F2 - Management Accounting Part B Class

F2- Management accounting
BPP text and revision kit - Lecture note - Slides and exercise sheets - ACCA student website
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F2 ACCA Phi Thanh Tu
Syllabus
Cost card- Cost statement of total cost of 1 unit of product

Direct labour Direct material Direct expense PRIME COST Variable production overheads MARGINAL PRODUCTION COST Fixed production overheads TOTAL PRODUCTION COST Non production overheads Admin cost Selling cost Distribution cost Finance cost TOTAL COST Profit (marked up 10%) Selling price Non-production cost 10 10 10 20 150 15 165 Production cost 30 20 10 60 10 70 30 100
Part B Cost accounting techniques

I. II. III.
IV.
V. VI.
VII.
Material cost Labor cost Overheads Marginal and absorption costing Job, batch and service costing Process costing Alternative costing techniques
Part B-1- Material cost

Ordering and accounting for inventory Order quantities and reorder levels
I. II.
I. Ordering and accounting for inventory

Inventory Accounting procedures for ordering and issuing inventory Recording of Inventory Physical inventory and book inventory
1. 2.
3.
4.
1. Inventory
Types of inventory: RM, FGs, WIP,
consumables/tools & supplies Control over inventory:

Ordering Purchasing Receipt Storage Issue Maintenance of Inventory at the most appropriate
level
7 F2 ACCA Phi Thanh Tu
2. Accounting procedures for ordering and issuing inventory

Departments requires new material by sending Purchase request to Purchasing department Ordering < authorized purchase request>
Purchasing department send PO to: Suppliers Purchase Accounting department order Good receiving departments (stores) Suppliers receive Pos to prepare to deliver goods Suppliers deliver the Goods with Delivery Notes Goods receiving department will check the Goods received with Delivery notes and PO. Good receipt Notes are updated and then the copies are sent to Purchasing and accounting departments Purchasing department will monitor GRNs with PO to supervise the PO status
Goods delivery
Invoice sent from suppliers directly to accounting department for payment Invoice, GRN and PO are matched (3-way match) to ensure proper quantity and price Invoices F2 ACCA Phi Thanh Tu
2. Accounting procedures for ordering and issuing inventory

Inventory issuing:
Material requisition notes Authorize store keepers to release RM To update store records
Material returned notes Record unused RM returned to stores To update store records
Material transfer notes Transfer materials from one department to another To update store records
3. Recording for inventory

Debit Inventory a/c: Purchase, Return to stores Credit Inventory a/c: Issuing, Return to suppliers Inventory valuation: FIFO, WAC, LIFO FIFO: assumes that materials are issued to out of stock in the order in which they were delivered into inventory WAC: values all items of inventory and issues at an average price. The average price is calculated after each receipt of goods. LIFO: assumes that materials are issued out of inventory in the reverse order to which they were delivered into inventory

The following transactions occur during May 2008 related to item A: Opening balance + Purchasing = Issuing +Closing
Quantity units
Opening balance, 1 May Receipts, 7 May Issues, 11 May Receipts, 16 May Issues, 21 May Closing balance, 31 May Total F2 ACCA Phi Thanh Tu 100 400 200 300 400
unit cost
2.00 2.10
Total cost
200 840
2.12
636
200
1676
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FIFO method- the cost of issues and closing inventory value would be:
Quantity units unit cost $ 100 at $2 100 at $2.1 300 at $2.1 100 at $2.12 200 at $2.12 Total cost $
Issues, 11 May
Issues, 21 May Closing balance, 31 May
200
400 200
$410
$842 $424 1676
12

LIFO method- the cost of issues and closing inventory value would be:
Quantity units unit cost Total cost
Issues, 11 May 200

Issues, 21 May 400 Closing balance, 31 May 200
200 at $2.1 300 at $2.12 100 at $2.1 100 at $2.1 100 at $2.0
$420
$846 $410 1676
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WAC method- the cost of issues and closing inventory value would be:
Quantity units Issues, 11 May Issues, 21 May Closing balance, 31 May 200 400 unit cost $ $1040/500= $2.08 $(624+636)/600= $2.1 Total cost $ 416 840 Inventory balance units 300 200 Inventory balance $ 624 420
200
$2.1
420
200
420
1676
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Exercise Exercise\FIFO WAC LIFO.docx
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4. Physical inventory and book inventory

4.1. Perpetual inventory vs. Periodic inventory
Perpetual inventory: Inventory is continuously updated. It is
the recording as they occur of receipts, issues and the resulting balances of individual items of inventory in ether quantity or quantity and value Inventory records are updated using stores ledger cards and bin cards, which show the records of receipts, issues and balances of the quantity (bin cards) and value (stored ledger cards).
Periodic inventory: Inventory is counted at the end of period
and then recorded accordingly. It records inventory purchase or sale in "Purchases/sales" account. Sales, Purchases" accounts are updated continuously
Inventory subsidiary ledger is not updated after each purchase
or sale of inventory. Inventory quantities are updated on a periodic basis.


4.2. Stock taking
Definition: Stocktaking process involves: checking the physical
quantity of inventory held on a certain date and check this balance against the balances on the store ledger (record) cards or bin cards.
Method: Period stocktaking: count every item of inventory at the same
date (usually at the balance sheet date) Continuous stock taking: count selected items of inventory on a rotating basis. Each item is checked at least once a year with a valuable items being checked more frequently

4.2. Stock taking
Physical count
Stock count is carried out It is the difference between book inventory vs. physical inventory <bin cards/ store ledger cards vs. inventory count> Investigate the inventory discrepancies Adjust store ledger cards/bin cards to reflect the true physical inventory count Identifying slow moving and obsolete item to bring attention to management Slow moving: items take long time to use up Obsolete: out of date, no longer required Management solutions on the slow moving and obsolete items
Inventory discrepancies
Adjust book inventory
Slow moving and obsolete items
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4.3. Control procedures to minimize discrepancies and loss of inventory
Problems Ordering goods at inflated prices(higher/unreasonable) control procedures use standard costs for Purchase quotation (for special items) Segregation of ordering and purchasing Physical controls over materials receipt, Fictitious purchase usage and inventory Check in all goods inwards at gates Shortage on receipts Delivery signature Regular stock taking Losses from inventory Physical security procedures Writing off obsolete or damaged inventory control of responsible officers over all which is good written-offs Losses after issue to production Record all issues department Standard usage allowance
II. Order quantities and reorder level

1. 2. 3.
4.
Costs of holding inventory Economic order quantity Gradual replenishment of inventory Inventory control levels
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1. Cost of holding inventory

1.1. Reasons of holding inventory Sufficient goods available to meet expected demand Prevent hold-ups in the production process Meet future shortages Take advantage of bulk purchases discounts
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1.2. Holding costs Costs associated with holding inventory are known as holding costs Holding cost included: Interest on capital tied up in inventory Cost of storage space Cost of insurance Risk of obsolesce Deterioration: disposal cost for unusable inventory Holding cost can be distinguished between fixed holding costs and variable holding costs It is often stated as being valued at a certain percentage of the average inventory held
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1.3. Ordering/procurement costs
Ordering/procurement costs: are the costs associated with placing orders. They include: Administrative costs: are usually a fixed cost per order. The total admin costs of placing orders will increase in proportion to the number of orders placed. >>> Variable costs Delivery costs: are usually a fixed charge per delivery (order). The total delivery costs will also increase in direct proportion to the number of deliveries in the period. >>> Variable cost
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1.4. Stock out costs
Stock-out costs: are the costs associated with
running out of inventory and they include loss of sales, loss of customers and reduced profit
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1.5. Stock control and inventory holding cost
If inventory level is too low, there is a danger that
the number of stock-outs will increase, and there will increase in the number of order placed An increase in the number of order placed will cause a corresponding increase in ordering costs So, it should maintain inventory at a level (optimum level) where the total of holding costs, ordering costs and stock-out costs are at minimum. This is the main objective of stock control
2. Economic order quantity

EOQ is the reorder quantity which minimizes
the total costs associated with holding and ordering stock = holding cost + ordering costs are at a minimum at the EOQ Graph:
Holding cost= ordering cost
EOQ= (2CoD/Ch) D= demand per annum Co= cost of placing one order Ch= cost of holding one unit for one year Q= Reorder quantity
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2. Economic order quantity EOQ assumptions:

Average inventory= EOQ/2
The number of orders in a year= expected annual
demand/EOQ Total annual holding cost= EOQ/2*holding cost per unit of inventory Total annual ordering cost = number of orders*cost of placing an order TAC= CO * D/Q + ChQ/2
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EOQ with discount Discount for bulk orders Effect of quantity discount: The annual purchase price will decrease The annual holding cost will increase The annual ordering cost will decrease To establish whether the discount should be accepted or not: Calculate the TAC with the discount (including the purchase cost) Compare with the annual costs without the discount at EOQ point Steps: Calculate EOQ ignoring discount If EOQ< min purchase quantity to obtain bulk discount, calculate the
total cost for the EOQ (= the annual stockholding costs+ stock ordering costs + stock purchasing costs) Recalculate the total cost for a purchase order size that is only just large enough to qualify for the bulk discount = TAC of the bulk quantity Compare the total costs when the order quantity is the EOQ with the total costs when the order quantity is just large enough to obtain the discount. Select the min cost alternative
3. Gradual replenishment of inventory

EOQ: inventory to be replenished immediately when organization
buy inventory from suppliers EBQ: inventory to be replenished gradually by manufacturing their own products internally Setup cost replaces ordering cost of EOQ Average inventory held in EOQ is greater than average held in EBQ for the same size of batch EBQ = (2CoD/[Ch(1-D/R)] Q= batch size D= Demand per annum Ch= cost of holding one unit for one year Co= cost of setting up a batch ready to be produced R= annual replenishment rate
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3. Gradual replenishment of inventory

Producing large batches at long interval will lead to low machine
setup costs (as fewer machines setups will be needed) and high holding costs (as more inventory)
Producing small batches at short interval will lead to high machine
setup costs (as more machine setups will be needed) and low holding costs (low average inventory levels as less inventory held)
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4. Inventory control level
Reorder level: when inventory reaches the reorder level, a replenishment order should be placed
RL= usage*lead-time (when demand in the lead time is constant)
RL= max usage* max lead time (when demand in the lead time is
not constant)
o Lead time= this is the time expected to elapse between placing
an order and receiving an order for inventory

o Reorder quantity: when the reorder level is reached, the quantity
of inventory to be ordered is known as the EOQ

o Demand: this is the rate at which the inventory is being used up
= inventory usage
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4. Inventory control level
Max inventory- this is a warning level when inventory are dangerously high.
Max inventory level = reorder level + reorder quantity min
usage*min lead time
Min inventory- this is a warning level when inventory are dangerously low and that stock-outs are potential threat. It is know as buffer inventory/safety inventory
Min inventory level = reorder level average usage*average lead-
time

Average inventory= Reorder quantity/2+ min inventory Free inventory= physical inventory + inventory on order- inventory requisitioned (not yet issued)
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Part B-2- Labor cost

Direct and indirect labor cost Recording, calculating and accounting for Labor cost Remuneration method Labor turnover and Measuring labor activity
1. 2.
3.
4.
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1. Direct and Indirect labor cost

Direct Make up part of the prime cost of a product Include basic pay of direct workers <Pay to employees who are directly involved in making a product> Indirect Make up part of overheads Include basic pay of indirect workers <Pay to employees who are not directly involved in making products> Bonus payment
Idle time: workers are paid but not making any products
Sick pay Pay for time spent by direct workers doing indirect jobs
1. Direct and Indirect labor cost
Overtime and overtime premium of direct employees
Overtime paid = basic element + overtime premium
Direct cost Indirect cost Overtime premiums are treated as direct labor cost if it is at the specific request of a customer.
Shift allowance/premium >>>> similar to overtime premium
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2. Recording, calculating and accounting for Labor cost

2.1. Recording and calculating Labor cost Recording time spent doing jobs Time records: for payment, determining cost to be charged E.g.: Attendance record- show days absent or attend. E.g.: Time cards (gate or lock cards)- record time of arrival and departure. To be used in manufacturing industry Activity time record: Period related timesheets: commonly used in service industries, cover days/weeks/longer period Task related activity time records (job sheets, operation charts, piecework tickets)
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2.1. Recording and calculating Labor cost Organization for controlling and measuring labor cost: Personnel department Production planning department Time keeping department Wages department Cost accounting
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2.2. Accounting for labor cost Wages payment: Dr wage control account Cr Bank account Direct labor: Dr WIP account Cr Wages control account Indirect labor: Dr Production overhead account Cr Wages control account
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3. Remuneration method
Remuneration methods
(1) Time work
(2) Piecework scheme
(3) Bonus/incentive scheme
Wages = Hours worked x rate of pay per hour
Wages = Units produced x rate of pay per unit (a) High day rate system (e) Profit sharing schemes
(b) Individual/discretionary bonus schemes

(c) Time saved bonus scheme (d) Group bonus schemes 40 F2 ACCA Phi Thanh Tu
(f) Incentive schemes involving shares

(g) Value added incentive schemes
(3) Bonus/ incentive schemes
(a) High day rate system is a system where employees are paid a high hourly rate in the expectation that they will work more efficiently than similar employees on a lower hourly rate in different company. (b) Individual bonus schemes Individual employees can qualify for a bonus on top of their basic wage, which each person's bonus being calculated separately. The bonus is unique to the individual. It is not a share of a group bonus The individual earns a bigger bonus with the greater his efficiency. quality safeguard.
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(3) Bonus/ incentive schemes
(c) Time saved bonus schemes: Employees are paid for the time saved in completing the job The bonus encourage employees to do work at a faster rate.
(d) Group bonus schemes is an incentive plan which is related to the output performance of an entire group of workers, a department, or even the whole factory. (e) Profit sharing schemes is a scheme in which employees receive a certain proportion of their company year-end profits. Possible criteria of this scheme: position of employees and employment time.
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3. Remuneration
(3) Bonus/ incentive schemes (f) Incentive schemes involving shares A share option scheme is a scheme in which gives its members the right to buy shares in the company for which they work at a set date in the future and at a price usually determined when the scheme is set up. (g) Value added incentive scheme It is an alternative to profit as a business performance measure Value added = Sales - cost of brought-in materials and services Target value added should be set, some of any excess value added earned would be paid out as bonus.
4. Labor turnover and measuring labor activity

4.1. Labor turnover To measure proportion of people leaving relatively to the average number of people employed Causes: Avoidable causes: poor remuneration/working conditions, lack of training opportunities/promotion prospect Unavoidable causes: retirement, illness, death, family reasons
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4.1. Labor turnover Costs of labor turnover: Replacement costs: advertisement, selection, training costs, efficiency decreases Lower the performance of current employees Preventative costs: incurred to minimized Labor turnover, associated with escaping the avoidable causes: Increase wages Improve working conditions Increase training programs Promotion scheme Investigate high LT rate Labor turnover rate = Number of leavers who require replacement / average number of employees
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4.2. Measuring labor activity Efficiency ratio (Productivity ratio)= (Expected hours to make output)/(Actual hour taken) x 100% If the ratio > 100%: productivity is greater than expectation If the ratio < 100%: less than expectation, inefficient labor Capacity ratio= (actual hours taken)/(budgeted hours) x 100% If the ratio >100%: work above capacity If the ratio <100%: work below capacity Production volume ratio/ Activity ratio = (Expected hours to make output)/(Budgeted hours) x 100% Production volume ratio = efficiency ratio x capacity ratio If the ratio >100%: produce more than budget If the ratio <100%: produce less than budget
Part B-3- Overheads

1. 2. 3.
4.
5.
Overheads and cost categories review Absorption costing Under and over absorption of overheads Accounting entries Non-production overheads
47
1. Overheads and cost categories review

Overheads is the cost incurred in the course of making product,
providing a service or running a department but cannot be traced directly and in full to the product/service/department Categories: Indirect Materials + Indirect labor + Indirect expense: Production OH: can be fixed or variable Administration OH Selling & distribution OH
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1. Overheads and cost categories review

Why should OH be included in the total cost of product?
Stock valuations Closing stock figure in the balance sheet Cost of sales figure in the P&L account Pricing decisions If companies follow full cost plus pricing strategy. Establishing the profitability of different products.
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2. Absorption costing
2.1. What is absorption costing? It is a method of sharing overheads between a number of different products an a fair basis. Objective: to include in the total cost of a product (unit or job) an appropriate share of the organizations total overhead By an appropriate share, an amount that reflects the amount of time and efforts has gone into producing a unit or completing a job Closing stock in the balance sheet and the COGS in the P&L a/c must be valued at full in PRODUCTION COST
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2.2. Absorption costing procedures Stage 1: Allocation
Stage 2: Apportionment
Stage 3: Absorption
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2.2. Absorption costing procedures STAGE 1: Allocation Allocation is the process by which whole cost items are charged direct to a cost unit or a cost centre. Indirect materials, Indirect labors, Security guard, Depreciation, Rent, etc.
Canteen
Maintenance
Machining
Assembly
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2.2. Absorption costing procedures STAGE 2: Apportionment Apportionment is a process whereby indirect costs are spread fairly between cost centers. 2 stages: Apportionment Re-apportionment
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2.2. Absorption costing procedures STAGE 2: Apportionment Basic of apportionment: apportion OH to Cost centers (production+service cost centers)
Overheads Rent, rates, heating and light, repairs and depreciation of buildings Depreciation, insurance of equipment Personnel office, canteen, welfare, wages and cost office Heating and cooling
Basic of apportionment Floor area occupied by each cost center Cost of book value of equipment Number of employees or labor hours worked in each cost center Volume of space occupied by each cost center
2.2. Absorption costing procedures STAGE 2: Apportionment Basic of re-apportionment- apportioning service cost centers overheads to the production cost center using appropriate bases
Service departments Stores Maintenance Production planning Basic of apportionment Number of cost/value of material requisitions Hours of maintenance work done for each cost centers Direct labor hours worked in each production cost center
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2.2. Absorption costing procedures STAGE 2: Apportionment- reapportionment Service cost centre costs may be apportioned to production cost centers by using one of the following methods: Direct method Reciprocal method Step method
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2.2. Absorption costing procedures STAGE 2: Apportionment- Direct method Costs of each service costs centre are apportioned only to production cost centers
DIRECT METHOD
Interactions between service departments are ignored and all costs are apportioned directly to operating (Production) departments.
Service Department (Canteen)
Operating Department (Machining)
Service Department
(Maintenance)
Operating Department (Assembly)
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2.2. Absorption costing procedures STAGE 2: Apportionment- Step method Costs apportionment are performed in a step-down fashion, using predetermined ranking procedures (e.g., degree of support) STEP METHOD
Service Department Once a service departments costs are apportioned, other service department costs are not apportioned back to it.
Operating Department
(Canteen)
(Machining)
Service Department (Maintenance)
(Assembly)
2.2. Absorption costing procedures STAGE 2: Apportionment- Reciprocal method Recognizes interactions of service costs centers prior to apportion to production cost centers Costs of each service costs centre are apportioned not only to production cost centers, but also to other service cost centers which make use of its services. The results of the reciprocal method may also be obtained using algebra and simultaneous equations.
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2.2. Absorption costing procedures STAGE 2: Apportionment- Reciprocal method
RECIPROCAL METHOD
Service Department Interdepartmental services are given full recognition rather than partial recognition as with the step method. (Canteen)
Operating Department (Machining)
Service Department (Maintenance)
(Assembly)
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2.2. Absorption costing procedures STAGE 3- Absorption
Overhead absorption is the process whereby overhead costs
allocated and apportioned to production cost centers are added to cost units, jobs or process costs using an appropriate basis
A product cost can now be determined:
Direct materials + + Direct labor Absorbed overhead Product cost
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2.2. Absorption costing procedures STAGE 3- Absorption OH are usually added to cost units using a predetermined overhead absorption rate. Step 1: Estimate the OH likely to be incurred during the coming period. Step 2: Estimate the activity level for the period. This could be total hours, units, or direct costs of whatever it is upon which the OH absorption rates are to be based. Step 3: Divide the estimated OH by the budgeted activity level --> the OH absorption rate.
OH absorption rate
Step 4:
Total budgeted overhead costs

=
Total budgeted act. level
Absorb the OH into the cost unit by applying the calculated absorption rate. Overhead absorbed = predetermined OAR x Actual level of activity
2.2. Absorption costing procedures STAGE 3- Absorption Possible bases of absorption rate:
Rate per unit Rate per machine hour Rate per direct labor hour Percentage of direct material cost Percentage of direct labor cost Percentage of total direct cost Percentage of factor cost (for admin overhead) Percentage of sales or factory cost (for selling and distribution
overhead)
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2.2. Absorption costing procedures STAGE 3- Absorption 3 methods of Absorbing Overhead Costs: Overhead can be absorbed into cost units in one of three ways:
Blanket absorption rate (Single plantwide rate)
Separate absorption rates (Departmental overhead rates)
Activity-based costing (later)
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2.2. Absorption costing procedures STAGE 3- Absorption 3 methods of Absorbing Overhead Costs- Method 1- Blanket absorption rate Indirect Costs Cost Absorption Base Cost Objects
Overhead Cost
Blanket absorption rate
Product 1
Product 2
Product 3
2.2. Absorption costing procedures STAGE 3- Absorption 3 methods of Absorbing Overhead Costs- Method 2- Separate absorption rate Overhead Cost
Indirect
Costs
First
Stage Department A
Department A Overhead Rate Product 2
Department B
Department B Overhead Rate Product 3
Cost Objects
Absorption Base
Second
Stage
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Product F2 ACCA Phi Thanh 1 Tu
Cost Objects
3. Under/Over absorption of overheads

Normal costing involves using the predetermined absorption rate in order to establish the actual cost of production.
Direct materials Direct labour Overheads

(based on the predetermined absorption rate)
xxx xxx xxx xxx
Actual cost of production
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Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.
.
Overhead is over absorbed
Over absorption means that the OHs charged to the cost of sales are greater than the OH actually incurred. Actual OH Absorbed OH Over absorbed OH 1000 (1200) 200
Actual overhead costs incurred
Overhead absorbed to Work in Process
(OAR Activity)
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Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.
.
Overhead is under absorbed
Overhead absorbed to Work in Process Actual overhead costs incurred (OAR Activity)
Under absorption means that inssufficient OHs have been included in the cost of sales. Actual OH Absorbed OH Under absorbed OH 1000 (900) 100
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Adjusting of Over absorbed and Under absorbed Overhead:
--->Adjusting Cost of sales for under absorbed or over absorbed overhead

Overhead is:
Cost of sales Adjustment is: will:
Actual overhead > Underabsorbed overhead absorbed
Too low
Increase Cost of sales
Actual overhead < Overabsorbed overhead absorbed
Too high
Decrease Cost of sales
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4. Accounting entries
Occurrence of overhead
Dr Production overhead account Cr Inventory/ Wages control /Cash/Creditor accounts Absorption of overhead Dr WIP account Cr Production overhead account Over-absorption of overhead Dr Production overhead account Cr under/over absorbed overhead (P&L) Under-absorption of overhead Dr under/over absorbed overhead (P&L) Cr Production overhead account
5. Non-production overheads
Method 1: Choose a basic for the overhead absorption rate
which most closely matches the non production overhead. E.g.: direct labor hours, direct machine hours and so on.
Method 2: Allocate non-production overheads on the ability of the
products to bear such cost. One possible approach is to use the production cost.
Estimated non production overheads
OAR=
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Estimated production costs
5. Non-production overheads
Other bases for absorbing overheads
Types of overheads Selling and marketing Possible absorption rate Sales value
Research and development
Consumer cost (= pro.cost cost of direct materials)

Sales value Consumer cost
Distribution Administration
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Part B-4- Marginal and absorption costing

1. 2. 3.
4.
Recap of absorption costing Marginal costing definition and principles Absorption costing vs. Marginal costing Reconciling the profit figures given by 2 methods
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1. Recap of absorption costing

Absorption costing (Full costing): The cost of a unit of product consists of:
Direct materials Direct labor Manufacturing overheads
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2. Marginal costing definition and principles

Marginal cost is the variable cost of one unit of product or service >>>> would be avoided if that unit were not produced or provided The cost of a unit of product consists of only variable (marginal) manufacturing costs: Direct materials Direct labor Variable manufacturing overhead

Contribution = sales revenue variable costs of sales Fixed costs are treated as period costs and are charged in full to the PL account of the accounting period in which they are incurred
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2. Marginal costing definition and principles

No extra fixed cost incurred when output is increased By selling an extra item of product or service, the following will happen: Revenue will increase by the sale value of item sold Costs will increase by the variable cost per unit Profit will increase by the amount of contribution earned from the extra item
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3. Absorption costing vs. Marginal costing
Absorption Costing Direct Materials Product Costs Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Period Costs
Variable Selling and Administrative Expenses
Variable Costing
Product Costs
Period Costs
Fixed Selling and Administrative Expenses
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3. Absorption costing vs. Marginal costing

Manufacturing Cost Flows
Balance Sheet
Costs Material Purchases Direct Labor
Inventories
Raw Materials
Income Statement Expenses
Variable Manufacturing Overhead

Fixed Manufacturing Overhead Selling and F2 Administrative ACCA Phi Thanh Tu
Work in Process Cost of Goods Sold Selling and Administrative
Finished Goods
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Period Costs
4. Reconciling the profit figures given by 2 methods

The difference is due to the difference stock valuation method used
Relation between production and sales Relation between marginal and absorption profit
Effect on inventory
Production > Sales
Inventory increases
Inventory decreases
Absorption > marginal

Absorption < Marginal Absorption = marginal
Production < Sales
Production = Sales
No change
4. Reconciling the profit figures given by 2 methods

Income statements Sales Less COS + Opening inventory + Add production cost -Less Closing inventory Subtotal COS Add/less Under/Over absorbed O/H Less other variable costs Contribution Gross profit Less Fixed production O/H Fixed selling O/H Net profit
Phi Thanh, Tu (EXTOther - VN/Hanoi): At variable production cost
Marginal costing $'000 $'000 X X X (X) (X) (X) X
Absorption costing $'000 $'000 X X X (X)
Phi Thanh, Tu (E Other - VN/Hano At full production c
(X) X
X (X) (X) X NIL (X) X
Part B-5- Job, batch and service costing

Job costing 2. Batch costing 3. Service costing
1.
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Costing system
Specific order costing

Work done by an organization consists of separately identifiable jobs or batches Job, batch costing
Continuous operation costing

Goods or services are produced as a direct result of a sequence of continuous operation or processes Process costing
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1. Job costing
Job Costing
Used for production of large, unique, or high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.
84
1. Job costing
Materials Indirect Direct
Factory Overhead
Apportion
Work in Progress
Finished Goods
Indirect Labor Direct Cost of Sales
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1. Job costing
Receive order from customers Schedule the job
Predict cost to complete job
Negotiate a sales price and decide whether to pursue the job.
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2. Batch costing
Batch Costing
Similar to Job costing Within each batch are number of identical units but each batch will Total production cost of batch be different Cost per unit in batch =
Number of units in batch
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2. Batch costing
JOB
&
BATCH
The units of a particular job/batch are easy to identify.
Individual goods Value of WIP at or Total production cost ofthe year end is services have batch very different the sum of the characteristics in batch incurred on costs Number of units and costs. incomplete job/batch.
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3. Pricing the Job/Batch

Pricing the Job Cost plus method
Mark-up Cost of job + Profit % 100 25 Cost of job + Profit
Margin % 100 25
= Selling price 125 Profit Mark-up: 25% on job cost

= Selling price 125 Profit Margin: 20% on selling price
4. Service costing
Different characteristics of services: Simultaneity, Heterogeneity,
Intangibility, Perishability Difficulty in defining cost units. It is usually a composite cost unit E.g.: tones-miles for haulage companies patient days for hospital guest days for hotel services passenger miles for public transport companies Direct materials will be relatively small compared to labor & OH. However, service costing techniques are quite similar to job/batch costing: Cost per service unit
= -----------------------------------------
Total costs for period
Number of service units in the period
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Part B-6- Process costing

Process costing Losses in process costing Dealing with scrap value Losses with a disposal cost Valuing WIP Joint products & By-products
1. 2. 3.
4.
5. 6.
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1. Process costing
A form of continuous operation costing To be used in mass production of many identical products Output of process 1 forms the materials input of the next process Average cost per unit is calculated for each process
Average cost per unit
= -----------------------------------------
Costs of production
Expected or normal output
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1. Process costing
Differences Between Job-Order and Process Costing Job order costing Many jobs are worked during the period.
Process costing A single product is produced for a long period of time/ and/or going through different processes. Costs are accumulated by departments. Department production report is key document. Unit costs are computed by department (each process)
Costs are accumulated by individual jobs. Job cost sheet is the key document. Unit costs are computed by job
1. Process costing
Direct labor and manu. OH are often combined into one product cost called conversion.
Direct Material s Overhead
Direct Labor Direct Material s Conversion
Dollar Amount
Dollar Amount
Type of Product Cost
Type of Product Cost
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2. Losses in process costing

Framework for dealing with process costing Step 1: Determine output & losses
Step 2: Calculate cost per unit of output, losses & WIP
Step 3: Calculate total cost of output, losses & WIP
Step 4: Complete accounts
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Step 1: Determine output & losses Normal loss: The loss is expected in a process Expressed as a % of material input to the process If Normal loss does not have a scrap value, It is valued in the process account as NIL If Normal loss has a scrap value, it is valued in the process account at this value. Revenue from scrap value is used to reduce the input cost of the process
96

Step 1: Determine output & losses Abnormal loss and gains If the actual loss/gain in the process is different to what we are expecting, it is an abnormal loss or an abnormal gain Actual loss > normal loss = Abnormal loss Actual loss < normal loss = Abnormal gain Cost of abnormal loss and gain: not absorbed into the cost of good output Shown as loss and gain in the process account Value is the same as cost of unit of good output
97

Step 1: Determine output & losses
Input: 1000 units Production Process Normal loss rate: 10% Output: 860 units
Actual Losses: 140 units
Normal loss: 100 units (10% x 1000 units)
Abnormal loss: 40 units (140 units - 100 units)
98

Step 1: Determine output & losses
Input: 1000 units Production Process Normal loss rate: 10% Output: 960 units
Actual Losses: 40 units
Normal loss: 100 units (10% x 1000 units)
Abnormal gain: 60 units (100 units - 40 units)
99

Step 2: Calculate cost per unit Rule: Unit cost of output is calculated based on expected output
Example:
For both case 1 & 2 above, if total costs of input is $4,500,
Cost per unit of output is:

$4,500/ 900 units = $5 per unit
100

Step 3: Calculate total cost of output and losses Rule: Normal loss: No cost Abnormal loss: given a cost (equal to unit cost of out put) Abnormal gain: given a negative cost (equal to unit cost of out put)
Case 1 Normal loss: NIL Abnormal loss= 40units x $5 = $200 Output = 860units x $5 = $4300 Case 2 Normal loss: NIL Abnormal gain= 60units x $5 = $300 Output = 960units x $5 = $4800
101

Case 1:
INPUT Cost incurred
PROCESS ACCOUNT Units $ OUPUT 1000 4500 Normal loss Output Abnormal loss
Units 100 860 40
$ 0 4300 200
102

Case 1:
Process account
ABNORMAL LOSS ACCOUNT Units $ 40 200 Income statement
Units
103

Case 2:
INPUT Cost incurred Abnormal gain
PROCESS ACCOUNT Units $ OUPUT 1000 4500 Normal loss 60 300 Output
Units 100 960
$ 0 4800
104

Case 2:
Income statement
ABNORMAL GAIN ACCOUNT Units $ Abnormal gain
Units 60
$ 300
105
3. Dealing with scrap value

Losses or spoilage may have scrap value. Basic rule: Revenue from scrap is not treated as an addition to sales
revenue, but as a reduction in costs. Scrap value
Normal loss/gain
LOSS
Abnormal loss/gain
GAIN
Deduct from cost of process Dr Scrap a/c

F2 ACCA a/c 106 Cr ProcessPhi Thanh Tu
Deduct from cost of abnormal loss

Dr Scrap a/c Cr Abnormal loss a/c
Deduct from value of abnormal gain

Dr Abnormal gain a/c Cr Scrap a/c
3. Dealing with scrap value
Example:
JJ has a factory which operates two production processes, cutting and pasting. Normal loss in each process is 10%. Scrapped units out of the cutting process sell for $3 per unit whereas scrapped units out of the pasting process sell for $5. Output from the cutting process is transferred to the pasting process: output from the pasting process is finished output ready for sale. Relevant information about costs for control period 7 are as follows: Pls prepare accounts for the cutting/pasting process, abnormal loss, abnormal gain and scrap. Cutting process Pasting process Units Input materials Transferred to pasting process Material from cutting process Added materials Labor and overheads
107
$ 54,000
Units
18,000 16,000
16,000 14,000 32,400 28,000 70,000 135,000
Output Phi Thanh Tu F2 ACCA to FGs
4. Losses with a disposal cost

Disposal cost
Normal loss LOSS Add to cost of process Dr Process a/c Cr Disposal cost a/c
Abnormal loss/gain GAIN Add to value of abnormal gain

Dr Disposal cost a/c
Cr Abnormal gain a/c
Add to cost of abnormal loss Dr Abnormal loss a/c Cr Disposal cost a/c
108
5. Valuing WIP
Equivalent units are partially complete and are part of work in
process inventory. Partially completed products are expressed in terms of a smaller number of fully completed units- as a proportion of completed units. Calculating and Using Equivalent Units of Production Cost per equivalent unit
Costs for the period Equivalent units of production for the period
Different degree of completion for each cost element: Materials Conversion costs = labor + overheads
109
5. Valuing WIP
Example 1:
For process 1 in ABC Co, the following is relevant for the latest period: Period cost: $4440 Input: 800 units Output: 600 fully-worked units and 200 units only 70% complete. There were no process losses Prepare statement of Eus and Process 1 account.
110
5. Valuing WIP
Example 1: Statements of EUs Output FGs 600 % 100% Eus 600
Closing WIP
Total Costs Cost per EU
200
800
70%
140
740 $4440 $6
Process 1 A/c Units Input 800 $ 4440 Transferred to next process WIP Total 800 4440 Units 600 200 800 $ 3600 (600*6) 840 (140*6) 4440
111
5. Valuing WIP
How to value WIP if there is WIP at the beginning of the period? Valuing Opening WIP
FIFO method
Weighted Average method
Cost during period Work done during period

Cost till date Work done till date
5. Valuing WIP
Assumption in FIFO Assumption in WAC WIP at the beginning of the period Makes no distinction between work must be completed, and transferred done in prior and current period out first. Closing WIP includes the most recently incurred costs Blends together units and costs from prior period and current period.
113
5. Valuing WIP
Work in process, May 1: 200 units Materials: 55% complete. Conversion: 30% complete. Production started during May: Production completed during May: Costs added to production in May Materials cost Conversion cost Work in process, May 31: 400 units Materials 40% complete. Conversion 25% complete. $ 9,600 $ 5,575 5,000 units 4,800 units $ 368,600 $ 350,900
114
5. Valuing WIP
Prepare the process account for May 2008- FIFO
Materials 5,000 Units Started
Beginning WIP 200 Units 55% Complete

200 x 45%
4,600 Units Started and Completed
Ending WIP 400 Units 40% Complete
90 Equivalent Units 4,600 Units Completed 160 Equivalent Units 4,850 Equivalent units of Materials
400 40%
5. Valuing WIP
Prepare the process account for May 2008- FIFO
Conversion 5,000 Units Started
Beginning WIP 200 Units 30% Complete 200 x 70%
140 Equivalent Units 4600 Units completed 100 Equivalent Units

4,840 Equivalent units of Conversion
400 25%
116
5. Valuing WIP
Prepare the process account for May 2008- WAC
Materials 5,000 Units Started
4800 Units Completed 160 Equivalent Units 4,960 Equivalent units of Materials
400 40%
5. Valuing WIP
Prepare the process account for May 2008- WAC
Conversion 5,000 Units Started
4800 Units completed 100 Equivalent Units

4,900 Equivalent units of Conversions
400 25%
118
6. Joint and by products

6.1. Joint products
Joint products are two or more products produced
simultaneously by the same process up to a split-off point. Each is important and can have a significant sales value. Each should therefore be valued separately. e.g.., seafood processing, oil refining,... Cost incurred up to this point are called common costs or joint costs. The split-off point is the point at which the joint products become separate and identifiable. Should be treated as normal output from the process
119

6.1. Joint products
Joint Cost Apportionment Methods Physical units: production units Sales value at split-off point: the sales value of the total output
from the particular processes concerned.

Net realizable value: final sales value further processing cost
120

6.2. By products What are the differences between a joint and a by- product? The distinction between joint and by-products rests solely on the relative importance of their sales value. A by-product is a secondary product recovered in the course of manufacturing a primary product. Characteristics of By-products: Relatively low in sales value Small in quantity produced Sold in bulks
121

6.2. By products Accounting for by-products: Similar to Normal Loss Cost of By-product: Generally NO cost is apportioned to the by-products. Income of By-product: 4 methods added to sales of main products. treated as a separate, incidental source of income. deducted from the cost of production of the main product. Net realizable value (NRV) of the by-product is deducted from the cost of production in the period. ***** the most common method.
122
Part B-7- Alternative costing

1. 2. 3.
4.
5. 6.
7.
Activity based costing Calculation of ABC Absorption costing vs. ABC Advantages and disadvantages of ABC Total Quality Management Life cycle costing Target costing
123
1. Activity base costing (ABC)

Costs are firstly assigned to the activities which are the real
causes of the overhead Then costs of those activities are assigned to the products which are actually demanding those activities
Activity 1 Product 1 Overheads Activity 2 Product 2 Activity 3
1. Activity base costing (ABC)

Activities cause costs: the special engineering, special testing,
machine setups, etc(they cause the company to consume resources). The reasons for the development of ABC: (1) manufacturing overhead costs have increased significantly, (2) the manufacturing overhead costs no longer correlate with the productive machine hours or direct labor hours, (3) the diversity of products and the diversity in customers' demands have grown, and (4) some products are produced in large batches, while others are produced in small batches.
125
2. Calculation of ABC
Step1
Identify an organization's major activities
Step 2
Identify the cost drivers- factors which determine the size of the costs of an activity (cause the costs of an activity) Collect the costs of each activity into cost pools (equivalent to cost centers under the traditional costing methods) (each activity) Charge support overheads to products on the basis of their usage of the activity- number of the activitys cost driver it generates
Step 3
Step 4
126
1. Activity base costing (ACB)
Activity Ordering Materials handling Production scheduling Dispatching
Cost drivers Number of orders Number of production runs Number of production runs Number of dispatches
127
2. Calculation of ACB- Example

We will assume that a company has annual manufacturing overhead costs of $2,000,000of which $200,000 is directly involved in setting up the production machines. During the year the company expects to perform 400 machine setups. Lets also assume that the batch sizes vary considerably, but the setup efforts for each machine are similar. For simplicity, lets assume that the remaining $1,800,000 of manufacturing overhead is caused by the production activities that correlate with the companys 100,000 machine hours. Assume that a company manufactures a batch of 5,000 units and it produces 50 units per machine hour, calculate the cost assigned to the units with activity based costing and without activity based costing compares. If a company manufactures a batch of 50,000 units and produces 50 units per machine hour, show how the cost assigned to the units with ABC and without ABC compares.
128

With ABC Mfg overhead costs assigned to setups Number of setups Mfg overhead cost per setup Without ABC
$200,000
400 $500
$0
Not applicable $0
129

With ABC Total manufacturing overhead costs Less: Cost traced to machine setups Mfg O/H costs allocated on machine hours Machine hours (MH) Mfg overhead costs per MH Mfg Overhead Cost Allocations
Without ABC $2,000,000 0 $2,000,000 100,000 $20
$2,000,000 200,000 $1,800,000 100,000 $18 $500 setup cost per batch + $18 per MH
$20 per MH

If the company manufactures a batch of 5,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:
With ABC Mfg overhead for setting up machine No. of units in batch Mfg O/H caused by Setup Per Unit
Without ABC
$500
5,000
$0
Not applicable
$0.10
Not applicable
131

With ABC
Mfg overhead costs per machine hour No. of units produced per machine hour Mfg O/H caused by Production Per Unit Total Mfg O/H Allocated Per Unit
Without ABC
$18 50 $20 50
$0.36
$0.40
$0.46
$0.40

If the company manufactures a batch of 50,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:
With ABC Mfg overhead for setting up machine No. of units in batch Mfg O/H caused by Setup Per Unit $500 50,000
Without ABC $0 Not applicable
$0.01
Not applicable
133

With ABC
Mfg overhead costs per machine hour No. of units produced per machine hour Mfg O/H caused by Production Per Unit Total Mfg O/H Allocated Per Unit
Without ABC
$18 50 $20 50
$0.36
$0.40
$0.37
$0.40

As the tables above illustrate:
with activity based costing the cost per unit decreases from $0.46 to $0.37 because the cost of the setup activity is spread over 50,000 units instead of 5,000 units. Without ABC, the cost per unit is $0.40 regardless of the number of units in each batch. If companies base their selling prices on costs, a company not using an ABC approach might lose the large batch work to a competitor who bids a lower price based on the lower, more accurate overhead cost of $0.37. Its also possible that a company not using ABC may find itself being the low bidder for manufacturing small batches of product, since its $0.40 is lower than the ABC model of $0.46 for a batch size of 5,000 units. With its bid price based on manufacturing overhead of $0.40but a true cost of $0.46the company may end up doing lots of production for little or no profit.
135
3. Absorption costing vs. ACB

ACB ABC ascertains the purpose of each activity or service and assigns the cost of such activity or service to the product or service unit that demands such activity. Absorption costing Cost of a product unit under absorption costing = cost of direct materials + direct labor + variable manufacturing overheads + (fixed manufacturing overhead costs/units produced).
Traces the costs of product units. Allocates costs to product units. (define activity >>> allocate COST) (allocate all production cost)
ABC presumes that products or It works under the simple approach services consume activities, and of assigning resources to products activities consume resources. It or services directly. thus, works to convert indirect costs F2 ACCA Phi Thanh Tu 136into direct costs.
3. Absorption costing vs. ABC

ABC Identifies the actual proportion of fixed overheads costs incurred by the product unit. Price fixation in ABC bases calculations to derive the actual overheads incurred on a unit, and does not vary with change in inventory levels. Absorption costing Divides equally the fixed overhead costs with the number of product units Price fixation in absorption costing depends on the inventory. The higher the inventory, the lower the product cost and lower the inventory; or the higher per-product cost Allowed by GAAP Remains more suitable for small firms and enterprises with homogeneous products or services.
Not allowed by GAAP.

Improves the quality of management accounting information, especially in large and multi-product operations
4. Advantages and disadvantages of ABC

Advantages Estimate cost precisely Disadvantages The method is complex, time consuming and costly
Provide quantifiable figure for planning and estimates

Facilitate the determination of selling price
Not accept by GAAP

Difficult to identify/analyze/quantify cost in the activity
Help to identify inefficient/ nonprofitable products/activities

Help to allocate resources to profitable items Etc Etc
138
5. Total quality management

TQM is a process of applying a zero defect philosophy to the
management of all resources and relationships within an organization as a means of developing and sustaining a culture of continuous improvement which focuses on meeting customer expectation. Quality combines the criteria:
How well made a product is/ how well performed if it is a service How well it serves its purpose How it measures up against its rival
139
5. Total quality management

Basic principles of TQM:
Get it right, first time: basic principal of TQM- the cost of preventing
mistakes is less than the cost of correcting them. Continuous improvement: always possible to improve Performance measures for TQM must embrace every activity of the organization The requirement of quality: 8 requirements of quality according to Mark Lee Inman
Customer Preventing the cause of the defect in the 1st place Customer-supplier relationship Employees must be personally responsible for defect free production Emphasize cost of poor quality
Any level of defects is unacceptable All departments are involved Quality certification
6. Life cycle costing
141
5. Life Cycle costing

Market introduction Demand/sales -Demand needs to be created -Sales is slow to start Targeted price Growth Maturity Decline
- Public awareness increases - Sales volumes increase significantly Begin to decrease due to competition
Sales peaks
- Decline
Price
Tends to drop
Diminish
Cost
Very high
Reduced due to economics of scale

Begin to increase with a few players Begin to rise
Lower
Counter-optimal
Competition
Little or no
Increase
Increase/ Peaks
Profitability
Make no money
Go down
Diminish
142
7. Target costing
Target cost is an estimate of a product cost which is determined
by subtracting a desired profit margin from a competitive market price. This target cost may be less than the planned initial product cost but it is expected to be achieved by the time the product reaches the maturity stage of the product life cycle
143
7. Target costing
Step 1 Determine a product specification of which an adequate sales volume is estimated
Set a selling price at which the organization will be able to achieve a desired market share Step 2
Step 3
Estimate the required profit based on return on sales or return on investment

Calculate the target cost = target selling price- target profit
Step 4
Compile an estimated cost for the product based on the anticipated design specification an d current cost level Step 5
Step 6
Calculate cost gap = estimated cost - target cost

Make efforts to close the gap (at design phase)
Step 7
Negotiate with the customer before making the decision about whether to go ahead with the project Step 8

F2 - Management Accounting Part B Class

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F2- Management accounting

F2 ACCA Phi Thanh Tu

F2 ACCA Phi Thanh Tu

Cost card- Cost statement of total cost of 1 unit of product

F2 ACCA Phi Thanh Tu

Part B Cost accounting techniques

F2 ACCA Phi Thanh Tu

Part B-1- Material cost

F2 ACCA Phi Thanh Tu

I. Ordering and accounting for inventory

F2 ACCA Phi Thanh Tu

consumables/tools & supplies Control over inventory:

2. Accounting procedures for ordering and issuing inventory

2. Accounting procedures for ordering and issuing inventory

F2 ACCA Phi Thanh Tu

3. Recording for inventory

3. Recording for inventory

3. Recording for inventory

F2 ACCA Phi Thanh Tu

3. Recording for inventory

Issues, 11 May 200

F2 ACCA Phi Thanh Tu

3. Recording for inventory

F2 ACCA Phi Thanh Tu

3. Recording for inventory

F2 ACCA Phi Thanh Tu

4. Physical inventory and book inventory

or sale of inventory. Inventory quantities are updated on a periodic basis.

4. Physical inventory and book inventory

4. Physical inventory and book inventory

Adjust book inventory

Slow moving and obsolete items

F2 ACCA Phi Thanh Tu

4. Physical inventory and book inventory

II. Order quantities and reorder level

F2 ACCA Phi Thanh Tu

1. Cost of holding inventory

F2 ACCA Phi Thanh Tu

1. Cost of holding inventory

F2 ACCA Phi Thanh Tu

1. Cost of holding inventory

F2 ACCA Phi Thanh Tu

1. Cost of holding inventory

F2 ACCA Phi Thanh Tu

1. Cost of holding inventory

If inventory level is too low, there is a danger that

2. Economic order quantity

2. Economic order quantity

F2 ACCA Phi Thanh Tu

2. Economic order quantity EOQ assumptions:

The number of orders in a year= expected annual

F2 ACCA Phi Thanh Tu

2. Economic order quantity

3. Gradual replenishment of inventory

3. Gradual replenishment of inventory

F2 ACCA Phi Thanh Tu

4. Inventory control level

an order and receiving an order for inventory

of inventory to be ordered is known as the EOQ

F2 ACCA Phi Thanh Tu

4. Inventory control level

usage*min lead time