5. The nature and purpose of
management accounting
• Data and information.
• Planning, decision making and control.
• Responsibility centres.
• The role of management accounting.
6. Data and information
• Data and information are different.
– 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).
7. Good information
The ‘ACCURATE’ acronym:
– A – Accurate
– C – Complete
– C – Cost-effective
– U – Understandable
– R – Relevant
– A – Accessible
– T – Timely
– E – Easy-to-use!
10. Responsibility Centres
An part of the business whose manager has personal responsibility
for its performance.
Cost Centre
Profit Centre Responsibility Centre Investment
Centre
Revenue Centre
Managers to plan & control areas of performance on which they are
measured.
14. Management Accounting vs.
Financial Accounting
Management Accounting Financial Accounting
Information mainly Internal users, e.g. External users e.g.
produced for Managers and employees Shareholders, creditors, lenders,
banks, government
Purpose of To aid planning, control To record financial performance
information and decision making and position in a period
Legal requirements No Yes (limited companies)
Formats No set format – managers Limited companies must produce
decide on content & financial accounts
presentation
Nature of Financial & non-financial Mostly financial
information
Time period Historical & forward- Mainly an historical record
looking
19. Direct and Indirect costs
Direct costs : costs which can be directly identified with a
specific unit or cost centre
Total of direct costs =
Direct Materials + Direct labour + Direct expenses =
Prime Cost
Indirect costs : costs which can not be directly identified
with a specific unit or cost centre
Indirect costs =
Indirect Materials + Indirect labour + Indirect expenses =
Overheads
20. Cost Behaviour – variable cost
The way in which costs vary at different levels of activity
• A cost that varies with the level of activity, e.g. Material cost
21. Cost behaviour – Fixed Costs
A cost that, within certain output and sales revenue limits, is unaffected by
changes in the level of activity.
Stepped Fixed Costs : A fixed cost which is only fixed within a certain level
of activity. Once the upper level is reached, a new level of fixed costs
becomes relevant.
22. Cost behaviour – Semi variable
costs
A cost with a fixed and a variable element, e.g.telephone charges with fixed
line rental and charge per call
23. Cost behaviour – Hi-low method
Costs are analysed into variable & fixed
elements using the hi-low method.
Step1 :
Select high and low activity levels and their
associated costs.
Step 2 :
Variable Cost per unit
=
Change in Cost / Change in level of activity
Step 3 :
Find fixed cost by substitution
Fixed cost per unit
=
Total cost – (Variable Cost per unit * Number of
units)
26. Cost Objects, Units & Centres
A Cost object : any
activity for which a
separate
measurement of cost
is undertaken, e.g. A
product
Cost centre : a
production or service Cost unit : a unit
location, function, of product or
activity or item of service in relation
equipment for which to which costs are
costs can be ascertained e.g. A
ascertained e.g. A
ward in a hospital. hotel room.
29. Expected Values
The weighted average of a probability distribution, used
in simple decision-making situations.
EV = ∑px
Where p = probability of outcome occurring
x = outcome.
When using Expected Values :
•Only accept projects if EV is positive
•With mutually exclusive options, accept the one with
the highest EV.
31. Expected Values - Limitations
Expected values :
• Use past data and estimates, which may be
inaccurate
• Are not always suitable for one-off decisions as they
are long-term average. The expected value might
never occur for any single result
• Do not take into account the time value of money
• Do not take into account the decision maker’s attitude
to risk.
32. Regression
If x is the independent variable and y the dependent variable,
least squares regression finds the line of best fit through the
scatter diagram.
y = a + bx
Where a is the y value when x is 0, and b is the change in y
when x increases by one unit.
33. Regression
In the context of cost estimation :
y represents the total cost
x represents the production volume in units
a represents the total fixed costs
b represents the variable cost per unit
(Given)
34. Correlation Coefficient
r measures the strength of a linear relationship between two
variables.
-1 < r < 1
• If r = 1 perfect positive correlation
•If r = 0, no correlation
•If r = -1, perfect negative correlation.
(Given)
Correlation does not prove cause and effect – it merely suggests it.
35. Coefficient of determination
r² shows how much of the variation in the dependent
variable is dependent on the variation of the independent
variable.
E.g. If r = 0.95, r² = 0.90 or 90%
This means that 90% of the variation in y (costs) is
explained by the variation in x (level of output).
39. Paperwork
Document Completed Sent to Information
by included
Purchase Requisition form Production department Purchasing department Goods required
Manager’s authorisation
Purchase order form Purchasing Department Supplier Goods required
Accounting (copy)
Goods receiving department
(copy)
Delivery note Supplier Goods Receiving Department Check of goods delivered
against order form
Goods Received Note Goods receiving department Purchasing department Verification of goods received to
enable payment
Materials requisition note Production department Stores Authorisation to release goods
Update stores record
Materials returned notes Production Department Stores Details of goods returned to
stores
Update stores record
Materials Transfer notes Production Department A Production Department B Goods transferred between
departments
Update stores records
44. Holding & Ordering Costs
Stock-out costs : Holding costs: Ordering costs :
running out of inventory holding inventory placing orders
Fixed costs
• Cost of storage Administrative
Loss of sales
space, insurance costs
Variable costs
Loss of customers • Interest on capital Delivery
and goodwill tied up in stock
Order costs vary
Reduced profits with number of
orders placed
Minimise total of holding, ordering and stock-out costs
45. Economic Order Quantity
The EOQ minimises the total of holding, ordering &
stock-out costs
EOQ =
√ 2C0D
Ch
Where :
D = demand p.a.
C0 = Cost of placing one order
Ch = cost of holding one unit per year
Annual ordering costs = C0D/Q
Annual holding cost = Ch*Q/2
47. Economic Batch Quantity
The number of manufactured items to produce in a batch,
to minimise total costs
EBQ =
√ 2C0D
Ch(1-D/R)
Where :
D = demand p.a.
C0 = Cost of setting up batch
Ch = cost of holding one unit per year
R = Annual replenishment (annual production) rate
Annual setup costs = C0D/Q
Annual holding cost = Ch*Q/2 (1-D/R)
48. Re-order levels
The pre-determined level of inventory at which order is
placed, to avoid stock-outs.
Re-order level = usage per day * lead time in days
When lead time and demand in lead time is not constant :
Re-order level = maximum usage*maximum lead time
Maximum Inventory level = Re-order level + re-order quantity –
(minimum usage*minimum lead time)
Minimum Inventory level (buffer stock) = Re-order level – (average
usage *average lead time)
Average inventory = (Re-order quantity / 2) + minimum inventory
50. Direct or Indirect Costs?
‘Type’ of worker
Indirect workers
Directly involved in making products (Maintenance staff,
supervisors, Canteen
Direct Labour cost Indirect Labour cost
•Basic Pay •General O/T
Indirect Labour cost
premiums
•Overtime Premium •Bonus payments
‘on specific job’, ‘at
customer’s request’
•Idle time
•Sick pay
ALL COSTS
•Time spent on indirect
jobs
Dr Bank – Labour Costs Incurred
Cr WIP – Direct Labour Costs
Cr Production Overheads – Indirect Labour Costs
51. Remuneration Methods
•Time Based Schemes
•Total Wages =
(hours worked * basic pay/hour) + (o/t hrs worked * o/t premium/hour)
•Higher quality if workers are happy to spend longer on units to get them right;
However, no incentive to improve productivity.
•Piecework Schemes
•Total Wages =
Number of units completed * agreed rate per unit.
•May involve a guaranteed minimum wage;
•May use a higher rate per unit once productivity target achieved
•Higher productivity at the expense of quality?
•Other Schemes e.g. Flat salary + bonus
•Bonus Schemes (individuals or groups)
57. Absorption costing
Step1 : O/H allocated or
apportioned to cost
centres using suitable OVERHEADS
bases
Step 2 : Service cost Production Production Service Service
centres reapportioned to Department Department Department Department
production cost centres A B C D
Step 3 : Overheads
absorbed into units of A B
production
Cost Unit x
58. Absorption costing
Step1 : Allocation is the charging of overheads directly to specific departments where they
can be identified directly with a cost centre or cost unit.
Apportionment is the sharing of overheads which relate to one department between those
departments on a fair basis.
Step 2 : Service department costs need to be reapportioned to the production departments,
using a suitable basis linked to usage of the service.
Step 3 : Costs within production cost centres are charged to a cost unit, using Overhead
absorption rates (OAR) based on :
•Labour or machine hours
•% of direct labour cost
•....
OAR
=
Budgeted overheads / Budgeted level of activity
60. Over- or under-absorption of
overheads
Overheads Absorbed
=
Actual labour hours * OAR per labour hour
Actual Overheads Incurred
Overhead under- or over-absorbed
Actual overheads Actual activity level
different from budget different from budget
61. Ledger Accounting
• In • Debited to
Production one of the
Overheads non-
production
Account OH accounts
Indirect Non-
Production production
Costs Overheads
Over- or
Absorbed
under-
Production
absorption
Overheads
overheads
• Transferred to • Credited to the
income production
statement at the overheads
end of the account
period
63. Contribution
Sales Revenue
Per Unit Total Sales Revenue
Variable cost
Variable Production & Non-production
Total Variable Costs
cost per unit
CONTRIBUTION
Per Unit Total Contribution
Fixed Costs
Fixed Production & non production cost
Total Production cost
per unit
PROFIT
64. Absorption & marginal costing
and profits
ABSORPTION COSTING MARGINAL COSTING
Valuing units Total production cost Marginal (variable)
production cost
Valuing inventory Opening and closing stock valued at OS and CS valued at
total production cost marginal cost
Fixed production Carried forward from one period to FC charged in full against
overheads the next as part of the closing / profit in the period in which
opening stock valuation. Only hit they are incurred
profit when units are sold.
Adjusting for over- or Yes – in the income statement None needed
under-absorption
Impact of increase in Gives higher profit Gives lower profit
inventory levels
Impact of decrease in Gives lower profit Gives higher profit
inventory levels
Inventory level Same profit under both systems
constant
65. Profit Statements
Sales Revenue Sales Revenue
Units Sold Price
Units Sold
* Price *
Cost of sales
Cost of sales Units sold Full prod. cost/unit
Units sold Marginal cost/unit *
*
Over/Under absorption
Variable non-production costs incurred
Gross Profit
Contribution
Variable non-production costs
Fixed costs
Production Non-Production Fixed non-production costs
Net Profit / (Loss) Net Profit / (Loss)
78. Other Relevant Costs
•The Relevant cost of overheads is only that which
varies as a direct result of the decision taken.
•Fixed Assets
•Relevant costs are treated as if related to materials
•If P+M is to be replaced, then relevant cost =
current replacement cost
•If P+M not to be replaced, then relevant cost is
higher of :
•Sales proceeds (if sold)
•Net cash inflows arising from use of the asset
(if not sold).
80. Single Limiting factor
A limiting factor is a
factor that prevents a
company achieving the
level of activity it would
like to.
Scarce resources are
where one or more of the
manufacturing inputs
needed to make a product
are in short supply.
81. Multiple Limiting factor
Linear
Programming is
the technique
used to
establish an
optimum
product mix
when there are
two more
resource
constraints.
82. Finding the solution – Method 1
Draw an example contribution
line by making up a suitable value
of C, such that the sample line is
easy to draw on the graph.
To solve a maximisation problem,
whilst keeping its slope constant,
slide the line out, away from the
origin.
Find the last point where this is still
feasible.
Solve simultaneously the equations
of the 2 lines that cross at the
optimal point identified on the
graph.
83. Finding the solution – Method 2
Co-ordinates of each of
the corners of the
feasible region are
calculated using
simultaneous
equations.
For each corner calculate
the value of the objective
function.
Select the corner with the
highest or lowest value,
depending on whether you
are minimising /
maximising.
85. Job Costing
Each job
is unique
Produce
a cost
card for
each job.
PROFIT can be a
Use the same
principles of mark-up on cost,
costing or a margin (%).
86. Batch Costing
Each batch
is different,
but items
identical.
Determine
total cost
of batch.
Cost per unit :
PROFIT can be a
Total Cost of mark-up on cost,
batch / Number of
units in a batch. or a margin (%).
87. Process Costing - Features
Production is continuous.
Difficult to identify units of production.
Closing WIP
Output of one Period 1
process = By- products
Part-finished
= Losses & joint
input of next units
Opening WIP products
process
Period 2
88. Process Costing – Losses &
Gains
Normal Abnormal Abnormal
Losses losses Gains
Actual Losses Actual Losses
EXPECTED to
> Normal < Normal
occur
losses losses
Abnormal
Do not pick up Pickup a share
gains debit the
a share of of process
process
process costs costs
account
Sometimes
Valued like a Benefit credits
sold for scrap –
unit of good the income
credit process
output statement
account.
Written off in Remember to
income Credit the
statement scrap account
Cost reduced by
scrap proceeds
89. Steps for answering questions
Draw
process
account
Value Good Enter
output &
Abnormal inputs and
Loss or Gain value(£)
Calculate Enter Normal
Average Cost Loss units &
per unit scrap value
Balance ‘units’ Enter Good
column with
Abnormal Output –
Loss or Gain Units only
90. WIP – Equivalent Units
If incomplete units at the beginning or the end of
the period, the concept of Equivalent Units (EU)
is used.
Process
costs can
100 half be spread
Material Conversion WIP valued
completed evenly
Cost costs Weighted
= 50 between
spread over spread over average or
completed completed
all units Eus FIFO
EUs & part-
completed
units.
91. WIP – Equivalent Units
AVCO 2 Methods FIFO
Opening Opening WIP
Inventory Values Units are
are added to completed first.
current costs to Process Costs in
provide overall the period allocated
average cost per between :
unit •Opening WIP units
•Units started &
completed in period
•Closing WIP Units
96. Service & operation costing
HETEROGENEITY INTANGIBILITY
Output service
industries is different
from product of
manufacturing.
SIMULTANEOUS
PERISHABILITY PRODUCTION &
CONSUMPTION
97. Suitable Cost Units
May be
Based on their
necessary to use More than one
relevance to the
composite cost type of cost unit
service provided
units
Service Possible Cost Unit
Hotel Cost per guest per night
Transport Cost per passenger mile
College Cost per student
Hospital Cost per patient day / cost per
procedure
100. Purpose
A quantitative expression of a plan of action prepared in
advance. It sets out the costs and revenues that are
expected in future periods.
Planning
Co-ordinating Activities Controlling Costs
Budgets
Communication of targets Performance
Evaluation
Motivation
Authorisation of expenditure
101. Preparing Budgets
Define long-term objectives of the business
Form budget committee to communicate budget
policy, set and approve budgets.
Produce budget manual
Identify principal budget factor
Produce budget for principal budget factor
Produce and approve other budgets based on
budget for limiting factor
Review variances
102. Different types of budgets
•The Master Budget includes the budgeted income
statement, the cash budget and budgeted statement of
financial position (Balance Sheet).
•A continuous budget is prepared for a year (or budget
period) ahead, and is updated regularly by adding a further
accounting period (month, quarter) when the first accounting
period has expired (= Rolling Budgets).
103. Functional budgets
Sales
Budget
Overheads Production
Budget Budget
Functional
Budgets
Raw
Labour Material
Budget Usage
Budget
Raw
Material
Purchases
budget
108. Fixed, flexible & flexed budgets
Fixed Flexible Flexed
Budget Compares budget Prepared at the budget
start of the Changes as the
Original Budget
period, for volume of activity
with actual
different possible changes
results
levels of activity
Remains
Useful for
unchanged even Best, Most Likely,
budgetary control
though level of Worst
purposes
activity changes
Cost behaviour
Does not assist
of the different
in variance
items in the
analysis
original budget
Hi-low method
109. Flexed Budgets and budget
variances
Variances are differences arising between the original
budget and actual results.
Volume Variance Expenditure Variance
Fixed Budget Flexed Budget Actual results
Original Original Actual
expenditure expenditure expenditure
levels for levels for levels for
budgeted actual activity actual activity
activity level level level
Total Variance
111. The purpose of standard
costing
Standard Costing is a
control tool for management.
Standard Costs are
collected on a standard cost
card. They may be based on
Absorption Costing or
Marginal Costing.
113. Types of standard
Ideal
What would be expected under perfect operating conditions
Attainable
Basic
What would be
Types of Standards A standard left
expected under
unchanged from
normal operating
period to period
conditions
Current
A standard adjusted for specific issues relating to the current
period
114. Variance Calculations
Are we working with a marginal or absorption costing system?
Marginal Costing Absorption Costing
Sales (Budgeted Sales – Actual Sales) x (Budgeted Sales – Actual Sales) x
Volume standard contribution/unit standard profit / unit
Variance
Standard Selling Price is not used. When volume changes, so do production costs, and the
purpose of the variance is to show the impact on profit or on contribution
Fixed MC does not relate fixed o/h to Fixed o/h are related to cost units by
overhead cost units – fixed overhead is a using absorption rates.
variances period cost. No fixed overheads
volume variance. The Fixed overhead total variance is
equal to the over- or under-absorption of
The fixed overhead expenditure overheads.
variance is the difference between
actual expenditure & budgeted The FO Volume variance can be further
expenditure. It is the total subdivided into efficiency & capacity
variance. variances.
115. Sales Price Variance
Sales Price Variance
(Budgeted Sales Price – Actual Sales Price)
X
Actual Quantity sold
116. Direct Materials Variances
Materials Price Variance
Actual units purchased X Standard Price
-
Actual units purchased X Actual Price
Material UsageVariance
(Actual production X Standard usage per unit) @ standard cost per
kg/litre
-
(Actual production X Actual usage per unit) @ standard cost per
kg/litre
117. Direct Labour Variances
Labour rate (price) Variance
Actual hours paid X Standard Rate
-
Actual hours paid X Actual Rate
Labour efficiency Variance
(Actual Production in Standard hours X Standard
hourly rate)
-
(Actual hours worked X Standard hourly rate)
118. Variable Overhead variances
Variable Overhead expenditure Variance
Actual o/h cost incurred –(actual hrs worked X variable OAR per hour)
Variable overhead efficiency Variance
(Actual hours worked X variable OAR)
-
(Actual production in standard hrs X variable OAR per hour)
119. Fixed Overhead Variances
Absorption Costing
Fixed Production Overheads Total Variance
Expenditure Volume
Variance Variance
Efficiency Capacity
Variance Variance
120. Fixed Overhead Variances
Absorption Costing
Under- or over-absorption of overheads
Budgeted FOH (Actual Production in
standard hours x OAR)
–
– Budgeted FOH
Actual FOH
(Actual hours (Actual Hours
taken – standard worked –
hours for output budgeted hours
achieved) x OAR worked) x OAR
121. Fixed Overhead Variances
Marginal Costing
Fixed Production Overheads Total Variance
Expenditure
Variance
