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 -

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).

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

• 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

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

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

  ○Variable costing removes the effect of inventory changes on profit, unlike absorption costing, where profits can be distorted by fluctuating inventory levels

• Avoids fixed overheads being capitalised in unsalable inventories

  ○In periods of decreased sales demand, absorption costing 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 and are a 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

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;

   1. intercompany comparison difficult if some companies valued their inventories on an absorption cost basis while others on a variable cost basis.

2.  the users of external accounting reports need the reassurance that the published financial statements have been prepared 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

most orgs analyse profits by one or more ost objects such as 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

• scare resources limiting activites

• limited materials / labour hours/machine hours

• Throughput - 1

• linear programming - 2

Theory of constraints

• 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 sakes

• or 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 and Throughput accounting

Focus on short term

risk of gradually ignoring costs other than raw materials

no clear procedure as to how a TA system can cope when constraints are constantly elevated so that ew bottlenecks are identified

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

shadow price of a resource constraint in linear programming is usually defined as 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.
  

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

Total material variance

SC - AC

Material price variance

(SP - AP) X AQ

Material usage variance

(SQ - AQ) X SP

Total sales margin variance

(ASR-SCOS)-BC

Sales margin price variance

(ASP-SSP)X AV

Sales margin volume variance

(AV-BV)XSM

why do variances occur

out-of-date standards (e.g., due to frequent changes in prices or frequent technological changes in operations);

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

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).