6 $600 (A)
Labor total variance: $ 1,050 (A)
Variable O/H variances
(i) Variable O/H expenditure variance
 3,100 hrs should have cost @ $3 9,300
 3,100 hrs did cost 9,250
Variable O/H expenditure variance 50 (F)
(ii) Variable O/H efficiency variance
 1,000 units should have taken @ 3 hrs 3,000 hrs
 1,000 units did take 3,100 hrs
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Variable O/H efficiency variance 100 hrs (A)

@ standard $3 $300 (A)
Variable O/H total variance: $ 250 (A)
Fixed O/H total variance (Absorption costing)
 Overhead actually incurred $17,000
 Overhead absorbed (1,000 units x $15) $15,000
Fixed O/H total variance $ 2,000 (A)
This can be broken down into two components:
(i) Fixed O/H expenditure variance
 Budgeted O/H should have cost (1,100 units x $15) 16,500
 Actual O/H cost 17,000
Fixed O/H expenditure variance $500 (A)
(ii) Fixed O/H volume variance (Absorption Costing)
 Budgeted production 1,100 units
 Actual production 1,000 units
Fixed O/H volume variance 100 units (A)

@ standard $15 $1,500 (A)
Interpreting variances
Material price
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Favourable: Unanticipated discounts received, better purchasing/negotiation,

cheaper (substandard) materials
Adverse: Price inflation, poor purchasing, better quality materials
Material usage
Favourable: Better quality materials, more efficient processing
Adverse: Substandard material, waste, poor quality control, theft
Labour rate
Favourable: Low pay rates, cheap workers
Adverse: Wage inflation
Labour efficiency
Favourable: More efficient production, motivated/better trained workers, better

materials and/or equipment
Adverse: Poorly trained workers, deficient work organization, materials or

equipment
Overhead expenditure
Favourable: Cost savings, more efficient use of ancillary services
Adverse: Poor cost disciplines, complexity and bureaucracy
Overhead volume
Favourable: Using production capacities beyond the level budgeted
Adverse: Under-utilization of production capacities
theexpgroup.com
ExPress Notes
Inter-connections among variances
As can be seen above, a factor causing a favourable variance may at the same time be the
cause of an adverse variance in another part of the company’s operations.
It is management’s responsibility to understand these relationships and to be able to

anticipate, and if possible quantify, the impact of their actions on overall performance.
At the same time, management needs to review standards for their relevance and
usefulness, as well as apply common sense to the materiality and controllability of specific
variances.
Reconciliation of budgeted profit and actual profit
Operating statement
Prepare a reconciliation between the profit budgeted and that realized.
Budgeted profit (Absorption costing) 33,000
Sales volume variance 1,650 (A)
26,600
Cost variances:
Materials F A
Price 925
Usage 900
Labour
Rate 450
Efficiency 600
Variable
Expenditure 50
theexpgroup.com
ExPress Notes
Efficiency 300
Fixed
Expenditure 500
Volume 1,500
950 4,275 3,325 (A)
Actual profit 23,275
Note: Closing inventory is valued at standard cost
Operating Statement based on Marginal costing
Budgeted contribution (Marginal costing) 48,000
Sales volume variance 2,400 (A)
40,850
Cost variances:
Materials F A
Price 925
Usage 900
Labour
Rate 450
Efficiency 600
Variable
Expenditure 50
Efficiency 300
950 2,275 1,325 (A)
theexpgroup.com
ExPress Notes
Actual contribution 39,525
Fixed O/Hs Budgeted 16,500

Fixed O/Hs Expenditure variance 500 (17,000)
Actual profit 22,525
theexpgroup.com
ExPress Notes
Chapter 6
Short-term decision-making
techniques
Cost-Volume-Profit (CVP) Analysis
The breakeven formula
Total Costs = Fixed Costs + Unit Variable Cost x Number of Units
Total Revenue = Sales Price x Number of Units
If
TC = Total Costs,
FC = Fixed Costs,
V = Unit Variable Cost,
X = Number of Units,
TR = Total Revenue,
SP = Selling Price,
theexpgroup.com
ExPress Notes
C = SP – V = Unit Contribution and
CM%= C/SP = Contribution Margin,
Then the break-even point (the output level at which TR=TC) is:
 In units sold: X = FC/C

 In dollar sales: TR = FC/CM%
 Safety Margin = Budgeted Sales – Break-even point (units/dollars)

 C is an important indicator, as it shows the contribution of each unit sold towards
covering fixed costs. Therefore, in the short run, the firm may prefer to produce/sell
below break-even in order to recover some of its fixed costs.
Relevant costs, incremental analysis and linear programming
 Relevant costs are costs expected to vary with the action taken
o Past (sunk) costs are irrelevant
o Fixed costs are irrelevant if there is idle capacity
o Variable (marginal) costs are relevant
o Opportunity costs (foregone benefits) are relevant
 Incremental analysis uses relevant costs in order to quantify the short-term effects of
business decisions taken.
Applying incremental analysis in business decision-making
 Accept or reject a special order

o Accept if selling price exceeds variable production cost and there is spare
capacity
 Make (in-sourcing) or buy (out-sourcing)
theexpgroup.com
ExPress Notes
o Outsource least efficient activities if full capacity reached

 Capital budgeting
o Invest if marginal cost of investing is below marginal cost of not investing
(marginal benefit foregone)
 Disinvestment
o Divest if (marginal revenue generated + cost of resulting idle capacity +
severance payments + restoration costs) fall below marginal cost of
production + salvage value of assets
Determining optimal mix of products where there are limiting factors
It addresses the problem of maximizing or minimizing a linear function subject to linear

constraints. The constraints may be equalities or inequalities.
(end of ExPress Notes)
theexpgroup.com

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Notes

1. The Nature and Purpose of Cost and 7

5. Budgeting and Standard Costing 23

6. Short-term decision-making techniques 35

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Notes Notes Notes

To maximise your chances of success in the exam we recommend you visit

The Nature and Purpose of Cost and

The Characteristics of Good Information

The qualities of good information can be summarized in the word “ACCURATE”:

Cost Centres Revenue Centres Profit Centres Investment Centres

Cost centres: Responsible for current expenses only

Profit centres: Responsible for revenues and current expenses

The process of identification, measurement, accumulation, analysis, preparation,

Differences in purpose and scope, compared to Financial Accounting

 Aimed at internal users (as opposed to financial accounting, which is aimed at

 Focused on specific areas or activities (as opposed to financial accounting, which

Cost Classification, Behaviour and

In financial accounting, it is a convention to break down costs into:

Direct costs: are costs that can be directly attributable to a product.

Other types of costs:

Business Mathematics and

340 10% 34.0

Cost Accounting Techniques

The controls and procedures are designed to monitor inventory movements so as to

Economic Order Quantity

To determine the total costs, the following data is required:

D = quantity of product demanded annually

P = purchase cost for one unit

C = fixed cost per order (not incl. the purchase price)

H = cost of holding one unit for one year

The total cost function is as follows:

Total cost = Purchase cost + Ordering cost + Holding cost

which can be expressed algebraically as follows:

TC = PxD + C x D/Q + H x Q/2

It is this total cost function which must be minimized.

 PD does not vary;

Rearranging the above and solving for Q results in

Total Production Costs

Direct Costs Indirect costs (overheads)

2. Allocate/Apportion to Cost Centers

Production A Production B Service C

Contribution = Sales – Variable costs (both production and non-production)

A marginal approach to costing focuses on the variable (marginal) costs generated in a

Below is data on a manufacturing company.

Selling price (per unit): 120

Cost card (per unit):

There is a variable selling cost of $2 per unit

Budget (normal) production 1,100 1,100

Actual Production 1,000 1,100

Actual fixed production O/Hs $16,500 $16,500

Assume that the beginning inventory is zero.

Profit/Loss (Marginal costing)

Sales (950/1,150 units) 114,000 138,000

Less: Variable cost of sales

Opening inventory 0 3,600

Less: closing inventory