t4 Fia

Notes
FIA MA2
Management Accounting 2
For exams in 2013
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FIA MA2 Management Accounting
ExPress Notes
Contents
About ExPress Notes
1. 2. 3. 4. 5. 6. Management Information Cost Recording Costing Techniques Decision making Cash management Spreadsheets
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ExPress Notes
Chapter 1
Management Information
KEY KNOWLEDGE
Management Information Requirements
Purpose of Management Information Planning: has to do with the formulation of objectives within the organization, both in the short- and long-term (see below). Decision-making: refers to conclusions drawn once all relevant information has been analysed. Implementation of decisions taken (.e. the decision to take action) follows. Control: Post-implementation, actual results are analysed in order to determine whether planning and decisions taken need to be revised or to implement corrective actions. The control step acts as a feedback loop into the previous processes. Remember, look at theses systems dynamically: we learn from experience and need to take corrective steps and to improve processes continuously! The Features of useful management information
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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
Financial and Non-financial information for managers In addition to financial information which can be extracted from the financial accounting records, managers rely for their decision-making on a host of information that is derived from non-financial sources. These can range from industry data (overall size, market shares of different competitors) to customer opinions about the products and services offered. Internally, non-financial information can embrace a host of operational statistics which are relevant to managerial decision-making: examples include the rate of staff turnover; the time it takes to cook a hamburger (in a restaurant business); the rate of defects in a production process; the set-up time necessary between different production batch runs; or measurements of service/product quality. Planning at different levels of the organisation Strategic: Covers the big view of the organization and its objectives. Long-term in nature.
Tactical: Planning over the short-term (usually one year), and typically in connection with budgeting processes.
Operational: Day-to-day decisions, implemented on-the-spot and directly involving all levels of the organization.
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Management responsibilities Responsibilities correspond to specific areas and functions within an organisation. They are best understood in relation to the following diagram:
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 In order to competently manage his/her area of responsibility, a manager needs to have relevant information (and authority) pertaining to their job function. Relevant information not only supports decision-making, but also allows the performance of the respective responsibility centre to be monitored, both by the (direct) managers in charge as well as by the levels (above) to which they report.
The Role of Information technology Information technology has had a dramatic and far-reaching impact on the structure and conduct of business. IT has also been frequently poorly employed at great cost to companies. When implemented well, IT has made it possible for companies to exploit the benefits of increased accuracy of information and faster decision-making.
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Suitable formats for the presentation of management information according to purpose Managerial accounting is a free-style form of accounting in which format and structure of information are not prescribed externally, but conform to the requirements of the users (management and staff).
KEY KNOWLEDGE
Cost Accounting Systems
In order to understand the relationship between Management accounting and Financial Accounting systems, it is useful to summarize the differences between the two. Management accounting is: 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) Focused on specific areas or activities (as opposed to financial accounting, which provides a holistic view of companys performance) Employs non-financial indicators as well financial, while financial accounting uses only financial measures. Since the management accounting system is based on (or derived from) a companys financial accounting system, the two are usually combined (or integrated) for reasons of cost and efficiency, i.e. to avoid duplications. Coding transactions Transactions in a business are more easily processed by use of a coding system. This involves assigning to a particular transation a code, i.e. a kind of symbolic label, which identifies the nature of the transaction in a systematic and unambiguous way. In doing so, this allows transactions to be grouped together in information systems, processed, added up and analyzed in a manner that permits checking and reconciliation (against original records).
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The characteristics of a coding system shares some of the features of good information: it must be standardized, logical, objective, brief (i.e. capable of being summarized), verifiable, comprehensive and yet flexible (allowing development to cover all relevant situations in a relevant manner).
Cost units: The units are the discreet items to be measured, such as packs of nails (batches) or a student.
KEY KNOWLEDGE
Cost Classification
There are a variety of ways in which one can classify costs:
Production vs. Non-Production 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. Direct vs. Indirect 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.
Fixed vs. variable
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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.
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.
High/Low Method
Analyze the following operating costs as a function of output: Output (units) 1,000 1,200 1,400 1,600 Costs ($) 250,000 295,000 325,000 370,000
Take the maximum and minimum levels of output (the independent variable) and the associated costs (dependent variable) and calculate the differences: Max Min Diff. Output 1,600 1,000 600 Costs 370,000 250,000 120,000
The variable cost per unit is: 200 (120,000/600) Given the formula: Total cost = Fixed cost + (Variable cost per unit x No. of units) We can calculate the fixed cost Fixed cost = 50,000
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The high-low method can also be applied to the following situations: When fixed costs change (step) along the output range; and When the variable cost per unit changes
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ExPress Notes
Chapter 2
Cost Recording
KEY KNOWLEDGE Accounting for materials

Every company which buys, processes and sells materials will have established procedures for ordering, receiving and issuing (such materials) which are generically similar. Some may have highly automated systems in place, while others record the steps manually. The key documents one should be familiar with are: Purchase requisition form: This is an internal form that provides the authorization for materials to be ordered from a supplier (external). Purchase order (PO): The buyer issues a PO to the seller, indicating the Description Quantity Price
of the product ordered. The PO is a legal offer. Its acceptance by the seller creates a contractual commercial relationship for the intended transaction.
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Goods Received Note (GRN): This is completed by the buyer upon delivery to verify whether the order has been properly fulfilled. It will contain: Order No. Description Quantity ordered Quantity delivered
Materials issuance (or requisition) form: This is the form necessary to authorize the release of materials from inventory into the production process at the company. 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. Accounting entries Materials Debit (Dr) entries = Increase in inventory Inventory Credit (Cr) entries = Decrease in inventory
Economic Order Quantity Within a company, there is a natural temptation to accumulate buffer stocks (raw materials and semi-finished goods) so that production is never interrupted. Similarly, in order to avoid stock-outs, sales managers will insist on maintaining a plentiful level of finished goods. All of this costs money. The EOQ 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
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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: 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
EXAMPLE
A trucking company uses disposable carburettor units with the following details:
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Weekly demand Purchase price Ordering cost Holding cost
500 units USD 15 / unit USD 40 / order 7% of the purchase price
Assume a 50 week year. What is the optimal order quantity? The EOQ = 1,380 units
KEY KNOWLEDGE Accounting for labour
Direct and Indirect Labour Direct labour refers to work which is directly involved in the manufacture of a product. Indirect labour (e.g. the supervisors salary, or that of a security guard) forms part of overhead costs. It is important to note that the basic pay portion of direct labour costs is included in the prime cost of a product. Overtime premiums, bonuses, employers contributions, sick pay and idle time costs relating to direct workers are all accounted for as overheads (indirect costs). One exception: Overtime performed as a result of a client request is recorded as a direct labour cost. Accounting for labour costs Labour account Debit (Dr) entries Credit (Cr) entries = = Labour costs incurred Transfer to P&L Note: The transfer to the P&L takes place via the Work-In-Progress (WIP) account for direct labour costs and the production overheads account in the case of indirect labour costs.
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Remuneration methods There are two basic forms of remuneration: Time-based, and Outputbased (e.g. piecework)
Effective incentive schemes are designed to ensure that the interests and behaviour of individual employees and groups of employees are in-line (i.e. consistent) with the companys objectives. Managerial metrics relating to labour The key ratios to learn are: Labour turnover = No. of departing employees requiring replacement Average no. of employees
Labour efficiency = Standard hours of output Actual hours worked
Labour capacity = Actual hours worked Total budgeted hours
Labour production volume = Standard hours of output Total budgeted hours
This last ratio is the result of multiplying the labour efficiency with the labour capacity ratio.
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KEY KNOWLEDGE Accounting for other expenses
Direct and Indirect costs Traditionally, accountants maintain that costs have to be charged to whatever is being costed the goal is ultimately to link costs to the units of product themselves: Direct costs are not a problem as they are directly attributable to the product. Indirect costs in this context referred to as overheads -- are more difficult to link to products (e.g. a supervisors salary or a security guard).
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Chapter 3
Costing Techniques
KEY KNOWLEDGE 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 Centres
Production A 1. Allocate
Production B
Service C
3. Reapportion from Service to Production Production A Production B 4. Absorb Cost Unit
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ExPress Notes
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. Allocation and Apportionment Allocate, Apportion and Re-apportion indirect production costs (shown on the right side of the diagram) to cost units. Our focus is on the first category (production); the other overhead costs are not incurred at the time of production and do not find their way into inventory. Always think of the costs going into inventory and those that occur after the product leaves inventory!
EXERCISE
A company producing refrigerators and toasters has identified the following overhead costs relating to production: Rent Indirect materials Power Equipment insurance $ 8,000 1,500 3,000 2,500 15,000
The company has 3 cost centres, 2 production workshops (A & B) and 1 warehouse (C, service centre). 1. Suggest the basis on which the costs shown above might be charged to the various cost centres. Rent Indirect materials Power Equipment 8,000 1,500 3,000 2,500 Basis sq.m. Specific kWh Book A 4000 600 1500 1000 B 2500 700 1000 1400 C 1500 200 500 100
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ExPress Notes
insurance
value 15,000 sq.m.
7100
5600
2300
As a manager with cost centre responsibility, what could be your concerns with respect to the bases selected above? 2. Re-apportion the service centre costs to the production workshops. Assumption: C is used by A (65%) and B (35%): A Costs apportioned to A, B, C: Costs re-apportioned from C: Total overheads: 7,100 1,500 8,600 B 5,600 800 6,400 C 2,300 (2,300)
3. Absorb the overheads into the units produced. Assumption: The company absorbs overhead costs on the basis of direct labour hours Total labour Hrs Workshop A Workshop B 1,400 950 Overheads $ 8,600 6,400 Overhead Absorption Rate (OAR) $ 6.14 6.74
Each workshop uses its OAR to keep track of overhead costs as it produces. Alternatively, the company can use a blanket or company-wide OAR, calculated as: Total overhead costs Total labour hours = 15,000 = 2,350 6.38
A companys cost cards for two products (toasters and refrigerators) could look as follows: Refrigerator (cost per unit) Direct materials (15kg @ $2/kg) Direct labour (1.75hrs @ $15/hr) Variable OHs Fixed OHs (1.75hrs @ $6.38/hr) Total $ 30.00 26.25 5.00 11.17 72.42
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Toaster (cost per unit) Direct materials (1kg @ $3/kg) Direct labour (0.30hrs @ $15/hr) Variable OHs Fixed OHs (0.30hrs @ $6.38/hr) Total Summary Absorption costing
$ 3.00 4.50 2.00 1.91 11.41
Method of measuring the cost of products or services by including a fixed overhead fair share into the product manufacturing/service provision cost Results in reporting higher ending inventories and higher operating profits (as fixed factory overheads are taken to inventory cost instead of being expensed as incurred)
It addresses the problem of allocating factory overheads per product lines Step 1: Identify total factory overheads to be absorbed Step 2: Take the total quantity recorded for the absorption base o o The absorption base should be highly correlated with incurrence of overhead Most common absorption bases selected: direct labour hours, machine hours, units of output
Step 3: Compute overhead absorption rate (OAR) as Step 1 / Step 2 ($/unit of absorption base) Step 4: Obtain unit overhead cost per product line, by multiplying the OAR with the absorption base quantity recorded per unit Step 5: For each product, multiply Step 4 by total output to determine factory overhead to absorb in the production cost.
Over- and under-absorbed factory overheads o In practice, OARs are pre-determined on an annual basis, making assumptions on total activity levels for selected absorption bases. Such assumptions can be based on manufacturing technical capacity, normal capacity, or expected capacity.
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ExPress Notes
When actual activity levels differ from those used in pre-determining absorption rates, this results in over- or under-absorption.
KEY KNOWLEDGE Marginal costing
Features of 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. Marginal costing: Is an alternative costing method, with variable costs only being charged as a cost of sale (excludes fixed factory overheads from manufacturing costs) Results in reporting lower ending inventories and lower operating profits (as fixed factory overheads are fully expensed as incurred instead of being absorbed in inventory cost) Recognizes that fixed costs become irrelevant for short term production decision making based on product profitability (sunk costs) Avoids arbitrary bases for fixed overhead absorption into the production cost
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)
Example Below is data on a manufacturing company. Selling price (per unit): Cost card (per unit): Direct materials Direct labour 120 45 18
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Variable production O/Hs Total variable costs There is a variable selling cost of $2 per unit
9 72
Year 1 (units) Budget (normal) production Actual Production Actual Sales 1,100 1,000 950
Year 2 (units) 1,100 1,100 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 prepared. Assume that the beginning inventory is zero.
Profit/Loss (Marginal costing) Year 1 $ Sales (950/1,150 units) Less: Variable cost of sales Opening inventory Production costs: o Variable (1,000 x $72) (1,100 X $72) 72,000 0 3,600 114,000 Year 2 $ 138,000
79,200 0
Less: closing inventory (50 x $72) Less: Variable selling costs (950 x $2) (1,150 x $2) Contribution Less: Fixed production O/Hs
(3,600)
(68,400) (1,900) 43,700 (16,500)
(82,800) (2,300) 52,900 (16,500)
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Less: SGA costs Profit Inventory is valued at variable production costs.
(7,000) 20,200
(7,000) 29,400
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. Revised cost card (Absorption costing) Cost card (per unit): Direct materials Direct labour Variable production O/Hs Fixed production O/Hs Total production costs Profit/Loss (Absorption costing) Sales (950/1,150 units) Less: Variable cost of sales Opening inventory Production costs: o Variable (1,000 x $72) (1,100 X $72) Fixed (1,000 x $15) (1,100 X $15) 72,000 0 4,350 45 18 9 15 87 Year 1 $ 114,000
Year 2 $ 138,000
79,200
15,000
16,500 0 (84,150) 0 (100,050)
Less: closing inventory (50 x $87) Over/(under) absorption
(4,350) 1,500
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ExPress Notes
Gross Profit Less: Variable selling costs (950 x $2) (1,150 x $2) 1,900
29,850
37,950
2,300 7,000 (9,300) 28,650
(8,900) Less: SGA costs 7,000 Profit 20,950 Inventory is valued at the full production costs.
Summary of Absorption costing and Marginal costing formats
Absorption Costing Revenue Less: Cost of Sales Variable/Fixed production costs Gross profit Less: Expenses Variable/Fixed non-production costs Net Profit Reconciliation of the two methods
Marginal Costing
Variable production/ non-production costs Contribution
Fixed production/ non-production costs
The different profit figures calculated under Absorption costing and Marginal costing can be reconciled thus: The difference in profit = Net change in inventory (no. of units) X the fixed cost per unit It follows that: If the level of inventory increases in a given period, then profits (for that period) under the Absorption costing system will be greater than under Marginal costing; and
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ExPress Notes
If the level of inventory decreases, then profits under the Absorption costing system will be smaller than under Marginal costing If the inventory level does not change, then the profit calculated under both methods will be equal.
KEY KNOWLEDGE 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.
KEY KNOWLEDGE 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. Illustration 1 Process B $ 20,000 Output to Process C
units Input units from Process A Additional: Materials Labour Overheads 1,000
units 1,000
$ 30,000
1,000 Avg.cost/unit: 30
5,000 3,000 2,000 30,000
1,000
30,000
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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 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. Illustration 2 Normal loss 10% of input 1,000 = Avg. cost / unit Conclusion: Average cost per unit = Total cost of inputs No. of units of input Normal loss 33.3 900 + good 100 NL
Process B $ 20,000 Output to Process C
units 900
$ 30,000
1,000
5,000 Normal loss 3,000 2,000 30,000
100
1,000
30,000
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Illustration 3 Scrap value scrap/unit Avg cost/unit Conclusion: Average cost per unit = Total cost of inputs Scrap value of normal loss units No. of units of input Normal loss Process B $ 20,000 Output to Process C
5 32.78
units 900
$ 29,500
1,000
5,000 Normal loss 3,000 2,000 30,000
100
500
1,000
30,000
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). Illustration 4 Abnormal loss 1,000 =
850 + good
100 NL
50 AL
Conclusion: Average cost per unit = Total cost of inputs Scrap value of normal loss units No. of units of input Normal loss
Input units
units 1,000
Process B $ Output to
units 850
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20,000 from Process A Additional: Materials Labour Overheads 1,000 Process C 5,000 Normal loss 3,000 Abnormal loss 2,000 30,000 100 50 1,000
27,861
500 1,639 30,000
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
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. Joint processing and further processing Decisions need to be taken as to the further processing of products after their point of separation. Care must be taken to focus on the incremental (relevant) values.
EXAMPLE
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Determine which of the following products should be sold immediately (at the indicated price) or processed further (for later sale): Cost at point of Separation A B C 25,000 30,000 40,000 Immediate Price 27,000 28,000 45,000 Further (variable) processing cost 5,000 5,000 4,000 Post-processing Price 30,000 32,000 50,000
KEY KNOWLEDGE Service costing

Services distinguish themselves from products in the following ways: Heterogeneity: The quality of the service is rarely exactly the same, due to the human touch; e.g. hair cuts; Intangibility: Services are not tangible; Perishability: One cannot place a service in inventory; Simultaneity: Services are produced and consumed at the same time (Think of HIPS) Cost units Finding an appropriate cost unit is a challenge in service costing. In many cases, a Composite cost unit is identified; e.g. Student lunches, or Man-days
The cost per service unit is found by dividing the total cost of the service by the number of service units involved.
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ExPress Notes
Chapter 4
Decision-making
KEY KNOWLEDGE 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, C = SP V = Unit Contribution and
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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.
KEY KNOWLEDGE Break-Even Analysis

Marginal costing is useful in calculating the break-even level of sales. The break-even point is the level where the company achieves zero profit (neither gain nor loss). It just manages to cover its fixed costs. Below is data on a manufacturing company.
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Cost per unit (of product): Direct materials Direct labour Variable production O/Hs Total variable production costs Distribution & selling (variable) Additional info: Selling price per unit Fixed production costs Fixed Selling, General, Admin costs
$ 45 18 9 72 2
120 16,500 7,000
EXAMPLE
Based on the data in the previous example, calculate the break-even point of the company. Total fixed costs: Contribution per unit: 23,500 46
Break-even point: 23,500/46 = 511 units

Contribution per sale C/S ratio
This is understood as the amount of contribution generated by every dollar sold. In the previous example, the companys C/S ratio is: $ 0.3833 (120/46) The break-even level of sales can be calculated as: Break-even point (sales) = $ 61,310 Fixed costs C/S ratio
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KEY KNOWLEDGE Short-term decision-making
Limiting factors When a single limiting factor is present in a production plan, then it is necessary to identify it and to plan production around it. Take the following example: Product Selling price Labour cost per unit ($) Material cost per unit ($) Contribution X 30 10 5 15 Y 40 16 8 16 Z 50 20 10 20
It appears that in the face of unlimited demand for all three products, Product Z would be given priority as it maximizes the contribution per unit. Now, assume that labour hours are limited to 500 and that labour costs $2 per hour (demand remains unlimited for all three products). In the above case, Product Labour cost per unit ($) No. of hours per unit Contribution per hour X 10 5 3 Y 8 8 2 Z 20 10 2
Now it becomes clear that Product X is favoured for the full number of hours available (500). 100 units of X can be produced. If demand for X were limited to, say, 80 units (requiring 400 labour hours), then the remaining available hours (100) could be used to produce either Y or Z (in this case there is indifference between the two). The steps to be followed in working out the optimal production plan are: (1) Calculate the contribution per unit of product; (2) Calculate the contribution per unit of limited resource; (3) Rank the products according to Step 2;
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ExPress Notes
(4) Produce according to the priority established in Step 3, up to the demand limit of each product or until the limited resource is exhausted Make-Buy A make-buy decision requires the determination of all relevant costs.
EXAMPLE
An automotive components producer can supply itself externally with car heaters for USD 210 per unit. In considering whether to make these internally, the company calculates that an equivalent unit can be made in 2 labour hours using USD 100 worth of materials. Labour is currently at full capacity producing carburettors which generate contribution of USD 100. A carburettor takes 2.5 hours to produce. Labour costs USD 10 per hour. The carburettor also absorbs fixed overhead costs at the rate of USD 20 per labour hour. The relevant costs are ($): Materials: 100 Contribution lost (carburettors): 80 Labour (added-back): 20 200 It is cheaper to produce internally. Relevant costs
short-run based on relevant costs.

What is relevance?
One of managements responsibilities involves making decisions affecting the firm in the
A relevant cost is a cash cost which is uniquely incurred (or avoided) as a consequence of taking a decision; cash, because it is the main determinant of value (unlike accounting profit); and unique in the sense that is not common to the alternative choices that are under consideration.
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EXAMPLE
A company seeking to determine whether to continue to transport its products by truck or to switch to the railroad discovers that insurance costs are identical in both choices; in that case, insurance costs are not relevant to the decision. If, however, there is a difference in the two insurance costs, then one can speak as the difference between the two choices as being incremental; this difference (referred to in some places as the differential) is relevant to the decision under consideration. Future Relevant costs refer to the future, i.e. they can be influenced prospectively by choice. It follows that: Sunk costs are not relevant: They have already taken place and cannot be reversed. Committed costs, if they cannot be avoided, are likewise not relevant, even if the timing of their occurrence is in the future. Their unavoidability has already been established in the past (making them effectively the equivalent of sunk costs). In keeping with the above logic, relevant costs therefore involve cash, are incremental and relate to the future.
Costing projects It is a standard management accounting practice to determine the relevant costs of a new project in order to come up with a price quotation. Setting a price without having an accurate understanding of costs can put a company at a competitive disadvantage, particularly if there is intense competition.
EXAMPLE
A proposed project lasting 6 months requires the following inputs: 1) Labour
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The following resources are needed: A specialist specifically qualified for this work needs to be hired at a cost of USD 10,000 per month; The specialist will be assisted by two subordinates who are existing employees, each paid USD 40,000 p.a. One is not working on anything else for the foreseeable future, while the other is fully involved on another project and would need to be replaced for the duration of the proposed one at a cost of USD 5,000 per month; A division manager has agreed to supervise the project and estimates that 5% of his time (equivalent to USD 6,500) be allocated for this purpose.
2) Materials The project calls for the use of 200 litres of Agent Q and 50 kg. of Compound P. Additional data: Agent Q In stock 150 litres Historical price USD 7 USD 12 Current price USD 5 USD 15 Scrap value USD 1 USD 2
Compound P 100 kg. Agent Q is no longer in use.
Compound P is in regular use at the company.
3) R&D The project manager notices that R&D relevant to this project had been performed for another contract (later abandoned) at a cost of USD 15,000. He sees an opportunity to recover that cost now.
4) Equipment The company needs equipment for the project which would cost USD 15,000 to buy. Alternatively, it has some existing unused equipment that could be deployed. The used equipment is in good condition and could have been scrapped for USD 8,000 now or for USD 5,000 in 6 months. (Note: Ignore time adjustments of monetary values) Prepare the costs for the proposed project.
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Relevant costs need to be identified with care, as they may include opportunity costs.
EXAMPLE
A company considers building a storage facility on the site of a parking lot. If the parking lot had been generating parking fees which will now be lost, then this foregone revenue is an opportunity cost. Shut Down decisions Whether to close a plant making (accounting) losses depends on relevant costs:
Revenues (m) Costs (m) Profits (m)
40 (44) (4)
If 25% of the costs are fixed costs allocated by H.O., then it appears that closing the plant will leave the company worse off, as 40m in revenues and only 33m in costs will be disappear. A careful examination of all costs needs to be made before arriving at a final decision.
KEY KNOWLEDGE Principles of discounted cash flow

Simple vs. Compound interest Simple interest is the calculation of interest applied to the principal amount only. If $100 are lent at a simple interest of 5% p.a. then interest payments will be based only on the principal, as for example, an annual interest payment of 5% of $100, or $5 p.a. If interest is payble semi-annually on a compunded basis, then at the end of the first year, the interest will be $5.0625, calculated as:
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5% on $100 for the 1st half of the year, plus 5% on $102.50 for the 2nd half (i.e. the interest of $2.50 from the 1st half of the year is added to the principal amount and forms the basis for the interest calculation in the 2nd half). Nominal vs. Effective interest In the example above, 5% serves as the nominal interest rate, while the effective interest rate is 5.0625%; this is the total interest achieved on a compounded basis ($2.50 plus $2.5625). The preeminence of cash Cash, both its receipt and possession, lies at the basis of economic value. Cash is used to pay the bills and bonuses. It is a better indicator of wealth when compared with measures defined by accounting conventions, such as accounting profit. The relevance of cash flow to capital investment appraisal The appraisal process is predicated on the fact that capital expenditures are investments which will (hopefully) confer future benefits referred to as the payback. The payback may be a lengthy (and risky) one. Timing and value Tracking and measuring cash flows on a time-adjusted basis is critical: cash received quickly can be used to repay debt (avoiding interest costs) or invested (earning interest). Cash paid with a delay can reduce costs (as long as penalties are not incurred). It follows that the longer one waits for a receipt of cash, the less that cash is worth in todays terms. Among other factors, its purchasing value may diminish due to the effects of inflation. Compounding Instead of receiving USD 100 today, assume it will be received after one year. To compensate for the delay, what should the value be after one year?
Present Value (PV) 100
Future Value (FV) 100 x (1+r)
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In the above example, if r = 5% p.a. then the FV after one year will be USD 105. This process can be repeated year after year. Discounting The above relationship between PV and FV: can be re-arranged to: with r representing the discount rate. The above refers to one-period discounting, with r corresponding to the period. If discounting is done over more than one period, then the discounting effect will be: PV = FV (1+r)n where n refers to the number of periods. Thus, 100 received after two years, discounted at 10% p.a. will be PV = 100 = 82.6 (1.10)2 This reflects that the uncertainty of getting money back increases with time. This allows one to discount future values into present values and can be applied to a series of cash flows: Year: Future Values: 1 100 2 100 3 125 4 105 5 140 PV x (1+r) = FV PV = FV (1+r)
If discounted at r = 10%, then the above cash flows can be restated at their present values: FV discounted: PV: 100 1.10 90.9 100 (1.10)2 82.6 125 (1.10)3 93.9 105 (1.10)4 71.7 140 (1.10)5 86.9
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Added together results in total PV = 426. Reducing future cash flows of different timings and amounts to one PV is a powerful tool. Note: If all the cash flows had been equal say 100 then the PV calculation would have been simplified: FV discounted: PV: 100 1.10 90.9 100 (1.10)2 82.6 100 (1.10)3 75.1 100 (1.10)4 68.3 100 (1.10)5 62.1
The addition of the above is = 379 Net Present Value (NPV) To add meaning to the future cash flows, we can include the amount invested (which gives rise to the FVs): Year: 0 1 2 3 4 5
Investment: (200) FV: PV: (200) 100 90.9 100 82.6 125 93.9 105 71.7 140 86.9
Year 0 amounts denote the present and are automatically = PV. The NPV of the above cash flows is therefore = 226.
Internal rate of Return (IRR) The internal rate of return (IRR) is defined as the discount rate (r) at which the net present value (NPV) of a stream of cash flows will be equal to zero. In other words, If, at a discount rate r, NPV = 0, then IRR = r
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The IRR includes among its assumptions the following: any cash flows generated in the course of a project being evaluated are calculated as being reinvested at the IRR rate. This is illustrated thus: Time 0 1 2 Cash flows (20,000) 5,000 30,000
The IRR of the above cash flows (using interpolation or calculator) is 35.61%. The above cash flows is equivalent to re-investing the 5,000 (Year 1) at the IRR rate (35.61%) to maturity (Year 2). Time 0 1 2 Cash flows (A) (20,000) 5,000 30,000 Cash flows (B) (20,000) 0 36,780.5 (30,000 + 6,780.5*)
* 5,000 x 1.3561 = 6,780.5 The IRR of the cash flows shown in Column (B) is 35.61% -- exactly the same as in Column (A). Note: Column (B) cash flows resemble that of a zero-coupon bond, with investment at time 0 and no cash returns until the final year. This calculation confirms that interim cash flows are re-invested at the IRR rate. This assumption has been criticized for being unrealistic, since cash paid out of a project (returned to the investors, for example) is unlikely to obtain the same rate if invested elsewhere: they may be higher (i.e. interest rates may have risen in the meantime), or lower (placed in the bank to earn deposit interest).
Comparison of NPV and IRR methods The following decision rules apply to appraisal methods: NPV: Positive NPV projects are acceptable; the higher the better. IRR: An IRR in excess of a hurdle rate (set by the company) indicates acceptability; the higher (the IRR) the better.
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EXAMPLE
Year A B 0 -5,000 -7,500 1 6,000 8,850 IRR 20% 18% NPV: 10% 454 545 14% 263 263 16% 172 129
Intuitively, IRR should be preferable, as it relates return to amount invested. Equal investment amounts do not necessarily remove the ambiguity.
EXAMPLE
Year A B 0 -500 -500 1 100 500 2 600 155 IRR 20% 25% NPV (9%) 97 89
Payback method Initial Investment: 40,000 Cash flows (A) 5,000 6,000 12,000 13,000 15,000 51,000 Year 5 Cashflows (B) 15,000 13,000 12,000 6,000 5,000 51,000 Year 3
Year 1 Year 2 Year 3 Year 4 Year 5 Total Payback
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What are the advantages and disadvantages of this method?
Advantages
It is easy to understand and to use. It focuses on the time needed to cover the investment (in money terms) and no more; it can be considered a minimalists approach (psychologically). If you invest in a Central American country where you expect a coup in the next 2 years, the payback method may be for you! But remember, the net (money) returns start only after that point!
Disadvantages
It is a crude measure. It does not take opportunity costs or expected returns on money invested into account.
Discounted Payback We can apply the concept of discounting to the Payback method in order to capture the time value of money element. Year: 0 1 2 3 4 5
Investment: (200) FV: PV: (200) 100 90.9 100 82.6 125 93.9 105 71.7 140 86.9
In the table above, the (simple) payback period is in Year 2; The Discounted Payback period is longer (Year 3).
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Chapter 5
Cash Management
KEY KNOWLEDGE Cash and Cash Flow
Cash comprises both cash and bank deposits payable on demand and also cash equivalents which are defined as short-term, highly liquid investments that are readily convertible to known amounts of cash and which are subject to an insignificant risk of changes in value. The amount of cash held by a business at a point in time is found in the balance sheet under current assets. Cash flow refers to the movement of cash in and out of a business over a period of time. This information is found in a statement of cash flows, which is a primary financial statement. Such a statement is useful in that it is structured to show the extent to which a company is able to generate net cash from its operating activities and how such net cash is used in investing and/or financing activities.
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Examples of cash receipts and payments include: Operating: cash flow from trading activities, e.g. cash received from customers, cash paid to suppliers and to employees; Financing: Cash paid on interest; Taxation: Actual cash paid during the year; Investing: Cash flows on purchase or sale of non-current assets; Financing: Cash flows on raising or redeeming long-term finance, such as shares or Debentures; dividends can also be included here.
Cash flow accounting The relationship between cash flow accounting and accounting for income and expenditure lies in the use of accruals and decisions as to the capitalisation of expenditures. Cash flow accounting dispenses with the matching principle in financial accounting. As the cash flow statement is derived from the income statement and the balance sheet, adjustments need to be made to remove the effects of accrual accounting so that the cash movements can be made more transparent. Importance of cash flow management Planning, tracking and collecting cash are all important because cash PAYS THE BILLS. The failure to pay bills puts a company in danger of bankruptcy. What begins as a condition of illiquidity can evolve into insolvency.
Cash flow is vital to going concern and commercial success, regardless of profitability. Having enough cash on hand is therefore critical in being able to settle obligations when they fall due (both planned and unforeseen); however, holding too much cash in a business is costly. There is a trade-off between liquidity and profitability. Determining the optimal amount of cash to hold becomes the challenge facing managers. Cash management functions are typically handled by treasury, and include: Collecting cash from customers (as soon as possible); Disbursing cash to suppliers (as late as practically possible); Investing short-term cash surpluses in low-risk interest-bearing investments (such as Treasury bills) in order to generate additional income for the company;
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KEY KNOWLEDGE Cash budgets

A cash budget is an estimate of the receipt and payments of cash in and out of the business for a defined future period based on existing conditions and operating assumptions. By understanding the nature and timing of cash receipts and expenditures, management is better able to influence them and plan/budget for the future. The purpose is to ensure that the company has sufficient cash on-hand to avoid missing disbursements when they fall due. There are statistical techniques which assist management in planning cash levels. Cash budget/forecast Businesses should develop their cash budget/forecast formats in a way which best reflects the type of business conducted and transactions generated. Such tools serve as a mechanism for monitoring and control. Investing and Financing Cash surpluses and deficits occur as a result in timing differences between the receipt of cash and the necessity to settle obligations punctually. If a deficit results, then the company should have overdraft faciltities in place with a bank. If deficits prove to be longer-term in nature, then the company should consider short-term borrowing, or possibly, longer-term forms of finance if the deficit is expected to persist. In the event of surpluses, these can be invested (e.g. T-bills mentioned earlier); other types of investments include: Bank deposits Money- market deposits Certificates of deposit Government bonds Local authority stock
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Chapter 6
Spreadsheets
KEY KNOWLEDGE Use of spreadsheets
The use of spreadsheets is a basic skill that all accountants and business analysts should possess. A spreadsheet is a computer program that is organised in a tabular format. The vertical and horizontal arrangement of cells allows the input and processing of large amounts of data in a systematic way. Spreadsheets contain sophisticated formulae which can be used to operate on the data. Instead of merely adding up columns of numbers, spreadsheet formulae can handle discounting (i.e. net present value) calculations as well as simple logical (IF) functions. Apart from processing a large volume of data quickly, spreadsheets permit analysis to be performed with great efficiency. Thus, if an assumption is modified, then the spreadsheet can automatically adjust all affected values (known as what-if analysis), meaning that the management acccountant can focus on interpeting the output.
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Notes

FIA MA2 Management Accounting

FIA MA2 Management Accounting

START About ExPress Notes

FIA MA2 Management Accounting

How to get the most from these ExPress notes

At the start of the learning phase

FIA MA2 Management Accounting

Your stage in study for each paper Practice phase

These ExPress notes

ACCA online past exams

The night before the real exam

At the door of the exam room before you go in.

FIA MA2 Management Accounting

Our ExPress notes fit into our portfolio of materials as follows:

START About The ExP Group

FIA MA2 Management Accounting

Management Information Requirements

FIA MA2 Management Accounting

FIA MA2 Management Accounting

FIA MA2 Management Accounting

Cost Accounting Systems

FIA MA2 Management Accounting

There are a variety of ways in which one can classify costs:

Fixed vs. variable

FIA MA2 Management Accounting

FIA MA2 Management Accounting

FIA MA2 Management Accounting

KEY KNOWLEDGE Accounting for materials

FIA MA2 Management Accounting

FIA MA2 Management Accounting

FIA MA2 Management Accounting

Weekly demand Purchase price Ordering cost Holding cost

500 units USD 15 / unit USD 40 / order 7% of the purchase price

KEY KNOWLEDGE Accounting for labour

FIA MA2 Management Accounting

Labour efficiency = Standard hours of output Actual hours worked

Labour capacity = Actual hours worked Total budgeted hours

Labour production volume = Standard hours of output Total budgeted hours

FIA MA2 Management Accounting

KEY KNOWLEDGE Accounting for other expenses

FIA MA2 Management Accounting

KEY KNOWLEDGE Absorption costing

Indirect costs (overheads)

2. Allocate/Apportion to Cost Centres

3. Reapportion from Service to Production Production A Production B 4. Absorb Cost Unit

FIA MA2 Management Accounting

FIA MA2 Management Accounting

value 15,000 sq.m.

FIA MA2 Management Accounting

$ 3.00 4.50 2.00 1.91 11.41

FIA MA2 Management Accounting

KEY KNOWLEDGE Marginal costing

FIA MA2 Management Accounting

Year 2 (units) 1,100 1,100 1,150

(68,400) (1,900) 43,700 (16,500)

(82,800) (2,300) 52,900 (16,500)

FIA MA2 Management Accounting

Less: SGA costs Profit Inventory is valued at variable production costs.

16,500 0 (84,150) 0 (100,050)

Less: closing inventory (50 x $87) Over/(under) absorption

FIA MA2 Management Accounting

2,300 7,000 (9,300) 28,650