Advanced Management Accounting

Weeks 1 to 6

Advanced Management Accounting

INTRODUCTION AND REVISION INTRODUCTION
Welcome to Advanced Managerial Accounting and Finance 2011 Qualifying examination statistics Relevance of this course Nature of the course Answering test and exam questions:
Point Form Report formats where applicable CONTEXTUALISATION!!! MULTI DISCIPLINED integrated questions Deeper level of thinking, surface issues are not sufficient to pass.

Advanced Management Accounting

INTRODUCTION AND REVISION INTRODUCTION For example, consider the following:
The following table indicates operating results for an exporter:
ITEM VOLUME R/$ SALES VAR. COSTS FIXED COSTS 2010 10 000 R7 R70 000 R35 000 R50 000 2011 11 000 R8 R88 000 R44 000 R56 500 2012 11 500 R10 R120 000 R55 000 R58 000

Are variable and fixed costs under control for the exporter?? What is the key driver of the results for the exporter??

Advanced Management Accounting

INTRODUCTION AND REVISION REVISION Chap 2 Cost terms and concepts
Direct & indirect Period & product Fixed & variable Relevant & irrelevant Avoidable & unavoidable Sunk Opportunity Incremental & marginal

Chap 3 Cost assignment

Allocation of costs to products, overhead apportionment

Advanced Management Accounting

INTRODUCTION AND REVISION REVISION Chap 4 Job costing
Accounting entries to account for costs Calculating the cost of the job

Chap 5 Process costing

Valuing WIP and Finished goods in a process costing environment

Advanced Management Accounting

WEEK 1: STRATEGIC MANAGEMENT ACCOUNTING
New section to advanced managerial accounting therefore important. What is it? Big picture view of a company relative to its environment Differentiate between STRATEGY and TACTICS
TACTICS: Short to medium term actions designed to achieve the objectives set out in a strategy. Usually internal, and the work that you are familiar with in Managerial Accounting and Finance:
Setting capital budgets Determining WACC Relevant costing for repeat orders etc.

Advanced Management Accounting

WEEK 1: STRATEGIC MANAGEMENT ACCOUNTING
STRATEGY: Long term objectives set up by a company with reference to its external environment given its internal characteristics. These items are similar to the vision and mission of a company:
We want to capture the largest market share in our industry We want to grow our share price by 5% every year for the next generation

Your strategy determines your tactics. Your tactics should NEVER determine your strategy. Given our discussion above, what is strategic management accounting?
It is management accounting concerned with how the company fits into and grows in relation to its external environment

Advanced Management Accounting

WEEK 1: STRATEGIC MANAGEMENT ACCOUNTING
Before a company can set objectives for growth and adaptation to its environment, it needs to understand its environment and itself:

ENVIRONMENT: PEST ANALYSIS ITSELF: SWOT ANALYSIS

Now the company can set objectives for itself armed with the understanding it obtained above:
GOALS MUST BE: S.M.A.R.T GOALS MUST BE: Based and evaluated on BALANCED SCORECARD principles (similar to King III triple bottom line reporting).

Critical to environmental analysis are the principles developed by Micheal Porter:

Advanced Management Accounting

WEEK 1: STRATEGIC MANAGEMENT ACCOUNTING
External environment (beyond company control):
PORTERS FIVE FORCES used to determine how competitive an industry is: BARGAINING POWER OF SUPPLIERS BARGAINING POWER OF CUSTOMERS THREAT OF NEW COMPETITORS IN INDUSTRY THREAT OF SUBSITUTE PRODUCTS DEGREE OF COMPETITION IN INDUSTRY

Internal environment (can be controlled by company):

PORTERS THEORY ON COMPETITIVE ADVANTAGE What is it? How is it obtained?

Advanced Management Accounting

WEEK 1: STRATEGIC MANAGEMENT ACCOUNTING
Internal environment (can be controlled by company):
PORTERS VALUE CHAIN ANALYSIS Used to see where a company creates value and where value is destroyed. Don t only focus on manufacturing, but also on other activities in the business (HR, marketing, accounting etc) Split the analysis into: PRIMARY ACTIVITIES: MANUFACTURING/SERVICE INPUT OR INBOUND LOGISTICS PROCESSING/SERVICE DELIVERY OUTPUT OR OUTBOUND LOGISTICS/SERVICE DELIVERY SUPPORT ACTIVITIES: HR, MARKETING, ACCOUNTING, LEGAL, INFRASTRUCTURE

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
ACTIVITY BASED COSTING Traditional vs. ABC systems (pg 223) ABC is ..an absorption costing system that provides more accurate product costs by allocating indirect costs (e.g. overheads) to products by means of a variety of cause-effect cost drivers. Stages in implementation of ABC (4 steps) Need for ABC:
The % indirect cost is significant and increasing. Highly complex environments Numerous product lines on a continuous basis. Resources are shared by many products.

D 10.24, 10.26; Discuss theory on tut Q s

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
ACTIVITY BASED COSTING ABC profitability analysis: ABC product costs are not directly suitable for decision making, but more readily reveal potential unprofitable products. Three contribution levels should be analysed:
unit level contribution for each product (i.e. sales minus cost of unit level activities), batch level contribution (i.e. unit level contribution minus batch related costs), product sustaining contribution (i.e. batch level contribution minus product sustaining costs). Resource consumption model : PTO

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
ACTIVITY BASED COSTING

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
ACTIVITY BASED COSTING Resource consumption models:
ABC systems measure the cost of using resources and not the cost of supplying resources: Cost of resources = Cost of resources + Cost of unused Supplied used capacity Periodic financial statements measure the cost of resources supplied (i.e.15 000 orders at a cost of 300 000 in Example 10.2 Pg 234). ABC systems measure the cost of resources used (i.e. 13 000 orders at a cost of20 per order in Example 10.2). The difference between the cost of resources supplied and the cost of resources used represents the cost of unused capacity (i.e. 2 000 orders at 20 per order=40 000)

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
Example 10.2 Pg 234
(1) Resources supplied 10 staff at 30 000 per year Cost driver Annual quantity of cost driver supplied: (1 500 orders per employee) Estimated cost driver rate (2) Resources used Estimated annual number of orders to be processed Estimated cost of resources used assigned to parts/ materials (3) Cost of unused capacity Resources supplied (15 000) Resources used (13 000) at 20 per order

= 300 000 annual activity cost = Number of orders processed

= 15 000 purchase orders = 20 per purchase order (300 000/15 000 orders)

= 13 000

= 260 000 (13 000*20)

= 40 000 (2 000*20)

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
ACTIVITY BASED COSTING Selecting the cost driver denominator level
The correct denominator activity level to use is the level of capacity supplied (practical capacity)and not the anticipated usage.

Using anticipated usage in Example 10.2 would result in a cost driver rate of 23.08 (300 000/13 000) so that the cost of unused capacity will be hidden in the cost driver rate rather than being separately reported. Using anticipated usage would result in high cost driver rates in periods of low sales demand.

The ABC data base

Ideally maintained at estimated standard costs and periodically reviewed. In addition a cost and profitability audit of a firm s products, customers and sales outlets should be periodically undertaken.

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
JOINT AND BY PRODUCTS Joint products two or more products produced through the same process and separated in processing each having a sufficiently high saleable value to merit recognition as a main product. By- product output of some value produced incidentally while manufacturing the main product. Valuing joint products:
Common costs incurred up to the split off point. These common costs need to be allocated between the joint products.
Four methods suggested Physical measures method (Eg. 6.1) Sales value at split off point method (Eg. 6.1) Net realisable value method. (Eg. 6.2) Constant gross profit method. (Eg. 6.2)

Advanced Management Accounting

WEEK 2: ABC AND JOINT/BY PRODUCTS
JOINT AND BY PRODUCTS
Joint costs are irrelevant for decision making. Further processing decision illustrated in Eg. 6.3. By-product valuation - Net realisable value deducted from the joint cost of production of the main product\s. (Eg. 6.4) Tut Q Alloc joint costs discuss (b.)

Advanced Management Accounting

WEEK 3: ABSORPTION AND VARIABLE COSTING
Covered in 3rd year\intermediate See learning objectives page 141 Understand the differences in net profits where sales volumes differ from production volumes Understand the types of denominators that one could to absorb overheads:
Maximum Practical Normal Budgeted

Revise examples and ensure able to produce information in the required formats, and reconcile profits. Make sure that you can discuss the arguments for and against the different types of costing systems.

Advanced Management Accounting

WEEK 3: ABSORPTION AND VARIABLE COSTING
Arguments in support of variable costing
More useful incremental/relevant information for decision-making (e.g. buy or make). Separates fixed and variable costs facilitating cost estimation at different activity levels. Eliminates profit manipulation by means of increased inventory/production levels (deferring fixed costs). This strategy can also be discouraged by fixed inventory or stock turnover level requirements. Excludes capitalising fixed overheads in unsaleable/obsolete/surplus inventory.

Arguments in support of absorption costing

Considers fixed production costs as essential for production and inclusion in products/inventory costs. Emphasises the recovery of fixed costs in sales revenue in the long run. Consistent with IAS 2 used by financial markets to appraise an entity s performance and share price. The same reporting standards should be used to evaluate/reward managerial performance internally.

Advanced Management Accounting

WEEK 3: ABSORPTION AND VARIABLE COSTING
UKZN EXAMPLE
Assume UKZN Limited manufactures and sells 66 centimetre television sets. Actual data for 20X8 was: Opening stock 2 000 units Sales 24 000 units Production 26 000 units Selling price per unit R90 Variable costs per unit: Direct materials R20 Direct labour R10 Direct overheads R6 Selling costs R4 Fixed costs for the year: Production overhead Actual R324 000 (Budgeted R300 000) Selling costs R110 000 Administration costs R80 000 The company determined its fixed production overhead rate on the basis of its budgeted production volume of 25 000 units for the next year.

Advanced Management Accounting

WEEK 3: ABSORPTION AND VARIABLE COSTING
ABSORPTION COSTING Sales Cost of sales Opening stock Production Less: closing stock Normal gross profit Over/(under) absorption Actual gross profit Less: Selling /admin costs Selling costs fixed variable Administration costs Net profit (24 000 x R4) (24 000 x R90) 2 160 000 1 152 000 96 000 1 248 000 (192 000) 1 008 000 (12 000) 996 000 286 000 110 000 96 000 80 000 710 000

(2 000 x R48) (26 000 x R48) (4 000 x R48)

Advanced Management Accounting

WEEK 3: ABSORPTION AND VARIABLE COSTING
VARIABLE COSTING Sales Less: variable cost of sales Opening stock Production Less: closing stock Variable selling costs CONTRIBUTION Less: fixed costs Selling costs Administration costs Production Net Profit (24 000 x R90) (2 000 x R36) (26 000 x R36) (4 000 x R36) (24 000 x R4) 2 160 000 864 000 72 000 936 000 (144 000) 96 000 1 200 000 514 000 110 000 80 000 324 000 686 000

Advanced Management Accounting

WEEK 3: COST VOLUME PROFIT ANALYSIS
Objective of CVP Long run or short run? NP = (Unit sales x SPpu)-(Unit sales x VCpu) FC or NP = Unit sales x (SPpu-VCpu) FC Relevant range Basic formulas: examples pg 170 -173
Break even sales volume and value Sales volume\value required to make a given level of profit. Profit from a given level of sales Selling price required to show a given profit on a given level of sales. Profit volume ratio (contribution margin) Margin of safety. Cash break even Calculated using FC excluding depreciation.

Graphs Break even chart\ profit volume graph. Assumptions?

Advanced Management Accounting

WEEK 3: COST VOLUME PROFIT ANALYSIS
MULTI PRODUCT ANALYSIS
Example: Assume two products (A and B) are sold in fixed proportions of 2A:3B, contribution per product is R15 (A) and R25 (B) and total fixed costs R787 500. The multi-product breakeven can be calculated as follows: Total contribution per sales mix Total contribution for A (2x15 =R30) and B (3x25=R75) is R105 (R30+R75) and Breakeven is 787500/105 = 7500 sales mixes or 15 000 A (7500x2) and 22 500 B (7500x3) Note that the total contribution is R787 500 [(15 000A x R15)+(22500 x R25) Weighted average contribution per sales mix Weighted average contribution: A R6 (2/5 x R15) plus B R15 (3/5 x R25) = WA R21 (R6+R15) Breakeven is 787500/21 = 37500 units with 2/5ths or 15 000 of A and 3/5ths or 22 500 of B Again, total contribution is R787 500 [(15 000A x R15)+(22500 x R25) Work through See eg. 8.2 Pg 178 Tut Q 8.11 Drury students manual is a multi product example

Advanced Management Accounting

WEEK 3: COST VOLUME PROFIT ANALYSIS
Use of computers and CVP:
Sensitivity analysis Scenario analysis Monte Carlo Simulation

Semi variable costs

Apply the high low analysis to split costs into fixed and variable elements and work from there.

Advanced Management Accounting

WEEK 3: LEARNING CURVES AND REGRESSION ANALYSIS LEARNING CURVES
The more often you do something the better you become at it. Learning rate and Learning tempo. Doubling of production, the learning rate kicks in on an average time per product basis. Average production time per unit is not the same as cumulative production time. Learning curve formula: Y=a b(to the power of r) Example of 80% learning curve:
If 1 product requires 1 labour hour at R10/hour, how much will we spend on labour if 4 products are made? Production doubles twice, once at 2 units and then at 4 units. Average labour time at 4 products produced per unit = R10 x .8 x. 8 = R6.40 Total expense = R6.40 x 4 = R25.60

Advanced Management Accounting

WEEK 3: LEARNING CURVES AND REGRESSION ANALYSIS REGRESSION ANALYSIS
Mathematical means to determine the relationship between costs and cost drivers in order to predict future cost levels. Y= a +bx Detailed regression calculations not required. However, you must understand what the following are and what they represent:
Co-efficient of variation Co-efficient of correlation

Graphing the cost relationships on scatter graphs. Comparison of cost drivers.

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING RELEVANT COSTING: BASICS
Defined as future, incremental (differential) cash flows. Differential additional costs resulting from the decision Avoidable costs that would be avoided as a result of the decision Opportunity costs benefit foregone by choosing an opportunity over the next best alternative. ( cost of the next best alternative ) Non-relevant costs sunk costs, committed costs

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING
Materials current replacement cost unless already purchased and would not be replaced. In this case use the higher of resale value and\or opportunity cost. Using machines repairs, hiring, fall in resale value Testing any cost against the future differential rule should make the above obvious. Scarce resources where scarce resources are being diverted to the opportunity, there is an opportunity cost equal to the contribution currently being earned per unit of the scarce resource.

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING
Special pricing (Eg. 9.1) Product mix with limiting factors (Eg. 9.2) Replacement of equipment (Eg. 9.3) Outsourcing and make-or-buy (Eg. 9.4) Discontinuation decisions (Eg. 9.5)

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING RELEVANT COSTING: THEORY OF CONSTRAINTS
Definition: .a set of concepts ..which aim to identify the binding constraints in a production system and which strive for evenness of production flow . . No inventories should be held except prior to the binding constraint. Managing constraints Glodratt s 5 steps:
1. 2. 3. 4. 5. Identify the bottlenecks Exploit (achieving higher throughput in the short term) Subordinate (all operations subordinated to B\C) Elevate (i.e. take steps to inc. throughput from B\C) Return to step 1. (Once bottleneck is eliminated attention moves to next B\C)

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING RELEVANT COSTING: THROUGHPUT ACCOUNTING
Key terms
Throughput contribution = sales revenue direct material cost Other operational cost (Conversion cost) = all operating cost except direct material Investment cost = inventory, equipment, building cost

TA is an accounting system, based on TOC and JIT which measures the throughput contribution per factory hour (time period). Similar to marginal costing, but used to make longer term decisions. Main difference is that TA treats all labour as fixed in the short term.

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING RELEVANT COSTING: THROUGHPUT ACCOUNTING
TA ratio
Return (Throughput contribution) per time period/ cost per time period Based on throughput contribution of bottleneck resource. A profitable product would have a ratio greater than 1

Return per factory hour (time period)

(Sales price material costs) / time on key resource

Cost per factory hour (time period)

Total factory cost / Total time available on key resource

See example 9A.1 page 211

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING LINEAR PROGRAMMING
Used in relevant costing typically when there are multiple resource constraints and/or multiple products. Solved graphically and mathematically, although practical use is limited due to Excel and other software packages. Essentially you create linear equations for each resource input you use and you create an objective function equation. Consider the following:
Product A requires 5 labour hours, product B requires 3 labour hours. Product A requires 10 kgs of materials and product B requires 5 kgs of materials. Only 1 000 labour hours are available and only 1 000 kgs of materials are available.

Advanced Management Accounting

WEEK 4: RELEVANT COSTING AND LINEAR PROGRAMMING LINEAR PROGRAMMING
Consider the following:
Product A has a contribution of R20 per product and product B has a contribution of R15 per product. Determine the constraint equations and the objective function equation:
Note: A and B represent number of products of A and B, and y represents the maximum contribution given the constraints. Labour constraint: 1 000 = 5A + 3B Material constraint: 1 000 = 10A + 5B Objective: y = 20A + 15B

The equations above would be plotted on a graph and a maximum contribution subject to the constraints would be derived.

Advanced Management Accounting

WEEK 5: PRICING AND PROFITABILITY ANALYSIS
Cost plus pricing
Price taker vs price setter Long-run vs. short-run price decisions

Whether price taker or price setter, in short-run decisions a price should be set so that incremental revenue exceeds incremental cost. Must meet the following conditions:
Sufficient capacity must be available to meet the order. The bid price should not effect future selling prices and the customer should not expect repeat business at short-term incremental cost. The order will utilize unused capacity for only a short period and capacity will be released for use on more profitable opportunities.

Advanced Management Accounting

WEEK 5: PRICING AND PROFITABILITY ANALYSIS
A price setting firm facing long-run pricing decisions Three scenarios considered:
1. Pricing customized products using cost-plus pricing. 2. Pricing non-customized products using cost-plus pricing or demand estimates. (see example 11.2 Pg 252)(next OH) 3. Pricing non-customized products using target costing.

In the long-term a firm can adjust the supply of resources that are committed to it - therefore a product or service should be priced to cover all of the resources that are committed to it. This is effectively a full-cost plus (excluding only facility sustaining costs) pricing policy.

Advanced Management Accounting

Non-customized products PRICING DECISIONS AND PROFITABILITY ANALYSIS Example 11.2(a) Sales volume 100 Total cost 10 000 Required profit contribution 2 000 Required sales revenues 12 000 Required SP to achieve target profit contribution 120.00 Unit cost 100.00 Example 11.2(b) Potential selling price Estimated sales volume at the potential selling price Estimated total sales revenue Estimated total cost Estimated profit (loss) contribution

120 140 160 180 200 10 800 11 200 11 600 12 600 13 000 2 000 2 000 2 000 2 000 2 000 12 800 13 200 13 600 14 600 15 000 106.67 90.00 100 94.29 85.00 80.00 72.50 90 80 81.11 75.00 70.00 65.00 70 60

120 140 180 190 200 12 000 12 600 14 400 13 300 12 000 10 800 11 200 12 600 12 800 13 000 1 200 1 400 1 800 500 (1 000)

Management and Cost Accounting, 7th edition. 2008 Colin Drury

Advanced Management Accounting

WEEK 5: PRICING AND PROFITABILITY ANALYSIS
A price taker firm facing long-run product-mix decisions In the long-term a firm can adjust the supply of resources that are committed to it Therefore the sales revenue from a product or service should be sufficient to cover all of the resources that are committed to it. Periodic profitability analysis is required to ensure that only profitable products/services are marketed, that is that you product mix optimises your profits. Profitability analysis should be used as an attention-directing mechanism. Ideally ABC hierarchical profitability analysis should be used (see figure 11.1 page 255).

Advanced Management Accounting

WEEK 5: PRICING AND PROFITABILITY ANALYSIS
Cost + pricing arguments for & against
Criticisms of cost-plus pricing: Ignores demand Does not necessarily ensure that total sales revenue will exceed total cost. Can lead to wrong decisions if budgeted activity is used to unitize costs. Circular reasoning Volume estimates are required to estimate unit fixed costs and ultimately price. Reasons for using cost-plus pricing: May encourage price stability Demand can be taken into account by adjusting the target mark-ups. Simplicity Difficulty in applying sophisticated procedures where a firm markets hundreds of products/services. Used as a guidance to setting the price but other factors are also taken into account. Applied to only the relatively minor revenue items.

Advanced Management Accounting

WEEK 6: RISK AND UNCERTAINTY
Very important concepts both in Managerial Accounting and in Managerial Finance What elements in managerial accounting are subject to risk and uncertainty?
Returns on projects (in the forms of cash flows) Costs to be incurred in projects (again cash flows) Refer to the examples discussed on pages 271 and 272 likelihood of an outcome Probability must be exhaustive. Probability can be:
Mutually exclusive (shown in simple probability distributions)

Probability:

Advanced Management Accounting

WEEK 6: RISK AND UNCERTAINTY
Probability:
Probability can be: Conditional (decision trees) Subjective (you input your experience and judgement into a probability calculation) Objective (you use historical data and research to form a probability) Which do you consider to be the better measure? Probability distributions are tables that show you values for outcomes of certain events together with the probabilities that these outcomes will occur. Expected value or the expected cost is simply the probability of an event occurring multiplied by the event s expected outcome.

Expected Value:

Advanced Management Accounting

WEEK 6: RISK AND UNCERTAINTY
Measures of risk:
Standard deviation
What is it? Historical versus Probabilistic Problems? What is it? Historical versus Probabilistic Problems?

Coefficient of variation

Remember the risk and return measures are on measures based on average units. Up to this point we considered simple probability. However this is not realistic since probabilities are conditional on the choices management makes.

Advanced Management Accounting

WEEK 6: RISK AND UNCERTAINTY
Decision trees (see figure 12.1)
Example
A company is considering whether to develop and market a new product. Development costs are estimated to be 180 000, and there is a 0.75 probability that the development effort will be successful and a 0.25 probability that the development effort will be unsuccessful. If the development is successful, the product will be marketed, and it is estimated that:

(i) (ii) (iii)

If the product is very successful, profits will be 540 000. If the product is moderately successful, profits will be 100 000. If the product is a failure, there will be a loss of 400 000.

Each of the above profit and loss calculations is after taking into account the development costs of 180 000. The estimated probabilities of each of the above events are as follows: (i) Very successful 0.4 (ii) Moderately successful 0.3 (iii) Failure 0.3

Advanced Management Accounting

WEEK 6: RISK AND UNCERTAINTY
Decision tree for example on previous slide

Advanced Management Accounting

WEEK 6: RISK AND UNCERTAINTY
Expected Value of Perfect Information
Enables one to calculate how much expected profits will be increased by if information to remove uncertainty was available

Example: Machine A: Machine B: Low Demand High Demand EV R100 000 x .5 + R160 000 x .5 = R130 000 R10 000 x .5 + R200 000 x .5 = R105 000

Equal probability of high and low demand. What is the expected value? What is the value of perfect information? Asks the question how much would EV increase by, if advance information about demand was available ?