Chapter 1: Introduction to accounting

Accountability: the quality of being accountable Assumption 2: Monetary Measurement or Measurability

Accounting: technical, social and moral practice concerned with - Financial statements only include transactions measured
the sustainable utilisation of resources and proper accountability reliably and accurately using monetary unit of measurement
to stakeholders to enable the flourishing of organisations, people (AUD)
and nature Assumption 3: Accrual Basis
Types of business structures: - Measures all business transactions in accordance with when
Sole proprietorship: consists of a single individual they occur, whether they may involve cash or not
- Benefits: ease of formation, high level of control Assumption 4: Going Concern
- Risks: unlimited personal liability, limited life for the business, - Assumes a business will continue to operate as normal in
limited ability to raise capital and limited expertise foreseeable future
Partnership: consists of two or more people who contribute to the - A company filing to repay bank loans and experiencing
business declining sales is likely to not be a going concern
- Benefits: ease of formation, better access to capital and Assumption 5: The Period Assumption
expertise - Describes the time interval between financial statement
- Risks: unlimited personal liability, limited life of partnership reports
Corporation: involves one or more owners who are legally distinct o Company can present useful info in short time periods
from the business Principle 1: Revenue Recognition Principle
- Easy to access large amounts of capital through loans or - Directs a company to recognise revenue in the period in
selling shares which it’s earned
- Business operates beyond the life of the shareholders - Does not need to be a correlation between when cash is
collected and when revenue is recognised
Chapter 2: Processing and Recording Economic Principle 2: Matching Principle
Events - Matching expenses with associated revenues in the period
Process of Accounting which the revenue was earned
1. Identifying Principle 3: Historical Cost Principle
- Refers to business transactions - Assets must be recorded as its value at the date of acquisition
- Includes: Principle 4: Conservatism Principle
o Withdrawals of cash - Uncertain/estimated expenses/losses should be recorded,
o Payment of wages/salaries but uncertain or estimate revenues/gains should not
o Earning of revenue Accounting Equation
o Purchases Assets = Liabilities + Owners Equity
o Capital contribution Expanding the equation
o Incurring of interest on loans
2. Measuring
- Analysis, recording, and classifying of business transactions
- How transactions will affect the entity’s position
- Individual assets, expenses, income, equity and liabilities
3. Communicating
- Done through accounting reports
- Requires extensive training, experience, and judgement
4. Decision making Assets:
- Info reported on financial statements should be relevant and - Cash, accounts receivable, inventory, supplies, prepaid
reliable to make sound decisions expenses, notes receivable, equipment, buildings, machinery
- Important decisions include whether to invest, to and land
manufacture or outsource, or if debts can be paid Liabilities:
Methods for measuring value - Accounts payable, notes payable, unearned revenue
Historical cost: Assets of a company recorded at the price for Equity:
which they were originally acquired - Contributed capital, retained profits, dividends, shareholders
Replacement cost: cost to a business to acquiring an asset equity/new shares
identical to an existing one Chapter 3: Refining the Recording Process
- Equivalent to original cost - Current asset – used or consumed in a year or less
- Changes with time as price fluctuates - Non-current asset – used or consumed over a longer period
Fair value: measure of an item’s market price on a particular date of time
Not realisable value: the value of a product after subtracting - Current liabilities – settled in one year or less
expected costs – calculated as historical cost less depreciation - Non-current liabilities – expected to be settled in more than
Present value: the value at the present time of a payment/cash one year
flow occurring in past/future – involves taking future cash flow Sales for cash
and discounting them at appropriate rate
Assumptions and principles
Assumption 1: Economic Entity
- Business is separate from the owner
- Entity only records activities on financial statements related
to operations
Sales made on credit Recognising the use of property, plant, equipment (PPE)

Customer repayments for sales on credit

Receiving the funds from a bank loan

Sales made in advance

Making loan repayments

Completing the job for sales made in advance

Making interest-only repayments

Purchases for cash

Repaying an interest only loan at the end of the loan term

But in the real world, buying supplies is an expense

Paying wage-earning employees

Purchases made on credit

Paying salaried employees

Making repayments for purchases on credit

Recognising employee work at the end of the year

Prepayment of expenses

Paying employees after recognising prior work

Using up prepaid expenses

Issuing shares

Recognising when we use inventory

Paying dividend using cash

Purchase of non-current assets

Paying dividends using shares
Chapter 4: Systems of Internal Control and Internal controls over cash
How businesses manage cash:
Reducing Fraud 1. Payments for goods and services can only be made
Framework for systems of internal controls electronically
- Internal controls: systems used by a business to manage risk 2. Cash registers track all transactions
and diminish the occurrence of fraud 3. Security cameras
Control environment: the 4. Regular checks of bank statements
culture that management
creates, and how they
Chapter 5: Creating the Financial Statements for
hire and remunerate External Users
employees. It strongly - Creating a trial balance: contains the closing balance for every
influences employee single account used by the company
attitudes about fraud. Creating a profit and loss statement
Risk assessment: It is - We need the trial balance to create the profit and loss
an assessment of statement
their operating
environment to Revenues
identify any potential risks and ability to achieve their goals. Less Cost of Sales
Internal control activities: policies, procedures, systems and Gross Profit
processes to ensure all employees engage in a manner that helps
the business achieve its objectives. Less Expenses
Communication and information systems: important for Marketing
Rent
businesses to gather data about their processes to allow them to
Wages
make optimal decisions in their day to day operations.
Utilities
Monitoring of internal controls: it oversees all of the other
Net Profit Before Tax
components, and is important for management of a business to Creating a statement of changes in equity (SoCiE)
know when that control stops operating – a failing control - It is a reconciliation between the opening balance of Equity
increases the opportunity for fraud. and any transactions related to the equity, to provide the
Identifying risks using fraud triangle closing balance of equity
Detected through:
Monitoring the aspects of Opening Balance + Profits + Share Capital – Dividends = Closing Balance
the fraud triangle,
Analytics tools to monitor Creating a balance sheet
systems and data, - Balance sheet is a statement of financial position
Regular audits, - Shows the position of the company at a single point in time
Hotline to report fraud, Sample Company Ltd
Forensic investigation. Balance Sheet
As at 30 June 20XX
Identifying common components of internal controls ASSETS
- Establishment of clear responsibilities – allows for issues that
are uncovered to be easily traced and responsibility placed Current assets
where it belongs Non-current assets
- Proper documentation – can be paper copies/documents or Total assets
can computer generated and stored on flash drives or online LIABILITIES
- Adequate insurance – may be a significant cost to a business,
Current liabilities
but is necessary specifically in regards to assets
Non-current liabilities
- Separation of duties – to minimise the risk of fraud, certain
Total liabilities
staff members have authorisation power for transactions NET ASSETS (Total assets – Total liabilities)
- Use of technologies – has made the process of internal EQUITY
control simpler and more approachable to all businesses
Designing internal controls Share capital
Step 1: What is the risk? Reserves
- Conduct the risk assessment (errors or frauds?) Retained earnings (or Accumulated losses)
- Should be conducted in a separate transaction process Total equity
Step 2: Design the control Understanding the statement of cash flows
- Tools and technology - A summary of cash inflows and outflows for the business over
- Separation of duties? the financial period that covers 3 main categories:
After designing the internal controls Operations, Investing, Financing
- Implementation – new systems, training staff, etc
- Monitoring
Understanding financial reporting requirements in Australia for - Measures the financial health of an organisation in the short-
different types of businesses term
Business Liability Keep Submit Have - Larger difference – business can cover ST debts
type accountin financial financial - Too large difference – business may not be correctly using
g records statement statements assets to grow business
s to audited Working Capital = Current Assets – Current Liabilities
regulator Liquidity ratios – current ratio
Sole Unlimite Yes (5 No No - Higher ratio the more likely the company can cover ST debt
trader d years) Current ratio = Current assets/current liabilities
Partnershi Unlimite Yes (5 No No The best range is between 1.5:1 to 2:1
p d years)
Liquidity ratios – quick ratio
Proprietar Limited Yes (7 No At the
- CA are more narrowly defined as the most liquid assets
y company years) request of
Quick ratio = (Cash + ST investments + Acc receivables)/Current Liabilities
shareholder
Solvency ratios – debt to equity ratio
s
- Less risky and less costly to use equity for financing
Public Limited Yes (7 Yes Yes
company years) - For every $1 of equity, a certain amount is contributed
Debt to equity = Total Liabilities/Total Equity
Chapter 6: Analysing Financial Reports Ratio > 1 = less equity than debt
Financial statement analysis Ratio < 1 = more equity than debt
- Reviews financial information found on financial statements Solvency ratios – times interest earned
to make informed decisions about the business - Ability to pay interest expense on LT debt
Advantages: TIE= (Earnings before interest and taxes)/interest expense
- Helpful in making future business decisions Efficiency ratio – accounts receivable turnover
- Assists with understanding the makeup of current operations - How many times in a period a business will collect cash from
within the business accounts receivable
Disadvantages: - Higher number is preferable as cash collected can be
- Past performance does not always dictate future perform. reinvested at a quicker rate
- Economic influences skew numbers being analysed AccRecTurnover = (Net Credit Sales)/(Average Accounts Receivable)
(inflation/recession) AvgAccRec = (Beginning Acc Rec + Ending Acc Rec)/2
Horizontal and vertical analysis Higher ratio, the better indicates more regular collection of debt
Horizontal analysis: looks at trends over time on various financial Shorter avg days indicates quicker return of credit to those owing the bus.
statement line items Efficiency ratio – days in receivables
- Gives businesses valuable info on overall performance and - How many days a customer’s debt is outstanding before they
areas for improvement pay
Dollar change = Year of Analysis Amount – Base Year Amount Days in receivables = 365/Acc Rec Turnover
Percent Change = (Dollar change/Base year amount) x 100 The average period of time to give a customer credit is 30 days
Vertical analysis: comparison of a line within a statement to Efficiency ratio – inventory turnover
another line item within that same statement - How many times during the year a business has sold and
- Can help a business to know how much of one item is replaced inventory
contributing to overall operations - Higher ratio is preferable
- The business needs to determine which line they are - Extremely high ratio – company does not have enough
comparing and calculate the % makeup inventory available to meet demand
- Typical for an income statement to use revenue as the - Low ratio means too much supply of inventory
comparison line item – revenue is set at 100% and all other Inventory turnover = COGS/Avg inventory
line items will be a percentage of revenue Avg inventory = (Beginning inventory + Ending inventory)/2
- On the balance sheet, two areas are looked at: 1. Total assets, Efficiency ratio – day’s sales in inventory
2. Total liabilities and shareholders equity - Number of days it takes a business to turn inventory into
o Total assets set to 100% and all assets represent a % of sales
total assets - Assumes no new purchases of inventory occurred
o Total liabilities and shareholders equity set to 100% and - Fewer number of days, the more quickly the business can sell
all line items within liabilities and equity represent a % of its inventory
total liabilities and equity Days in inventory = 365/Inventory turnover
o Line item set at 100% (base amount) and comparison Efficiency ratio – total asset turnover
line (comparison amount) - Ability of a business to use their assets to generate revenues
Common-size % = (comparison amount/base amount) x 100 - Higher total asset turnover means the business is using their
Ratio analysis assets very efficiently to produce net sales
Liquidity: the ability of the business to pay ST obligations with - For every $1 of assets, the total asset turnover amount of
assets that can be quickly converted to cash sales revenue are generate
Solvency: business can meet its LT obligations and stay in business Total asset turnover = net sales/avg total assets
in future Profitability ratio – profit margin
Efficiency: how well a business uses and manages their assets - How much of sales revenue is translated into income
Profitability: how well a business produces returns given their - The larger the ratio (closer to 1), the more of each sales $ is
operational performance returned as profit
Liquidity ratios – working capital Profit margin = Net profit/revenue or sales
 Distinguishing between fixed an variable costs is important – the
total cost is the sum of all fixed costs and variable costs
Profitability ratio – return on assets (ROA)
- Business’s ability to use its assets successfully to generate Calculate the contribution margin
profit Contribution margin: amount by which a product’s selling price
- Higher ratio, the more profit is created from asset use exceeds its total variable cost per unit
ROA = Net income/Avg total assets Contribution margin = Sales – Variable costs
Avg total assets = (Beginning total assets + ending total assets)/2 Contribution margin per unit = per unit sales $ -- variable cost per unit
Profitability ratio – return on equity (ROE) Contribution margin ratio = contribution margin per unit/sales per $
- Business’s ability to use its invested capital and retained Total contribution margin = total sales x contribution margin ratio
earnings to generate income Determine the break even point for a business
- Higher the return, the better the business is at using Break-even: the $ amount or production level at which the
investments to yield a profit company has recovered all variable and fixed costs
ROE = Net profit/avg total equity Break even (per unit) = fixed costs/CM per unit
Avg total equity = (Equity current year + equity previous year)/2 Target units = target profit + Fixed costs/CM
NPBT = NPAT/(100-tax) x 100
Chapter 7: Accountability and Management
Sensitivity analysis when you sell a single product
Decision Making Sensitivity analysis: shows what will happen if the sales $, units
Internal users of accounting information sold, variable cost per unit, or fixed costs change
Sales staff: Examine sales trends to determine sales strategies, and Condition Result
determine which sales people are performing strongly Sales Price Break-even point decreases (contribution margin is higher,
Marketing staff: Combine acc info and marketing metrics, and Increases need fewer sales to break even)
Sales Price Break-even point increases (contribution margin is lower,
work with sales staff to determine future sales strategies
Decreases need more sales to break even)
Production/ manufacturing staff: Use info related to costs of inputs Variable Costs Break-even point increases (contribution margin is lower,
and labour to evaluate cost of production – helps achieve Increase need more sales to break even)
economies of scale Variable Costs Break-even point decreases (contribution margin is higher,
Logistics/shipping staff: Examine sales trends over time to predict Decrease need fewer sales to break even)
the need for logistical support. Fixed Costs Break even point increases (contribution margin does not
Increase change, but need more sales to meet fixed costs)
Research and development staff: Business must plan and decide Fixed Costs Break even point decreases (contribution margin does not
the R&D activities they engage in to continue business growth – Decrease change, but fewer sales to meet fixed costs)
requires budgets and evaluations Sensitivity analysis when you sell multiple products
Internal audit staff: To determine whether there is any fraud or a Sales mix: the % of company’s total rev that comes from multiple
failure to follow business procedures. products
Three main primary responsibilities of management - Mix of products changes, and the break-even point
Planning: occurs at all levels of an organisation and covers various - Demand shifts and customers purchase more low-margin
periods of time products, the break-even point rises
- Strategic planning involves setting priorities and determining - If customers purchase more high-margin products, the break-
how to allocate corporate resources to help ST and LT goals even falls
- Mission statement: short statement of a company’s purpose - It total sales $ unchanged, break-even can change based on
Controlling: the monitoring of the planning objectives that were sales mix
put into place Degree of operating leverage (DOL)
- Include financial or performance measures DOL: measure of the proportion of fixed costs to a business’s
Evaluating: comparing actual results against expected results overall cost structure
- Managers determine where changes must be made within DOL = CM/Net Profit or Income
the business
Chapter 9: Planning for the future using budgets
Characteristics of information for decision making
- Helps businesses consider the costs of strategies and plans
Information must be:
- Helps a company reach strategic goals by allowing
- Accurate: recorded correctly from the original transaction
management to plan and control
- Complete: all transactions have been recorded, with no
- Can be used to evaluate and benchmark the performance of a
transactions missing or purposely omitted
business unit
- Reliable: useful in the decision making process (and is highly
- Accountants need to use ethical standards when assisting the
dependent on the decision being made)
development and creation of budgets
- Timely: produced so it’s available when decisions need to be
Understanding the structure of budgets
made
Master budget: contains every source of revenue coming into the
Chapter 8: Decision Making in the ST – Cost- business and every cost that needs to be paid
Volume Profit Analysis Financial budget: plans the use of assets and liabilities and
Understanding the cost equation results in a projected balance sheet
Variable cost: changes as the quantity of g or s produced/provided Operating budget: plan future revenue and expenses and
changes results in a projected income
Fixed costs: costs that remain the same regardless of Sales budget: management uses no. of units from sales
quantity/volume budget and inventory policy to determine units need to
Y = a + bx produce – this information in units and in dollars becomes
Y (total cost), a (fixed cost), b (variable cost/unit), x (level of activity) the production budget
 Materials: variable cost raw materials units
– Beginning 0 312 234 286
Labour: variable cost of people
inventory
Overhead: fixed costs that support manufacturing (i.e. (target
rent for premises, cost to maintain machines, power to inventory of
prev. quarter)
run machines)
How are budgets developed
Required
production
1612−0=1612
1794−312=1482
1456−234=1222
1650−286=1364
Top down approach: begins with senior management Direct Material Budget
- It takes 0.5m2 of material to make each pair of shoes and this costs
ties in to the strategic plan and company goals, and final $10 per m2. Management want 15% of next month’s materials in
anticipated costs are reduced by the vetting (fact-checking and inventory at the end of the quarter (and at the end of Q4, 100m2)
info gathering) process Quarter 1 Quarter 2 Quarter 3 Quarter 4
Production 1612 1482 1222 1364
Bottom up approach: begins at lowest level of company DM per unit 0.5 0.5 0.5 0.5
after senior management has communicated expected Total m^2
1612 ×0.5=806
1482 ×0.5=741
1222 ×0.5=611
1364 × 0.5=682
department goals, department plan and predict sales needed

info is communicated to the supervisor who passes it on to

+ Desired
ending
0.15 ×741=111.15=112
0.15 ×611=91.65=92
0.15 ×682=102.3=103 100

upper management inventory

Combination approach: guidelines and targets set at the top while Total
material
112+ 806=918
92+741=833
103+611=714
100+682=782
managers develop a budget within the targeted parameters – Beginning 0 112 92 103
Zero-based budgeting approach: budgeting begins with zero inventory
dollars and then adds to the budget revenues and expenses Material
purchased
918+ 0=918
833+112=945
714+ 92=806
782+103=885
Rolling budget approach: budget is adjusted monthly, and a new Price of 10 10 10 10
month is added as each month passes material
Preparing a sales budget Total cost of
DM
10 ×918=9180
10 ×945=9450
10 ×806=8060
10 ×885=8850
Used to determine how many units must be produced and when Direct Labour Budget
and how cash will be collected from sales. - There are no beginning or ending inventory values for labour – we
can’t store it up!
Generated sales forecast includes sales activity, competitor sales - Each pair of shoes takes 30 minutes to make.
activity, industry trends, economy-wide trends, planned marketing - Labour is paid $35 per hour (don’t worry about taxes,
campaigns, etc. superannuation
Example: Rory’s Kicks etc)
Cash Budget
Sales quarter = no. of units x sales price Assume there are no accounts receivables – all customers must pay with cash or
Example: Rory’s Kicks credit card
Rory’s Kicks is a shoe manufacturer and retailer. They make fancy white For suppliers of raw materials, we pay 60% in the current quarter, 40% in the next
sneakers that have a cult social media following. quarter
For labour, 100% is paid in the quarter the labour is utilised
There is a waiting list for all of their shoe designs and they don’t want
All overheads and sales/admin costs are paid in the quarter incurred
to sell too many, keeping them rare is part of their strategy. Rory wants to have at least $100,000 in cash at the end of each quarter
The business has a 1 July to 30 June financial year. Overhead Budget Quarter Quarter Quarter Quarter Total
Management predict they’ll sell 100 pairs of shoes a week in the first - There
1 is $4 of overhead
2 costs 3
(electricity, supervisor
4 costs etc) per
13 weeks (quarter 1). Then 120 pairs a week in quarter 2 (this quarter Cash unit manufactured.
455,000 573,300 451,479. 579,393. 2,059,172.
includes Christmas). In quarter 3 they predict to sell 90 pairs per week -
receipts There are also the following fixed
6 costs each1 quarter: 7
because summer weather means customers wear less sneakers and From - Rent $20,000
total - Salaries $25,000
then in quarter 4, they have budgeted sales of 110 pairs per week.
sales
Pairs sell for $350 in quarter 1, then rise 5% per quarter.
revenue
Rory’s Kicks
Sales budget
Cash
For the year ending 30 June
payment
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total
s
Expecte
d sales
100 ×13=1300
120 ×13=1560
90 ×13=1170
110 × 13=1430 5460
Materials
First 60%
(units)
paymen
Sales
price
350
350 ×1.05
367.5
%=367.5
×1.05
385.875
%=385.88
×1.05 %=405.17
1,508.55
t
Second
Selling 40%Budget
and Admin
per unit
paymen
- There are no sales commissions, however for each unit sold, there is
Total
sales
1300 ×350=455000
1560 ×367.5=573300
1170× 385.88=451479.6
1430 × 405.17=579393.1
2,059172.
7
t $12 in packaging and shipping fees
Q1 (60%
- Total
Fixed cost andTotal
selling admincost
expenses per quarter
revenu
now, 40% - DM Website
Q1 x DM salaries
staff Q1 x $15,000
e
next Q) - 60%Web hosting 40%costs $2,000
Preparing production budgets -9180 × 0.6=5508
9180 × 0.4=3672
Sponsored social media posts $2,500
Q2 Total cost Total cost
Beginning Inventory DM Q2 x DM Q2 x
+Purchases/Production 60% 40%
= Goods available for sale 9450 × 0.6=5670
9450 × 0.4=3780
-- Ending Inventory Q3 Total cost Total cost
DM Q3 x DM Q3 x
= Cost of goods sold/sales 60% 40%

Example: Rory’s Kicks

8060 × 0.6=4836
8060 × 0.4=3224
Q4 Total cost
Production budget
DM Q4 x
- Management wants inventory at the end of the quarter to be 20% of Preparing a cash budget 60%
next quarter’s predicted sales. In quarter 1 of the following year, they
expect to sell 1100 units 8850 × 0.6=5310
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Labour Total cost Total cost Total cost Total cost
Expected 1300 1560 1170 1430 of DL of DL of DL of DL
sales = 28,210 = 25,935 = 21,385 = 23,870
Target ending
inventory
0.2 ×1560=312
0.2 ×1170=234
0.2 ×1430=286
0.2 ×1100=220 Overhead
s
Total
overhead
Total
overhead
Total
overhead
Total
overhead
s s s s
Total required
1300+312=1612
1560+234=1794
1170+ 286=1456
1430+220=1650
 = 51,448 = 50,928 = 49,888 = 50,456 t
Selling Total Total Total Total
and Selling Selling Selling Selling Cash Net cash
admin and and and and needed –
Admin Admin Admin Admin purchase
= 35,100 = 38,220 = 33,540 = 36,660 –
Total Sum of 124,425 113,429 119,520 100,000
cash Q1 down cash
payments to S&A balance
= =
120,266 (265,266
)
Net cash Cash 448,875 338,050. 459,873.
receipts 6 1 Borrow? 300000
– cash Min lots
payment of
s $50,000
= Using budgets to evaluate performance
334,734
What if they needed to invest in a new machine in Q1 that cost $500,000? Budgets are created using a number of assumptions: customer
How much cash would they need to borrow to meet the $100,000 minimum cash demand, economic sentiment, price of raw materials, availability
balance?
of raw materials, pay rates of labour, price of overhead and selling
Quarter Quarter Quarter Quarter Total
1 2 3 4 and administration costs.
Cash 455,000 573,300 451,479. 579,393. 2,059,172. Flexible budgeting: where an original budget can be adjusted for
receipts 6 1 7
From total
changes in sales volume or activity
sales Evaluating performance involves comparison: current and prior
revenue years, industry averages, business performance
Cash Chapter 10: Short-term performance evaluation
payments
Materials using variance analysis
First 60% Creating a flexible budget
payment
Second 40%
Flexible budget: the restating of our original budget using the sales
payment quantity recorded
Q1 (60% Total Total Results in the static budget: original budget – uses projected sales
now, 40% cost DM cost DM
next Q) Q1 x 60% Q1 x 40% quantities and $, materials, labour and overhead; and flexible
9180 × 0.6=5508
9180 × 0.4=3672 budget: uses the same assumptions about sales $, cost of raw
Q2 Total Total materials, cost of labour but adjusted for actual units sold.
cost DM cost DM To create the flexible budget – we use standard amounts for
Q2 x 60% Q2 x 40%
sales $, materials, labour, overhead, and selling and
9450 × 0.6=5670
9450 × 0.4=3780 administration costs.
Q3 Total Total
cost DM cost DM We then compare our static budget, flexible budget and actual
Q3 x 60% Q3 x 40% Conducting a variance analysis using the static and flexible
8060 × 0.6=4836
8060 × 0.4=3224 budget
Q4 Total Variance: difference between the flexible budgeted performance
cost DM
Q4 x 60% and the actual performance.
8850 × 0.6=5310 Identifying variance doesn’t tell us what is causing the issues,
Labour Total Total Total Total but highlights the issue so that management and the business
cost of cost of cost of cost of can investigate the cause.
DL DL DL DL Favourable Unfavourable
= 28,210 = 25,935 = 21,385 = 23,870 Results in an increase in profit Results in a decrease in profit
Overhead Total Total Total Total Actual sales > Budgeted sales Actual sales < Budgeted sales
s overhea overhea overhea overhea Actual expenses < Budgeted expenses Actual expenses > Budgeted expenses
ds ds ds ds
= 51,448 = 50,928 = 49,888 = 50,456
Identifying the causes of variances
Selling Total Total Total Total Sales related variances:
and admin Selling Selling Selling Selling Budgeted sales = Predicted sales (units) x Sales $
and and and and
Admin Admin Admin Admin
Material-related variances:
= 35,100 = 38,220 = 33,540 = 36,660 Direct materials budget = Sales (units) x Budgeted materials used per unit x
Loan 100,000 100,000 100000 Price of raw materials
repaymen Labour-related variances:
ts
Total cash Sum of 224,425 213,429 219,520
Direct labour budget = Sales (units) x Budgeted labour hours per unit x
payments Q1 down Rate of pay for labour
to S&A Overhead and selling and administration-related variances:
= Overhead variances Selling and administration variances
120,266
The business negotiated a decrease in The business changed advertising
a fixed cost such as rent. strategies from fixed costs in
Net cash Cash 348,875 238,050. 359,873. traditional media (print, television,
The business installed solar panels on
receipts 6 1 radio) to a greater focus on social
the factory roof – less paid for
– cash media spending which has a greater
electricity to run the manufacturing
payment variable component.
equipment.
s
The business re-evaluated how they The business shifted from standard
=
calculated their overhead costs and post services to express post to keep
334,734
found an error resulting in a change in customers happy and encourage sales.
the overhead.
Purchase 500,000
of new Describe how companies use variance analysis
equipmen
1. Calculating the standard prices, materials, hours of labour, etc Fixed overhead
used in budgets Total costs
300+500+200=$ 1000
2. Asking managers to explain variances Potential
revenue
$ 3 ×500=$ 1500
a. Both unfavourable and favourable Profit of $500, therefore the special order should be accepted.
b. Only unfavourable Make or buy a component
c. Only large variances Outsourcing: the act of using another company/business to
3. Consider the risk of budgetary slack – intentional provide g/s that your business requires
manipulation in the original budget to create favourable Common outsourcing: component parts in manufacturing, services
variances that are common to many industries
4. What changes need to be made in the next budget Why outsource?
5. Evaluating management performance and allocating bonuses, - Outsourcing providers often focus on providing that one good
and setting performance targets for future periods or service and can do so at a lower cost
Chapter 11: Short-term decision-making using - Specialised expertise
relevant costing - Free up capacity within your production processes
Example: Felix’s Fantastic Donuts
Identify relevant information for decision-making FFD makes their chocolate icing for donuts themselves in-house using organic
Short-term decision-making Long-term decision-making cacao and other raw ingredients. But it can be quite time-consuming, so the
Accepting a special production order Buying new equipment versus business is considering outsourcing by purchasing icing powder from another
Determining the best product mix remodeling old equipment supplier.
from current products Choosing which products to What information do we need to make the decision?
Outsourcing a part or service manufacture - Cost to make the icing
Further processing or refining a Expanding into a new area or country - Cost to buy the icing
current product Diversifying by buying another - Any avoidable costs?
business - Any qualitative factors?
The process of decision-making in a managerial business The chocolate icing requires 1kg of cacao powder at $8 per kg. Then 2kg of icing
sugar at $3 per kg. The recipe also uses 500g of glucose ($3 per kg) and 250ml of
environment can be summed up in these steps: milk ($2 per litre). This produces 4kg of icing.
1. Identify the objective or goal Alternatively, the business can purchase icing at $14 per 4kg from another
2. Identify alternative courses of action that can achieve the goal supplier.
FFD would also save $50 per month on delivery charges for the icing raw
or address an obstacle that is hindering goal achievement materials. They make on average 8kg of chocolate icing a day and operate 6 days
3. Perform a comprehensive analysis of potential solutions per week.
Make chocolate icing in- Purchase chocolate
4. Decide, based upon the analysis, the best course of action house icing from supplier
5. Review, analyse, and evaluate the results of the decision

(
$ 14 ÷14 kg=$ 3.50 1
)(
Direct materials
Relevant Not Relevant ( 1 kg × $ 8 )+ ( 2 kg × $ 3 ) + kg × $ 3 + litre
Costs or revenue that differ Costs or revenues that are the same 2 4
regardless of the option
Direct labour $0 $0
Avoidable costs Unavoidable costs
Variable $0 $0
Sunk costs
overhead
Future costs that are different Future costs that are the same
Opportunity costs
Avoidable fixed
costs
8 ×6 × 4=192 kg per month
$ 50 per month ÷ 192 kg=$ 0.26 per kg
Total cost per kg $4.26/kg $3.50
Accept or reject a special order Therefore it makes much more sense to buy the chocolate icing from the supplier
than making it in-house.
- Typically for goods and services at a reduced price However, other qualitative factors might come into play:
- Usually a onetime order that does not affect normal sales - What is the quality of the outsourced icing?
- Can it be delivered on time when we need it?
- Management must consider several factors when deciding - Are we buying from another small business or a large international
whether to accept a special order: conglomerate?
1. The capacity required to fulfill the special order - What actions might the supplier engage in that could affect us?

2. Whether the price offered by the buyer will cover the cost Keep or drop a product (or service or department)
of producing the product 1. Compare CM and fixed costs
3. The role of fixed costs in the analysis 2. Compare total net income if the segment/product/service is
4. Qualitative factors retained vs dropped
Example: FFD has been asked to fill a special order Example: FFD has been trialling cronuts
For a breast cancer fundraiser, Hazel wishes to order 500 pink and white donuts Is it something that the business should keep or drop?
at a cost of $3 each. Information that we need:
What do we need to know? How many cronuts are sold?
- Do we have the capacity to make another 500? How much we charge for each cronut?
- How much do we normally charge for donuts? The variable costs for cronuts?
- What is the cost to make these donuts? Fixed costs – are they eliminated? What is avoidable?
Critical information The business would also save on oven rental of $200 per week because the
FFD can make up to 3000 donuts per week and normally they make 2400 donuts. cronuts require cooking in the oven rather than frying like a traditional donut.
The retail price in the FFD store for the donuts is $4 – plain glazed, flavoured The materials and labour are also more expensive because of the different
glazes and with or without sprinkles. manufacturing process.
The variable cost to make donuts is $0.50 of materials and $1 of labour. There are Are they profitable?
variable selling and admin costs of $0.40. Cronuts
There are also fixed costs of $5000 for store rental, wages for staff who work on Sales – 120/week at $4
120 × $ 4=$ 480
the front counter and equipment hire. Variable expenses
There are more sprinkles required on the fundraiser donuts which will cost an
Materials $1 $120
extra $0.10.
Labour $1 $120
Current cost to produce Fundraiser special
order
Selling + admin
$0.60
120 × $ 0.60=$ 72
Direct materials
($ 0.50+ $ 0.10)×500=$ 300 Contribution margin
480−120−120−72=$ 168
Direct labour
$ 1× 500=$ 500 Fixed costs $200
Variable
$ 0.40 ×500=$ 200 Net income/profit
168−200=−$ 32
overhead
 Therefore they should drop the cronut idea.
Qualitative considerations:
- How much social media exposure is received from the cronuts?
- Do people who come in for cronuts also buy something else?
Making decisions when resources are scarce or limited
- The initial step in allocating scarce or constrained resources is
to determine the unit contribution margin
o This is the selling price per unit minus the variable cost
per unit
- If constraints are not managed, a bottleneck usually results,
meaning that production slows and a back-up occurs at stages
prior to the bottleneck

Example: changing the circumstances at FFD

- FFD normally make 2800 donuts
- We need to calculate the CM of regular donuts vs the fundraiser
donuts
Regular donuts Fundraiser special order
Sales revenue $4 $3
Variable costs $1.90 $2
Contribution $2.10 $1
margin
Longer term decision making
- Longer term investment requires CAPITAL EXPENDITURE
o Buildings
o PPE
o Staff
- Detailed forecasting for revenue and expenses
o Budgeting
- Is the project worth it? Net Present Value