Intermediate Management accounting

Cost object

any activity for which a separate measurement of cost is required (e.g., cost of making a product or providing a service).

Functions of management accounting

• score keeping - involving capturing and and recording financial information ,costs

• problem solving - provides relevant information for manager desciosn

• attention directing - focus management by providing information for planning,control, performance , preformace measurement

Differences between management and Financial accounting

• legal req - only FA id it necessary to take into account all info regardless of useful / MA info only produced based on its benefits it offers management

• focus on individual parts or segments of business - MA focuses on parts - cost /profitbility of services

• generally accepted accounting values

• time dimension

• report frequency and less emphasis on precision

Direct costs

costs that can be specifically and exclusively identified with a particular cost object (e.g., direct materials, direct labor).

• in manuf orgs physical observation is used to measure quantity consumed by each product and COM can be charged

• no applicable to merchnaiding and service

Direct labour

• labour costs that can be exclusively allocated to a particular cost object

• physical observation can be used / may involve measurement of repeated tasks

• inc costs of converting raw materials into a product

Indirect costs

cannot be specifically and exclusively identified with a particular cost object, e.g., manufacturing overhead (e.g., rent of factory), non-manufacturing costs (e.g., administration costs).

Difference between indirect costs and direct

• some direct costs are treated as indirect- not cost effective to trace them directly - nails used to manufacture a desk (DC ) BUT COST OBJECT LIKELY TO BE INSIGNIFIGANT - not justifying calculating more accurate

• depends on the cost object -

• If a resource, like a machine or a worker, is used for multiple products or projects, its cost might be treated as an indirect cost allocated across those different outputs.

Prime costs

direct costs of product

consists of direct labour costs + direct materials and direct expenses (e.g., the cost of hiring a machine for producing a specific product is an example of a direct expense).

direct cost tracing

• where a cost can be directly assigned to a cost object

Cost allocation

• process if assigning cost where a quantity of resources consumed by a particular cost object cannot be direclty measured

Manufacturing overhead

consists of all manufacturing costs other than direct labour, direct materials and direct expenses (e.g., rent of the factory and depreciation of machinery).

why should budget overhead rate be used over actual

• use of actual causes delay in calc of product/service

• establishment of monthly rate cause fluctuations

conversion cost

Direct Labour + manufacturing overhead

Process costing

• used where masses of similar products or services are produced in a flow process.(PRODUCED SAME / CONSUME SAME COSTS)

• oil refining

Job costing vs process costing

JB - small quantity of distinct products/ services

assigns costs to jobs and the units

PC - large quantity of homogenous products/services - using avg technique, assigns costs directly to units produced during period.

Process costing formula

cost of input / expected output in units

First in First out

• assumes OP WIP is the first group of units to be processed and completed AND is charged separately to completed production,

• based on the assumption that the current period unit costs should only be used and reported rather than unit costs based on the weighted average method

• the cost per unit for the current period is based only on the current period costs and production for the current period. The CL WIP is assumed to come from the new units started during the period.

Absorption costing

• allocates all manufacturing costs - variable/fixed)

• values unsold inventories at total costs of manufacture

• fixed overheads essential fro production

• consistency with external reporting

• avoids fictitious losses being reported - ensuring all prod costs stay with inv till sold offering a fairer match between costs and revenues

• doesn’t understate importance of fixed costs

Product cost

cost attached to the product

Period cost

Cost attached to the period - office rent

Variable costing

only variable manufacturing costs are assigned to products and included in the inventory valuation / fixed manufacturing costs are not allocated to the products but are considered period costs

• Provides more useful information for decision making - useful for short-term decision-making, - make-or-buy choices / product mix, by separating fixed and variable costs.

• accurate cost projections and relevant cost analysis for different activity levels, though absorption costing can still be used for profit measurement and inventory valuation.

• Removes the effect of inventory changes from profit figures - unlike AC, where profits can be distorted by fluctuating inventory levels

• Avoids fixed overheads being capitalised in unsalable inventories

  ○when decreased sales demand, AC can lead to overvaluation of surplus inventories, as fixed overheads are allocated to unsold inventory, potentially overstating profits

  -If these inventories cannot be sold, the profit calculation may be misleading, with fixed overheads deferred to future periods,

ABC VS VC

●VC - fixed manufacturing overhead costs are excluded from stock costs (period cost)

• Inventory valuation lower / used in internal reporting

• profit only changes based on sales volume better for analysing cost behaviour and control

●ABC - these costs are stock costs (product cost) and become expenses only when a sale occur

• higher inventory valuation

• profit changes with production vol

• external reporting - GAAP/IFRS

• can obscure cost volume profit relationships - fixed overhead is spread across all units, a sudden increase in production can, on paper, decrease the cost per unit and artificially inflate reported profit.

arguments for and against the use of variable costing for inventory valuation for the purpose of external reporting

1. unacceptable if companies changed their methods of inventory valuation from year-to-year; - intercompany comparison difficult

2.  the users of external accounting reports need reassurance that the published financial statements are in accordance with generally accepted standards of good accounting practice.

3. Financial reporting standard 102 (UK) and IAS 2 require that companies to adopt absorption costing for external reporting.

Special pricing decisions

Decisions outside of the main market usually involving one time orders or orders below prevailing market prices

Outsourcing

• process of obtaining goods or services from outside suppliers instead of producing the same goods or providing the same services within the organisation

Discontinuation decisions

• Determining whether to eliminate a product, service, department, or business segment due to unprofitability or other strategic reasons.

• most orgs analyse profits by one or more of the following objects - products services customers and location

• periodic profitability analysis can highlight unprofitable activities that require a more detailed appraisal to ascertain if they should be discontinued

Limiting factors sr

• scare resources limiting activites

• limited materials / labour hours/machine hours

• Throughput - 1

• linear programming - 2

Theory of constraints

• Methodology used to determine the most important limiting factor reducing efficiency and eliminating it

• When products are made from multiple parts and processed on different machines / processes leading to dependencies amount operations

Constraint

any factor limiting system performance relative to goal

Bottleneck

any resource with a capacity less than the demand placed upon it , usually recess or machine , create a Backlog slowing down te production process due to insuffient capacity

Managing bottleneck resources

Identify bottleneck

decide how to exploit bottleneck

‘subordinate everything else to the decision in step 2

Remove bottleneck

go back to step 1 if bottleneck in a previous system is broken

Throughput accounting

• performance measurement which identifies the rate that a company generates profits from sales/ the rate at which raw materials are turned into sales

• all op costs other than Direct are considered fixed in SR

Limits of theory of constraints oult

1. oversimplication - assumes one constrainrs when complex systems have multiple interacting constraints

2. unintended consequences - Addressing one constraint may shift the bottleneck, potentially worsening overall system performance - raising inventory costs if production increases without corresponding sales.

3. Lack of Strategic Alignment: can enhance operational efficiency but may misalign with strategic goals, resulting in rapid production without adaptation to market demands /innovative development.

4. TOC originated in manufacturing - best suited for linear, process-oriented environments directly applying to non-linear, dynamic, or creative industries (like marketing, R&D, or software) requires adaptation.

Linear programming

assumes straight line relationships in the use of resources

finds optimal combination of output that maximises benefits while efficiently utilising limited resources

Linear programming steps

Define decision variables

Formulate the objective function

identify the constraints

set up the mathematical model

solve linear programming

interpret results

shadow price

the maximum price which should be paid to obtain an additional unit of re- source

Price takers

rices are set by overall market and supply and demand forces, and they have little influence over
the selling prices of their products and services

Price setting firm - short run pricing desciosn

• company with temporary unutilised capacity, are faced with the opportunity of bidding for one-time special orders in competition with other suppliers.
  ● In this situation only the incremental cost of undertaking the order should be taken into account.
  ● Given the short-term, one-off nature of the opportunity, many costs will be non-incremental.
  ● Bids should be price> incremental cost and must meet the following conditions:
  ➢ sufficient capacity must be available to meet the order;
  ➢ the bid price will not affect future selling prices and the customer should not expect repeat business at short-term incremental cost;
  ➢ the order will utilise unused capacity for only a short period and capacity will be released for use on more profitable opportunities.
  ➢ Existing customers do not become aware of this special price and expect the same deal.
  

variance analysis

• helps find practical pointers to causes of off-standard performance so that management can improve operations and increase efficiency

• however this depends on source / if related to another variance

Sales Variances

• used to analyse the performance of the sales function or revenue centres on similar terms to those for manufacturing costs

• doesn't give info on the impact of sales on profit

Standard costs

• predetermined costs; they are target costs that should be incurred under efficient operating condition

Budget

relates to the cost for the total activity, whereas standard relates to a cost per unit of activity

reasons for material variances

wage rate -

• Poor HR department performance

• Using a higher-grade workers than planned

• Change in labour market conditions

Labour effiency

• Poor supervision

• Poor material used than planned

Total sales margin variance

(ASR-SCOS)-BC

why do variances occur

1. out-of-date standards (e.g., due to frequent changes in prices or frequent technological changes in operations);

2. inefficient operations (e.g., due to a failure to follow prescribed procedures, faulty machinery or human errors);

3. random or uncontrollable factors for which no cause can be found (e.g., when a particular process is performed by the same worker under the same conditions, yet performance varies).

mix variance

when the actual mix of materials differs from the pre- determined standard mix

yield variances

when there is a difference between the standard output for a given level of inputs and actual output (yield)

Why is it not meaningful to analyse total sales margin variance into price and volume components

• since changes in selling prices are likely to affect sales volume.

• A favourable price variance will tend to be associated with an adverse volume variance and vice versa.

• may be unrealistic to expect to sell more than the budgeted volume when selling prices have increased.

avoidable costs

• costs that may be saved by not adopting a given alterative

Unavoidable costs

costs that could not be saved

sunk costs

cost of resources already acquired where the total will be unaffected by the choice

between various alternatives.

opportunity costs

• cost that measures the opportunity (or benefit) that is lost or sacrificed when

• relevant to decsion making because the cost of selecting a particular alternative includes the implications from not being able to select the other alternatives.

• Financial reporting is concerned with providing investors with reliable information. These reports dont measure events on the basis of oportunity costs subjective and theoretical nature .

• Managerial reports are concerned with providing decision-makers information to make good decisions. Such reports should include some consideration of the opportunities that decision-makers are conceding when making a decision.

incremental costs

difference between the costs of each alternative action that is being considered.

Cost plus pricing

• Cost of item + desired profit margin

• Easy to calculate

• sustainable

• Easy to explain to customers

• Straightforward way of testing new markets

disadvantages of cost plus pricing

• Limits revenue potential: can lead to missed opportunities for revenue maximisation and discourage efficiency improvements.

• Reduces incentive to cut costs: In a pure cost-plus model, cost reductions lead to lower prices, offering limited immediate benefit if there is no competitive pressure.

• May not reflect product/service value: This strategy can undervalue high-impact offerings, especially in sectors like SaaS, where customers are often willing to pay more for value.

• Fails to reward customer contributions: Customers making large upfront payments may expect discounts, which cost-plus pricing doesn't inherently accommodate.

• Ignores market dynamics: Cost-plus pricing is rigid and unresponsive to demand shifts or customer sentiment, potentially leading to lost profits (e.g., pricing turkeys the same year-round).

Planning variance

• compares an original standard with a revised standard that should or would have been used if planners had known in advance what was going to happen.

• not controllable by management

• helps see how well management anticipates future conditions

Operational variances

• caused by adverse or favourable operational performance, compared with a standard which has been revised in hindsight.

• compares an actual result with the revised standard.

• controllable by management.

Target costing approach to pricing

1. determine target selling price

2. target profit margin is deducted to derive a target cost. ( estimated long run costs of a product/service )

3. Predicted actual costs are compared with the target cost. If the target cost is not achieved the product/service is unlikely to be launche

Target costing appraoch example

if a company is designing a new smartphone and they have a target price of $500 and desired profit margin of $100 he company would need to keep the cost of making the phone below $400. This might mean choosing a less expensive camera or leaving the camera out entirely.

Target costing limitations

1. time consuming - involves collaboration between department and review of reports

2. low target price - Lower target costs might hamper creativity and innovation in the production process. Low target prices also affect the quality of customer service.

3. pressure on supplier - When suppliers reduce cost, cost of production will come down. his may lead to sacrificing the quality, innovation and reliability of goods. The safety of the goods is also sacrificed while putting pressure on cost reduction.

4. lack of flexibility - dynamic market means target cost will be difficult to adjust and often outdated