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CAP1 MANAGEMENT ACCOUNTING SESSION 1 INTRODUCTION NOTES

By the end of this session, you should: Be able to explain the role of the Management Accountant in an organisation. Be able to explain the different ways of categorising costs

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Contents
Syllabus .................................................................................................................................... 3 Organisational objectives and the role of the management accountant ........................ 3 Role of management accounting - Chapter Reference 1.1 and 1.2 (Pages 1 to 8) ..... 3 Ethical Issues - Chapter Reference 1.5 (pages 16 to 20)................................................. 5 Management Accounting Today - Chapter Reference 1.3 and 1.6 (Pages 8 to 11 and 20 to 21) .................................................................................................................................... 6 Cost Classification - Chapter Reference 2.2 (pages 30 to 40) ....................................... 8 Analysing Costs between fixed and variable .................................................................... 10

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Syllabus
Organisational Context Budgetary Control Standard Costing & Variances Cost and Management Accounting Decision making

Key Points to Note : Continuous assessment - 15% Final Exam 85% Move from knowledge based to competency based exams

Organisational objectives and the role of the management accountant


Outline the role of management accounting in the achievement of organisational objectives Distinguish profit making businesses and other types of organisations Describe the operating environment of the management accountant; internal and external Describe the management accounting system Outline the role of management accounting in running the business Outline possible ethical issues facing the management accountant

Cost Classification Explain basic cost classifications, revenue classifications and typical terms used by management for planning Analyse cost by cost function and type Explain cost behaviour patterns, to include fixed, variable and semi-variable costs Explain how cost behaviour patterns vary on an activity basis and per unit basis Distinguish between contribution and gross margin

Role of management accounting - Chapter Reference 1.1 and 1.2 (Pages 1 to 8)


Planner e.g. budgeting Information provider e.g. operating statements Controller e.g. budgetary control Motivator e.g. providing budgets Decision maker e.g. relevant costing

Planning 1. Establishing Objectives 2. Short or long Term 3. Levels of Planning, for example, Strategic, Tactical and Operational
CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Types of Organisations Manufacturing Service Companies Not for Profit organisations Decision Making Stages in Decision Making Planning Phase 1. Set Objective 2. Identify ways to achieve objective 3. Make a decision about best way to achieve objectives Implement Decision Control Phase 1. Gather information about actual results 2. Compare actual to plan results 3. Revise original objectives if necessary Types of Decisions
1. 2. 3. 4. 5. 6. Product Mix Sales Price Credit Terms to offer to customers Sources of Finance to use Capital Expenditure Setting Budgets for marketing spend

Responsibility Accounting & Responsibility Centres Cost Centre A production, service or location, function, activity or item of equipment whose costs can be identified and recorded. Profit Centre Part of Business for which both costs and revenues are identified. Investment Centre Managers responsible for investment decisions as well as costs and revenues. Revenue Centre Only accountable for revenue Financial Accounting is recording of transactions and summarising them in periodic financial statements for external users. Duties of Financial Accountant: Maintaining bookkeeping system of nominal ledger, Accounts payable control, Accounts receivable control, Preparation of Statutory accounts Information prepared by financial accountant is at too high a level for individual managers. Cost and management Accountant provides this more detailed information Cost Accounting Careful evaluation of resources used within the company,

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Techniques employed are designed to provide financial information about the future performance. Historical cost of product or service Management Accounting Forward Looking Budgets and Forecasts Provision of non financial information to managers Provide advice based on information to management Include involvement in planning, decision making and control

Ethical Issues - Chapter Reference 1.5 (pages 16 to 20)


Ethical issues facing the management accountant Corporate Social Responsibility Vs maximising shareholder wealth Ethical investment Short term opportunism Vs Long term sustainability Decisions impacting adversely on stakeholder groups e.g. suppliers, employees etc. Examples of Unethical Behaviour by Management Accountant Not accruing for unpaid expenses, Delaying maintenance expenditure in an effort to reduce costs, Inflating closing inventory valuations in order to increase reported profits. Why motivates this unethical behaviour? Financial Incentives offered to management, Promotion Opportunities and Avoid Scrutiny Code of Conduct Principles underlying the code of conduct are: Integrity, Objectivity, Professional Competence and Confidentiality. Resolution of Ethical Conflict
1. 2. 3. 4. Discuss with Superior Confidential Discussion with Independent Advisor Withdraw / Resign from assignment Inform Organisation / Regulatory Authorities

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Management Accounting Today - Chapter Reference 1.3 and 1.6 (Pages 8 to 11 and 20 to 21)
Users of Management Information Internal Users
Employees Management

External Users
Investors Customers / Suppliers Competitors Government General Public Lenders

Internal Activities of a Company Production Research & Development Product Design Marketing Sales and Delivery Customer Service
Human Resources

Changing Competitive Environment Customers Expectations Excellent Service High quality products at low price, Variety and range of products. Shorter Product Life Cycles Increased International Competition Technological Advances and Improvements Difference between Management and Financial Accountant Management Accountant What When Who Why How Key Attributes Parts of organisation Monthly (prospective) Internal Managers Planning & Control Free Format Relevance & Timeliness Financial Accountant Whole Organisation Annual (Retrospective) External Users Financial Decisions Prescribed Format (GAAP) Verification and Precision

Management Accounting is concerned with the provision of information to internal management to hep direct and control the organisations operations. Primarily concerned with Planning, Decision Making and Control.

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Financial Accounting is concerned with the provision of information to shareholders, creditors and other users outside of the organisation to assist them in making financial decisions. Primarily concerned with stewardship. Computers in Management Accounting Speed of information availability Checks can be incorporated to validate input for reasonableness Electronic Storage Maintenance required to prevent corruption of data from virus attack Adaptability of information e.g. coding structures and report writers Computers in Management Accounting Capture of information e.g. bar coding Immediate update / amendment of data Can handle a large of volume of data quickly Output can be presented in a variety of formats Ability to model/analyse information e.g. spreadsheet modelling Ability to present and transfer information e.g. graphs, e-mail attachments etc. Characteristics of Financial Information Accurate Complete Cost Effective Understandable Reliable Available to Users via appropriate delivery channels Timely Factors affecting Quality of Information Source of Information Type of Information Financial or non-financial Methods of recording and processing data Manual or computerised Presentation of Information

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Cost Classification - Chapter Reference 2.2 (pages 30 to 40)


Classification of Costs Element Material, Labour and Expense Separating costs into fixed and variable elements Nature Direct or Indirect Behaviour Variable, Fixed, Semi Variable or Stepped Fixed Function production or non-production costs, for example, Selling, distribution or administration costs Fixed Costs

Total fixed costs ()

Fixed costs per unit ()

5k

Activity (units)

Activity (units)

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Variable Costs

Total variable cost ()

Variable costs per unit ()

10 30 20 10

Activity (units)

Activity (units)

Changes in Fixed and Variable costs in total and on a per unit basis Total Cost Variable Cost Fixed Cost Total Cost changes as the activity level changes Total fixed costs remain the same as activity levels change Cost Per Unit Cost per unit remains the same as activity changes Cost per unit decreases as activity level increases

Semi Fixed / Stepped Costs Costs are fixed until certain trigger points are breached e.g. number of supervisors If one supervisor is required for 10 staff then the supervisors salary costs will remain fixed until more than 10 staff are employed when a second supervisor will be required
Total semifixed costs (k)

60 40 20

10

20

30

Activity (no of staff)

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Semi Variable Costs

Total semivariable costs ()

Variable element

Fixed element

Activity

Cost separation is the process of separating the fixed and variable elements of a semi-variable cost : Methods High Low Method Scatter graph method

Analysing Costs between fixed and variable


Example 1 You have been provided with the following information regarding costs incurred over the past two months: June 3,000 units 7,500 July 2,000 units 6,000 Expected output in August is 4,000 units. Requirement What will the variable and fixed costs be? Solution Use the High / Low Method: Step 1 Calculate the variable cost per unit Cost at high Volume - Cost at low volume High activity level Low activity Level 7,500 6,000 = 1,500 3,000 2,000 1,000 = 1.50 Variable Cost per unit

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Step 2 Calculate the fixed costs Once you know the variable cost per unit you can calculate the fixed costs. You can select either activity level given in the question to calculate the fixed cost. Activity Level of 3,000 units Total Cost 7,500 Variable Cost (3,000 X 1.50) (4,500) Fixed Cost 3,000 Activity Level of 2,000 units Total Cost 6,000 Variable Cost (2,000 X 1.50) (3,000) Fixed Cost 3,000 Step 3 Calculate the Cost at 4,000 units of output Fixed Cost 3,000 Variable Cost (4,000 X 1.50) 6,000 Total Cost 9,000 Question 1 Over the last two months the following production costs were incurred by Department XZ: Level of activity Production cost May 3,180 units 15,405 June 4,200 units 18,873 In July budgeted production was 5,000 units. What is the budgeted production cost for July? Example A company manufacturing a single product has the following costs at two different activity levels: Activity level (units) 30,000 50,000 Total costs () 189,000 303,000 Variable costs are constant at all activity levels, but fixed costs increase by 4,000 every 20,000 units. Requirement What is the total costs at an activity level of 35,000 units? Solution We need to make an adjustment to the total costs before we put them into the formula. The reason for this is because each activity level has a different amount of fixed costs. Total Costs at 50,000 units Additional Fixed Costs 303,000 ( 4,000) 299,000

Variable Cost per unit. 299,000 189,000 = 110,000 = 5.50


CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

50,000 30,000

20,000

Activity Level of 30,000 units Total Cost Variable Cost (30,000 X 5.50) Fixed Cost Activity Level of 50,000 units Total Cost Variable Cost (50,000 X 5.50) Fixed Cost Costs at 35,000 units of output Fixed Cost Variable Cost (35,000 X 5.50) Total Cost

189,000 (165,000) 24,000

303,000 (275,000) 28,000

24,000 192,500 216,500

Alternative Method Only difference between costs at 30,000 and 35,000 units is the additional variable costs. The fixed costs are the same. Total Costs at 30,000 units 189,000 (35,000 30,000) X 5.50 27,500 216,500 Question 2 A company manufacturing a single product has the following costs at two different activity levels: Activity level (units) 25,000 35,000 Total costs () 185,000 255,000 Variable costs are constant at all activity levels, but fixed costs increase by 5,000 every 10,000 units. Requirement What are the fixed costs at an activity level of 28,000 units?

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Scatter Graph Approach Plot all previous activity levels & costs on a graph Draw a line of best fit, using your judgement Use line to determine cost for other activity levels The intercept of the line on the vertical axis should be the fixed cost, i.e. cost when activity level is zero We can then calculate the approximate variable cost by substitution into one of our existing data points

450,000

400,000
350,000 300,000 250,000 200,000 150,000 100,000 50,000 100 200 300 400 500 600 700 800

Cost Behaviour Summary Total Cost Variable Total cost changes as activity level changes Total cost remains the same even when the activity level changes Includes a fixed element and a variable element Total cost remains the same but only for a set time period or level of activity Cost per Unit Cost per unit remains the same even when the activity level changes Cost per unit goes down as activity level goes up Includes a fixed element and a variable element Cost per unit goes down as activity level goes up (within each time period or level of activity)

Fixed

SemiVariable Stepped

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Example 3 Classify the following costs according to their behaviour: Cost Behaviour Petrol Quarterly Rent for Factory Telephone Bill Raw Materials Depreciation of one and two machines Electricity Bill Petrol Example 4 Classify the following costs as one of the following: Production Selling Distribution Administration Finance

Costs to be classified: Cost Print Cartridges for General Office Salary of Factory Supervisor Salary of Payroll Supervisor Interest Charge on Overdraft Sales staff commissions Road Tax for delivery vans

Function

Direct Cost A Direct Cost is incurred on a specific product, service, job or batch Direct Cost include: Direct Materials, for example, Flour for Bread, Direct Labour, for example, Production Workers Wages, Direct Expense, for example, Plant hire Total of Direct Costs = Prime Cost Indirect Costs Indirect Costs cannot be traced to a specific product, service, job or contract. Indirect costs can be either manufacturing or non manufacturing. Indirect costs are also referred to as overhead. Manufacturing Overhead is apportioned to product and services.

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Non Manufacturing overhead is charged to the SOCI in the period it is incurred. Non manufacturing overhead is made up of administration, selling, distribution and finance costs. Examples of Manufacturing Overhead are: Indirect Materials, for example, glue, oil, Indirect Labour, for example, factory supervisor, Indirect Expense, for example, factory rent, machine depreciation

Example 5 Classify the following costs by element and by nature Cost Material / Labour / Expense ( by Element) Hire of Plant Specific Job Factory Supervisors Salary Depreciation on Equipment Factory Workers Salary Packing Materials for Finished Goods Oil for Machines Example of Cost Card Direct Material Direct Labour Direct Expense PRIME COST Variable Production Overhead MARGINAL PRODUCTION COST Fixed Production Overhead TOTAL PRODUCTION COST Non Production Overhead Administration cost Selling Cost Distribution Cost TOTAL COST Profit Sales Price

Direct / Indirect (by Nature)

X X X X X X X X X X X X X X

Companies set their selling price to achieve a particular mark up or margin:


Mark Up on cost Selling price is set to achieve a particular mark up on cost of producing the product. Margin of Selling Price Price is set to achieve a percentage of profit on the selling price

Example 6 A Ltd has estimated the cost of producing its latest product as 7.50 per unit. What is the selling price if the company wants to achieve :
(a) A mark up of 20%, or (b) A margin of 25%.

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

Solution
(a) To calculate the selling price per unit :

Cost X 100 + Mark Up 100 7.50 X 100 + 20 = 7.50 X 120 = 9.00 100 100
(b) To calculate the selling price per unit:

Cost / (1 Margin) where the margin is expressed as a percentage 7.50 / (1 0.25) = 10.00 Product Costs and Period Costs Product costs Costs associate with a particular product/service Include direct & indirect costs (manufact. overheads) Initially recorded as part of the value of inventory Treated as expenses (cost of sales) when inventory is sold Period costs (non-manufacturing costs) Dont relate specifically to a particular product/service Treated as expenses in period in which incurred
Never included in the value of inventory

Relevant and Non Relevant Costs


Used in the process of decision making. A relevant cost will impact on the decision being made, whereas an irrelevant cost will not.

Sunk Cost A Sunk cost is a cost that has already been incurred or committed to and cannot be changed by any future action to be taken. Example : A company carried out market research to assess customer interest in a new product. The market research findings were favourable and the company is now assessing whether to begin manufacturing and selling the new product. In assessing whether the product should be produced the money spent on the market research is a sunk cost and not relevant to the decision to produce the product. The market research costs were already committed to and irrespective of whether the product is produced or not these costs have been committed to. Opportunity Cost The opportunity cost is relevant is evaluating the consequences of one course of action over another. In decision making a company must include all relevant costs as well as benefits foregone if the resources were committed to the next best alternative. This approach ensures that profits are maximised.

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

CAP1 Management Accounting, Academic Year 2011 / 2012 Chartered Accountants Ireland

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