ACCN3007

Management
accounting &
finance
2014

Nadeem Mahomed
 Chapter 1
INTRODUCTION TO MANAGEMENT ACCOUNTING
1. Differences between Financial and Management Accounting 3. New Management Approaches

FINANCIAL MANAGEMENT • Cost Efficiency: accurate, monitor trends, analyse profits

• Quality: measure + evaluate, quality of goods and services
• Time: reduced cycle time
Statutory requirement Yes No • Innovation
• Continuous Improvement: benchmarking
Describes Organisation as Small parts of • Employee Empowerment
a whole organisation

4. Functions of Management Accounting

Standards IFRS Not required to 1. Allocate costs between goods sold + inventories for profit
adhere to any reporting
standards
2. Provide relevant information to help managers make better
decisions
- profitability analysis
Information Historical Focuses on the - resource allocation
future - discontinuation decisions
- product pricing
Intervals Yearly Produces at more
frequent intervals 3. Provide information for planning, control, performance
measurement + continuous improvement
- long-term + short-term planning
- evaluate managerial performance
- controlling costs + improving efficiency
2. The Changing Business Environment
• Protected markets  highly competitive markets
• Growth in service industry
• Declining product life-cycles
• Advances in manufacturing technology
• Environmental issues
• Customer orientation
 Chapter 2
COST TERMS & CONCEPTS
1. Cost Objects 5. Estimating Cost Functions
 activity for which a separate measurement of cost is required LINEAR FUNCTIONS
Evaluating the Cost Driver
• Engineering methods Economic plausibility (existence
Cost Collection Systems: • Inspection of accounts of cause-and-effect)
• accumulates costs by classification into categories • Graphical scatter graph method Goodness of Fit (𝑟 and 𝑟 2)
• assigns costs to cost objects • High-Low method Slope of Regression Line

• Regression Analysis
2. Direct & Indirect Costs
Direct: can be specifically + exclusively identified with a given cost NON-LINEAR FUNCTIONS
object (also PRIME costs) • Learning curves (for labour related costs)
Indirect: cannot be specifically + exclusively identified with a given 𝑌𝑥 average time per unit of cumulative production of 𝑋 units
cost object 𝑎 time required to produce first unit of output
𝑌𝑥 = 𝑎𝑋 𝑏 𝑋 number of units of output
* distinction depends on cost object log(𝑖𝑚𝑝𝑟𝑜𝑣𝑒𝑚𝑒𝑛𝑡 𝑟𝑎𝑡𝑒)
𝑏
log 2

Conversion costs = Direct Labour + Manufacturing Overheads

6. Avoidable & Relevant Costs
Avoidable: costs saved by not adopting a given alternative
3. Period & Product Costs
Relevant: future costs and revenues changed by a decision
Manufacturing PRODUCT COST unsold Recorded
Cost (attached to product) as asset costs of resources already acquired. Unaffected by choice
SUNK COSTS
between various alternatives (irrelevant)

Non-Manufacturing PERIOD COST Recorded costs that measures opportunity lost when choice of
OPPORTUNITY COSTS
Cost ( not attached to product) as expense one course of action requires the other to be given up

hypothetical cost taken into account to represent a benefit

4. Cost Behaviour NOTIONAL COSTS
enjoyed in respect of which no actual expense is incurred
Variable Costs: vary in direct proportion with activity
Fixed Costs: remain constant over wide ranges of activity INCREMENTAL COSTS additional costs from production of a group of units
Semi-fixed Costs: fixed within specified activity levels, eventually
change at critical levels MARGINAL COSTS additional costs from production of one additional unit
Semi-variable Costs: include fixed + variable components
 Chapter 3
COST ASSIGNMENT
1. Assignment of Direct & Indirect Costs 3. Two-Stage Allocation Process
Direct
Costs OVERHEADS
 Assign manufacturing overheads to cost centres
e.g. ABC

Cause and Effect COST Production

Centre
1
Production
Centre
2
Service
Centre
1
Service
Centre
2
Allocations
OBJECTS
Indirect  Re-allocate service cost centres to production cost centres
Costs e.g. Traditional O/H rate O/H rate
METHOD 1: SPECIFIC ORDER OF CLOSING
Arbitrary
Allocations
 Compute O/H - allocate service cost centre with highest cost first
rates for each - distribute other service cost centres, adjusting %s
use of allocation bases that are production cost METHOD 2: DIRECT ALLOCATION METHOD
not significant determinants of
cost centre - distribute all service cost centres, adjusting %s

 Assign cost centre

COST SYSTEMS
O/H to cost objects

4. Budgeted Overhead Rates

Actual overhead rates are not used because: Denominator Levels
• delay in product costs - theoretical max
capacity
• fluctuating overhead rates will occur
- practical capacity
- normal avg long-
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑂/𝐻
 Calculate BUDGETED overhead rate run activity
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝐿𝑒𝑣𝑒𝑙 - budgeted activity
2. Blanket Overhead Rates vs Departmental Overhead Rates
single O/H rate for   different O/H rates for  Apply Overheads (𝐴𝑐𝑡𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 𝐷𝑟𝑖𝑣𝑒𝑟 × 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑂/𝐻 𝑟𝑎𝑡𝑒)
organisation departments
 Compare ACTUAL O/H with APPLIED O/H
• minimises risk of arbitrary
 Under/over absorption?
allocations
• accuracy of costing is 𝐴𝐵𝑆𝑂𝑅𝑃𝑇𝐼𝑂𝑁 = 𝑇𝑂𝑇𝐴𝐿 𝑉𝐴𝑅𝐼𝐴𝑁𝐶𝐸
improved
• costs can be more readily
used for decision-making EXPENDITURE VARIANCE VOLUME VARIANCE
𝐵𝑢𝑑𝑔 𝑂/𝐻 − 𝐴𝑐𝑡 𝑂/𝐻 + 𝐴𝑐𝑡 𝑉𝑜𝑙 − 𝐵𝑢𝑑𝑔 𝑉𝑜𝑙 × 𝐵𝑢𝑑𝑔 𝑂/𝐻 𝑟𝑎𝑡𝑒
 Chapter 7
ALTERNATIVE COST ACCUMULATION SYSTEMS
ABSORPTION COSTING VARIABLE COSTING Reconciliation between Profits
- traces all manufacturing costs to products - traces all variable costs to products Variable Profit XX
- treats non-manufacturing costs as period costs - treats fixed manufacturing and Opening Stock (𝑢𝑛𝑖𝑡𝑠 × 𝑓𝑖𝑥𝑒𝑑 𝑚𝑎𝑛. 𝑂𝐻) X
non-manufacturing costs as period costs Closing Stock (𝑢𝑛𝑖𝑡𝑠 × 𝑓𝑖𝑥𝑒𝑑 𝑚𝑎𝑛. 𝑂𝐻) (X)
Income Statement Income Statement Absorption Profit XX
Sales XX Sales XX
Absorption Profit > Variable Profit
Cost of Sales (XX) Cost of Sales (XX) when production exceeds sales
Opening Stock Opening Stock
Variable Profit > Absorption Profit
+ Direct Materials + Direct Materials
when sales exceed production
+ Direct Labour + Direct Labour
+ Variable Manufacturing OH + Variable Manufacturing OH
+ Fixed Manufacturing OH - Closing Stock
- Closing Stock not included in
when Variable Non-Manufacturing OH (XX)
valuation of stock
Over/under absorption XX actual ≠ budgeted
CONTRIBUTION XX
production
GROSS PROFIT XX
Fixed Manufacturing OH (XX)
Variable Non-Manufacturing OH (XX)
Fixed Non-Manufacturing OH (XX)
Fixed Non-Manufacturing OH (XX)
NET PROFIT XX
NET PROFIT XX

STOCK measured at STOCK measured at

(VARIABLE PRODUCTION COST + FIXED PRODUCTION COST) VARIABLE PRODUCTION COST

Arguments on Favour Arguments on Favour

• IFRS compliant • provides more useful information for decision-
• does not understate importance of fixed costs making
• avoids fictitious losses being reported • eliminates effect of stock changes on profit
• consistent with external reporting requirements • avoids capitalisation of fixed overheads in stocks
that cannot be sold

FAVOURED BY: volatile sales and changing stock levels

FAVOURED BY: seasonal sales, where stocks are built up
used in industries where similar products are produced in the Chapter 5
same manner, consuming the same amount of direct costs and PROCESS COSTING
overheads

1. Process Costing when all output is fully complete 2. Equivalent Production & Closing WIP

𝐼𝑛𝑝𝑢𝑡 𝐶𝑜𝑠𝑡𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑙𝑜𝑠𝑠

𝑪𝑷𝑼 = Cost Completed WIP Equiv.
Total
Cost per
𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝑂𝑢𝑡𝑝𝑢𝑡 Element
Total Cost
Units Units
Equiv.
Unit
Units
PROCESS ACCOUNT Previous
Process XX X X XX X
Units CPU Units CPU Cost
Scrap Value
Material X Normal Loss X X X Materials XX X X XX X
Labour X Abnormal Loss X X X
Conversion
XX X X XX X
Transfer to Costs
Overheads X next process/ X X X
Finished goods XXX X
Normal CPU Normal CPU
Abnormal X X X
Gain
Value of Work-in-Progress: 𝑬𝒒𝒖𝒊𝒗 𝒖𝒏𝒊𝒕𝒔 × 𝐶𝑃𝑈
XX XX XX XX Previous Process Cost XX
Materials XX
Conversion Costs XX XX
NORMAL LOSS ACCOUNT
Completed Units (𝐶𝑜𝑚𝑝𝑙𝑒𝑡𝑒𝑑 𝑢𝑛𝑖𝑡𝑠 × X) XX
Units CPU Units CPU
XXX
Process X Bank X– X X
Account AG

Abnormal Gain X X X
Scrap Value
of NL
ABNORMAL LOSS ACCOUNT
Units CPU Units CPU

Process X Bank X X X
Account Scrap Value
of AL
Profit & Loss 𝛽 X
3. Opening WIP

WEIGHTED AVERAGE METHOD

 assumes opening WIP is merged with current production

Current WIP Total Cost

Cost Opening Total Completed
Period Equiv. Equiv. per
Element WIP Cost Units
Cost Units Units Unit
Value of Work-in-Progress : 𝑬𝒒𝒖𝒊𝒗 𝒖𝒏𝒊𝒕𝒔 × 𝐶𝑃𝑈
Previous Previous Process Cost XX
Process X X XX X X XX X Materials XX
Cost
Conversion Costs XX XX
Materials X X XX X X XX X

Conversion
Completed Units (𝐶𝑜𝑚𝑝𝑙𝑒𝑡𝑒𝑑 𝑢𝑛𝑖𝑡𝑠 × X) XX
X X XX X X XX X XXX
Costs

XXX X

FIFO METHOD
 assumes opening WIP is completed first

Completed Closing
Current Total
Cost Units less WIP Cost per
Period Current
Element
Cost
opening WIP Equiv.
Equiv. Units
Unit Value of Work-in-Progress : 𝑬𝒒𝒖𝒊𝒗 𝒖𝒏𝒊𝒕𝒔 × 𝐶𝑃𝑈
equiv. units Units
Previous Process Cost XX
Previous Materials XX
Process XX X X XX X Conversion Costs XX XX
Cost

Materials XX X X XX X Cost of Completed Production: 𝑪𝒐𝒎𝒑𝒍𝒆𝒕𝒆𝒅 𝒖𝒏𝒊𝒕𝒔 × 𝐶𝑃𝑈

Conversion Opening WIP (pure cost) XX
XX X X XX X Previous Process Cost XX
Costs
Materials XX
XXX X Conversion Costs XX XX
XXX
4. Losses in Process and Equivalent Production

Where WIP has reached inspection point (Short-cut Method)

 apportions share of Normal Loss to WIP and Abnormal Loss

Total
Cost Completed Abnormal WIP Equiv. Cost per
Total Cost Equiv.
Element Units Loss Units Unit
Units Value of Work-in-Progress : 𝑬𝒒𝒖𝒊𝒗 𝒖𝒏𝒊𝒕𝒔 × 𝐶𝑃𝑈
Previous Previous Process Cost XX
XX X X X XX X Materials XX
Process Cost
Conversion Costs XX XX
Materials XX X X X XX X

Conversion
XX X X X XX X Completed Units (𝐶𝑜𝑚𝑝𝑙𝑒𝑡𝑒𝑑 𝑢𝑛𝑖𝑡𝑠 × X) XX
Costs

XXX X Abnormal Loss (𝐴𝑏𝑛𝑜𝑟𝑚𝑎𝑙 𝐿𝑜𝑠𝑠 × X) XX

XXX

Where WIP has not reached inspection point

Normal Loss Total Value of Work-in-Progress : 𝑬𝒒𝒖𝒊𝒗 𝒖𝒏𝒊𝒕𝒔 × 𝐶𝑃𝑈

Cost Completed WIP Equiv. Cost per
Element
Total Cost
Units
(equiv.
Units
Equiv.
Unit
Materials XX
units) Units Conversion Costs XX
Materials XX X X X XX X Share of Normal Loss XX XX
Conversion
Costs
XX X X X XX X Completed Units
𝐶𝑜𝑚𝑝𝑙𝑒𝑡𝑒𝑑 𝑢𝑛𝑖𝑡𝑠 × X XX
XXX X Share of Normal Loss XX XX
XXX
Cost of Normal Loss:
Materials XX
Conversion Costs XX
XX
Apportion in ratio of Completed
Units and WIP equiv. units
 Chapter 6
JOINT & BY-PRODUCT COSTING

JOINT PRODUCTS BY-PRODUCTS

outputs of a process that produces a group of products products that emerge incidentally from the production of major
simultaneously, with each product having a significant relative sales products and have a relatively minor sales value
value

* not identifiable until split-off point, therefore costs cannot be * main objective is to produce Joint Products, joint costs should only
traced to individual products be allocated to Joint Products
* Decision-making: do additional costs justify additional revenue?
Deduct NET REVENUE from JOINT COSTS
PHYSICAL MEASURES METHOD SALES VALUE METHOD
Dr Cash X
- costs are allocated - costs are allocated Cr By-Product X
according to ratio of according to ratio of sales Revenue from sale of by-products
volumes produced revenues
Dr By-Product X
 simple  costs allocated on basis of Cr Cash X
 joint-products must be product’s ability to absorb Further manufacturing costs for by-products
measurable by the same joint costs
unit of measurement  based on assumption that Dr By-Product X
sales determines prior Cr Joint Process Account X
costs Deduction of net revenue from by-products from joint costs

NET REALIZABLE VALUE METHOD CONSTANT GROSS % METHOD

- for when further processing - costs are allocated so that
costs are required overall gross profit % is the
- costs are allocated same for each product
according to ratio of NRV
𝐴𝑙𝑙𝑜𝑐𝑎𝑡𝑒𝑑 𝑐𝑜𝑠𝑡𝑠
𝑁𝑅𝑉 = 𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 – 𝐹𝑢𝑟𝑡ℎ𝑒𝑟 𝑐𝑜𝑠𝑡𝑠
= 𝑆𝑎𝑙𝑒𝑠 – 𝐹𝑢𝑟𝑡ℎ𝑒𝑟 𝑐𝑜𝑠𝑡𝑠
 Chapter 17
STANDARD COSTING & VARIANCE ANALYSIS
Price Variances Quantity Variances
1. Operation of a Standard Costing System 4. Variances
(𝐵𝑢𝑑𝑔 − 𝐴𝑐𝑡) × 𝐴𝑄 (𝐵𝑢𝑑𝑔 − 𝐴𝑐𝑡) × 𝑆𝑃
• Suited for a series of common or repetitive operations
• Variances are traced to responsibility centres (not products) VARIANCE SYSTEM ABSORPTION SYSTEM
• Actual costs are not required
• Comparisons after event provide information for corrective action or MATERIAL
highlight the need to revise the standards Price (𝑆𝑃 − 𝐴𝑃 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡) × 𝐴𝑄
Usage (𝑆𝑄 − 𝐴𝑄 𝑢𝑠𝑒𝑑) × 𝑆𝑃
Mix (𝐴𝑄 𝑖𝑛 𝑠𝑡𝑑 𝑚𝑖𝑥 − 𝐴𝑄 𝑢𝑠𝑒𝑑) × 𝑆𝑃
Yield (𝐴𝑐𝑡. 𝑌𝑖𝑒𝑙𝑑 − 𝑆𝑡𝑑. 𝑌𝑖𝑒𝑙𝑑 𝑓𝑟𝑜𝑚 𝑎𝑐𝑡 𝑖𝑛𝑝𝑢𝑡) × 𝑆𝐶
2. Establishing Cost Standards
Total 𝐴𝑃𝑟𝑜𝑑 × 𝑆𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 − 𝐴𝐶
• Past Historical Records
• Engineering Studies LABOUR
- detailed study of each operation Wage Rate (𝑆𝑅 − 𝐴𝑅) × 𝐴𝐿𝐻
- do not take the ‘human factor’ into account Efficiency (𝑆𝐿𝐻 − 𝐴𝐿𝐻) × 𝑆𝑅
Total 𝐴𝑃𝑟𝑜𝑑 × 𝑆𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 − 𝐴𝐶
3. Purposes of Standard Costing
- provides prediction of future costs that can be used for decision- VARIABLE PRODUCTION OVERHEAD
Expenditure (𝑆𝑅 − 𝐴𝑅) × 𝐴𝐻
making
Efficiency 𝑆𝐻 − 𝐴𝐻 × 𝑆𝑅
- provides a challenging target that motivates individuals
Total 𝐴𝑃𝑟𝑜𝑑 × 𝑆𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 − 𝐴𝐶
- assists in setting budgets and evaluating performance
- acts as a control device by highlighting those events that do not
conform to plan FIXED PRODUCTION OVERHEAD
- simplifies the task of tracing costs to products for inventory valuation FOH Volume - 𝐴𝑃𝑟𝑜𝑑 − 𝐵𝑃𝑟𝑜𝑑 × 𝑆𝑅 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
Efficiency 𝑆𝐻 − 𝐴𝐻 × 𝑆𝐹𝑂𝐻 𝑟𝑎𝑡𝑒
Capacity 𝐴𝐻 − 𝐵𝐻 × 𝑆𝐹𝑂𝐻 𝑟𝑎𝑡𝑒
5. Reconciliation of Budgeted and Actual Profit Expenditure 𝐵𝑢𝑑𝑔 𝐹𝑂𝐻 − 𝐴𝑐𝑡 𝐹𝑂𝐻 𝐵𝑢𝑑𝑔 𝐹𝑂𝐻 − 𝐴𝑐𝑡 𝐹𝑂𝐻
Total 𝐴𝑃𝑟𝑜𝑑 × 𝑆𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 − 𝐴𝐶
𝐴𝑐𝑡𝑢𝑎𝑙 𝑃𝑟𝑜𝑓𝑖𝑡 = 𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑃𝑟𝑜𝑓𝑖𝑡 ± 𝑇𝑜𝑡𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑛𝑐𝑒𝑠
SALES MARGIN
AM = 𝑆𝑆𝑃 − 𝑆𝑉𝐶 𝑆𝑆𝑃 − 𝑆𝑉𝐶 − 𝑆𝐹𝐶
AM = 𝐴𝑆𝑃 − 𝑆𝑉𝐶 𝐴𝑆𝑃 − 𝑆𝑉𝐶 − 𝑆𝐹𝐶

Price (𝐴𝑀 − 𝑆𝑀) × 𝐴𝑉

Volume (𝐴𝑉 − 𝐵𝑉) × 𝑆𝑀
Quantity (𝐵𝑉 − 𝐴𝑄 𝑖𝑛 𝑏𝑢𝑑𝑔 𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛) × 𝑆𝑀
Mix (𝐴𝑄 𝑖𝑛 𝑏𝑢𝑑𝑔 𝑝𝑟𝑜𝑝𝑜𝑟𝑡𝑖𝑜𝑛 − 𝐴𝑄) × 𝑆𝑀
Total 𝐴𝑅𝑒𝑣 − 𝑆𝑉𝐶𝑂𝑆 × 𝑇𝑜𝑡𝑎𝑙𝐵𝑀
 Chapter 11
ACTIVITY-BASED COSTING
1. Need for Cost Accumulation System 4. Two-Stage Allocation Process
• Indirect costs are relevant for decision-making  Identify major activities
- influenced by total cost and ability of a single driver
• An attention-directing information system is required to identify COSTS to provide a satisfactory determinant of cost
potentially unprofitable products that require more detailed studies
• Product decisions are not independent  Assign costs to cost centres (direct +
Activity Cost Activity Cost Activity Cost indirect)
Centre Centre Centre
2. Types of Cost Systems 1 2 3

Direct Traditional ABC  Determine cost driver for each activity

O/H rate O/H rate O/H rate
- indirect costs not - unsophisticated - sophisticated
assigned methods to methods to
 Assign cost of activities to products (cost
- used where costs allocate costs allocate costs
objects)
are mainly direct
Comparison
- allocate costs to - allocate costs to 5. Classification of Activities
departments activities
- rely on little - use many • UNIT LEVEL ACTIVITIES
volume-based second-stage - performed each time a unit is produced
cost drivers cost drivers - resources consumed in proportion to number of units produced
- use arbitrary - use only cause-
allocation bases and-effect cost • BATCH-RELATED ACTIVITIES
drivers - performed each tome a batch of goods is produced
- costs vary with number of batches made
- merge support - establish
and production separate rates • PRODUCT/SERVICE SUSTAINING ACTIVITIES
costs for support
- enable production of products or services
centres

3. The Emergence of ABC Systems • FACILITY/BUSINESS SUSTAINING ACTIVITIES

- performed to support the organisation as a whole
Traditional systems were appropriate when:
- common to all products/services
- direct costs were dominant costs
- indirect costs were relatively small
- information costs were high
- there was a lack of intense global competition
- a limited range of products were produced

* if volume bases are not the cause of indirect costs, costs will be
misleading and motivate the wrong strategy
 systematic method of examining the Chapter 8
relationship between: COST-VOLUME-PROFIT ANALYSIS
• changes in activity, selling price, variable
costs per unit, fixed costs AND
4. Operating Leverage 7. Approach to Uncertainty
• changes in total sales, total costs,
operating income  measures sensitivity of profits to changes in sales  Identify objective of decision-maker
 Identify set of alternative actions
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛
 Identify set of relevant events that
1. CVP Model Analysis 𝑃𝑟𝑜𝑓𝑖𝑡
can occur
• Revenue changes only because of changes in number  Assign probabilities for events
of units sold 5. Multi-product Companies  Identify possible outcomes
• Costs can be accurately divided into fixed and variable If sales mix is given in:
• Fixed costs do not change • units, use UNIT breakeven point
• Unit variable cost and selling price are constant per • revenue, use CM% breakeven point
unit of output
• All other variables remain constant
• Profits are calculated on a variable costing basis 6. Multiple Cost Driver Situations
• The analysis applies over the relevant range only If any costs are driven by a cost driver
• A constant sales mix is achieved as output changes other than that that drives revenue, those
• Relationship between total revenue and cost is linear costs are treated at Fixed Costs in
• All revenues and costs are compared without taking breakeven calculations
into account the time value of money (Short-term)

2. Breakeven Point 3. Target Operating Income

EQUATION METHOD 𝑂𝐼 = 0 𝑆𝑃. 𝑄 = 𝑉𝐶. 𝑄 + 𝐹𝐶 𝑆𝑃. 𝑄 − 𝑉𝐶. 𝑄 − 𝐹𝐶 = 𝑇𝐴𝑅𝐺𝐸𝑇

Unit method Unit method

𝑇𝑜𝑡𝑎𝑙 𝐹𝐶 𝑇𝑜𝑡𝑎𝑙 𝐹𝐶 + 𝑇𝑂𝐼
𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
* TOI becomes another ‘cost’ to cover
CONTRIBUTION METHOD
Revenue methods Revenue methods
𝑇𝑜𝑡𝑎𝑙 𝐹𝐶 𝑇𝑜𝑡𝑎𝑙 𝐹𝐶 𝑇𝑜𝑡𝑎𝑙 𝐹𝐶 + 𝑇𝑂𝐼 𝑇𝑜𝑡𝑎𝑙 𝐹𝐶 + 𝑇𝑂𝐼
× 𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠 × 𝑇𝑜𝑡𝑎𝑙 𝑆𝑎𝑙𝑒𝑠
𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 % 𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝐶𝑜𝑛𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑀𝑎𝑟𝑔𝑖𝑛 %

Where Where
GRAPH METHOD Total Revenue = Total Cost Total Profit = TOI
 Chapter 9
RELEVANT COSTING
1. Definitions 4. Special Studies
RELEVANT COSTS (REVENUES) SPECIAL PRICING DECISIONS
future costs (revenues) that will be changed by a - one-time orders
decision - orders below normal market price when there is idle capacity

SUNK COSTS
costs of resources already required and are unaffected MAKE-OR-BUY (OUTSOURCING) DECISIONS
by the choice between alternatives - involves obtaining goods and services from outside suppliers instead of from within the entity

2. Decision-Making Process DECISIONS OF REPLACEMENT OF EQUIPMENT

- IRRELEVANT COSTS: original cost of old equipment, written down value, depreciation
 Gather information - RELEVANT COSTS: disposal value of old equipment, cost of new equipment, difference in operating
 Make predictions costs
 Choose an alternative
 Implement the decision
 Evaluate performance DISCONTINUATION DECISIONS
- routine profitability analysis provides attention-directing information that highlights potential
unprofitable activities
3. Consideration of Factors
QUANTITATIVE ANALYSIS PRODUCT-MIX DECISIONS WHEN CAPACITY CONSTRAINTS EXIST
- relevant financial inputs are future cash flows that - decisions on optimal product mix
will differ between various alternatives - constraints = limiting factors
1 CONSTRAINT, MULTIPLE PRODUCTS: rank according to contribution per limiting factor
QUALITATIVE ANALYSIS > 1 CONSTRAINT, 2 PRODUCTS: use linear programming
- product quality
- staff training and morale
- pricing decisions
- legal implications
- long-term effects of decision
 Chapter 10
PRICING DECISIONS

PRICE SETTER PRICE TAKER COST-PRICING

 price stability
facing short-term decisions facing short-term decisions  simplicity
 easy to apply where firm produces many products
 can be used as a guide, taking into account other factors
Typically encountered when there is Typically encountered when there is
temporarily unused capacity and faced temporarily unused capacity and faced  ignores demand
with an opportunity of a special order with an opportunity of a special order  does not necessarily ensure that Total Revenue > Total Cost
 can lead to inappropriate decisions if budgeted activity is used
Conditions that must consist: Conditions that must consist:  circular reasoning
• price > incremental costs of order • price > incremental costs of order
• sufficient capacity to meet order • sufficient capacity to meet order
• bid price should not affect future • bid price should not affect future
prices prices
• unused capacity only utilised for a • unused capacity only utilised for a Pricing Policies
short period and will be released for short period and will be released for
PRICE DISCRIMINATION
more profitable opportunities more profitable opportunities
PEAK-LOAD PRICING

facing long-term decisions facing long-term decisions PRICE-SKIMMING

- exploitation of markets that are relatively price insensitive
- once market is saturated, prices are lowered
In the long-term, firm can adjust the Undertake periodic profitability analysis
supply of resources to distinguish between profitable and  when substitutes are available
∴ product/service should be priced to unprofitable products
cover all resources committed to it PENETRATION PRICING
Profitability analysis ⇒ Special studies - concept of charging low prices initially with the intention of
gaining rapid acceptance
Non-Customised
• Cost-plus Pricing  close substitutes are available
• Target Pricing  product is new
Customised
• Cost-plus Pricing
 Chapter 21
STRATEGIC COST MANAGEMENT
1. Target Costing 3. Activity-Based Management 6. Just-In-Time Systems
deployed in PLANNING STAGE to give maximum impact
based on the premise that activities consume  making of substantial changes to how
in determining level of locked-in costs
costs organisation currently operates
To achieve target cost, design teams use:
AIM: enable customer needs to be satisfied while AIM: to reduce waste by producing required items at
making fewer demands on resources the required quality and in the required quantities,
REVERSE ENGINEERING (AKA ‘Tear-Down Analysis’)
at the precise time they are required
- examination of competitor’s product to identify
By managing activities, costs will be managed in
opportunities for improvement
the long-term MAIN FEATURES:
- provides insights about processes used and cost of
- need to understand: • re-arrangement of processes
product
(i) what factors cause activities to be • reducing set-up times
- aim: benchmark design and incorporate advantages
performed • emphasis on Total Quality Management
(ii) what causes activity costs to change • workforce that can multi-task
• JIT purchasing arrangements
VALUE ANALYSIS
Need to reduce the cost of NON-VALUE ADDING • modification of performance measures and
- examination of factors that affect cost
activities, as this will not reduce the value of the costing systems
- aim:
products to customers
(i) identify designs that reduce cost without
sacrificing functionality 7. Quality Cost Management
(ii) eliminate unnecessary functions that increase 4. Benchmarking
cost and which customers will not pay more for
 involves comparing key activities with best COST OF QUALITY REPORT:
practices found within + outside the  indicates total cost of producing products that do
PROCESS IMPROVEMENTS organisation not conform to quality requirements
- processes to produce and market product are
potential sources of cost AIM: identify an activity that needs to be • Prevention costs
improved, studying how that activity is done or • Appraisal costs
can be improved and implementing those • Internal failure costs
improvements • External failure costs
2. Kaizen Costing
5. Business Process Re-Engineering NON-FINANCIAL MEASURES:
 term for making improvements to a process through
• defective goods delivered
small incremental amounts
 making of substantial changes to how • customer complaints
organisation currently operates • % of products that do not meet warranty req.
DIFFERENCE BETWEEN KAIZEN AND TARGET COSTING
• % of deliveries not on time
- Kaizen is applied in manufacturing phase
AIM: to improve key business processes by
- Kaizen costing focuses on reducing costs through
focusing on simplification, cost reduction,
increase in efficiency of processes; Target costing
improved quality and enhanced customer
focuses on reducing costs through product design
satisfaction
- relies on employee empowerment
 Chapter 19
PERFORMANCE EVALUATION
Determining which Assets/Income must be included:
- include assets/income over which the respective BALANCED SCORECARD
division has control • Financial Performance
• Customer Satisfaction
Return on Investment  simple to calculate • Internal Business Processes
 relative measure, easy to compare • Learning & Growth, Innovation
𝑰𝒏𝒄𝒐𝒎𝒆
𝑹𝑶𝑰 =  ignores risk
𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
 easy to manipulate need rewards to motivate employees to achieve company’s
- income must be what manager has control over  can lead to incorrect decisions from org. view
goals
 accounting-based measure of profit
- performance evaluation must be aligned to strategy
- need to evaluate managers on measures which will
Residual Income  considers risk (𝑟𝑒𝑞𝑢𝑖𝑟𝑒𝑑 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛) maximise sustainable long-term growth
 motivates correct decisions
𝑹𝑰 = 𝑰𝒏𝒄𝒐𝒎𝒆 − (𝑹𝒆𝒒𝒖𝒊𝒓𝒆𝒅 𝒓𝒂𝒕𝒆 𝒐𝒇 𝒓𝒆𝒕𝒖𝒓𝒏  considers income relative to investment
× 𝑰𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕) * Evaluation must only be made on items within respective
manager’s control
 absolute number - need to consider structure:
- profit excl. interest, dividends etc.  accounting-based measure of profit
- is profit enough to pay out investors? COST CENTRE: E
PROFIT CENTRE: I, E
Economic Value Added INVESTMENT CENTRE: A, I, E
 expansion of RI
 adjustments likely to lead to more goal * Effect of manipulation is combatted by used of non-
𝑬𝑽𝑨 = 𝑶𝑰𝑨𝑻 − 𝑾𝑨𝑪𝑪 × (𝑻𝑨 − 𝑪𝑳) congruent decisions
financial performance measures
OIAT Operating Income after Tax  easy to manipulate
 economic profit, excluding interest Targets
 encourages S/T decisions at expense of L/T
WACC Weighted-average Cost of Capital benefits - motivates and encourages employees
TA Total Assets what needs to be  difficult to compute - should be flexible
CL Current Liabilities financed  does not consider inflation - need to be challenging but still achievable
- employees should be involved in target-setting

Weighted-Average Cost of Capital Ongoing Process

- system must be continually addressed
𝑬 𝑫 - communication must be clear
𝑾𝑨𝑪𝑪 = × 𝑹𝒆 + × 𝑹𝒅 𝟏 − 𝒕
𝑽 𝑽 * use market values for E and D
E Equity * use market-related rates, adjusted for tax, for
D Debt sources of finance (D)
V Total Market Value of E and D
Re/Rd Return on Equity/Debt