CMA- fina exam notes - Summary Contemporary Management Accounting PDF

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Contemporary Management Accounting – Final Exam CHAPTER 6: Service Costing (Q. 6.9; 6.24; 6.27; 6.28; 6.29; 6.30;P6.39; P6.40 & C6.45) Predetermined overhead rate based on direct labour costs: Budgeted overhead Budgeted direct labour cost

Contribution margin: Revenue – Direct cost Q. We usually use job costing to estimate the cost of professional services. Why is it possible to use process costing in this case? Answer: Use process costing to estimate the average cost per unit processed. Q. Describe the service costing system that is most appropriate for: a) Professional service firms Job costing is appropriate. Direct costs (mainly labour) can be easily traced to job. Indirect costs (overhead including minor raw materials) allocated, usually based on direct labour. b) Service jobs. Hybrid costing is appropriate. Job costing where services are different (e.g. car repairs, printing) moving towards process costing (or more likely operation costing) where some parts of service are standardised. c) Mass service entity In many mass services, similarities in service means that process costing can be used. Modifications needed, depending on the degree of discretion. Q. Explain the key differences between job billing and job costing. The billing system estimates fees based on a chargeout rate per billable hour and that the chargeout rate includes an allowance to cover overhead and profit. In a service costing system the overhead costs are applied to the service using a single predetermined overhead rate for the business based on the number of professional labour hours worked. The total cost then needs to be increased by a profit margin to determine the fee charged. Q. Which method would you recommend for estimating client fees? Explain your answer. The billing system would be a preferred method for estimating client fees as it:  Estimates the client service fees based on chargeout rates per billable hour for the various categories of labour that have been consumed in providing the service (usually the chargeout rate is set to cover the cost of labour and overheads and a profit margin) rather than using a single business-wide overhead rate.  Provides an ongoing estimate of charges for each client.  Enables a firm to monitor current earnings on partially completed jobs by accumulating the billable charges for all clients.

Q. How might the management use the total cost information? Management may use the cost information: (a) as a basis for setting fees (b) to assess the profitability of each service (c) to decide on promotion, refinement or withdrawal of services (d) to control costs. Q. How would differ if the firm used a billing rather than a costing system? Using a billing system for estimating its service costs, it would estimate the cost of each job by accumulating the amounts that the client is to be charged for the service rather than by accumulating the costs of each job. The billing system would estimate the fees to be charged based on chargeout rates per billable hour for each separate labour type, rather than using one single predetermined overhead rate for the entire business to allocate overhead costs to services. Q. Do you think the costing system provides reliable estimates of the costs of the resources used to complete the two jobs? Explain your answer? The costing system is not accurate in the allocation of overhead. The basis chosen for allocation should reflect the behaviour of overhead costs, to the extent that this can be determined economically. The real driver of overhead costs is more likely to be the number of machine hours used rather than labour time, hence the use of direct labour costs as a basis for charging overhead is inaccurate. The items included in overhead also give an indication of how the recovery rate could be made more accurate. The costs relating to the expensive equipment should not be charged to services using mostly labour. The costs of accommodation should be charged according to the area of floor space occupied by the service and the wages of the receptionist and secretarial staff could be charged according to how much time each spends on work related to various services. Q. Once a project has begun and successful use of costing system tracks all direct costs to projects, how would managers use the cost information of costing system? Managers may break down the project into stages and compare the actual costs incurred to the planned costs for each stage. They will also be interested in whether the actual hours and cost, for each cost element, is in line with the estimated costs. Q. Do you think there is likely to be any link between the costing system used to account for existing projects and the system that the tender manager uses to prepare for potential projects? Explain. There is likely to be a connection, because there needs to be feedback from the performance of previous projects in terms of estimating the hours appropriately for each type of labour, and the cost per hour. Computer time and travel estimates could also be

monitored to make sure they are reasonably accurately estimated for the project and this may inform the tender process for other projects. Q. Explain why there is a different overhead rate for each class of labour. The different rate of overhead for each class of labour suggests that each rate has been calculated individually by identifying the budgeted overhead for that particular activity and dividing it by the budgeted labour costs for the activity. This approach enables the resort to recognise that more overhead resources are used per hour of professional labour in the gym and during the medical check up, possibly because of the expensive equipment associated with these services. In contrast relatively few overhead resources are consumed during the bush walk. If the resort had calculated a blanket rate for all activities, the ratio between overhead and labour cost would have been constant. As can be seen by the differential in overhead rates, using a blanket rate would have concealed the level of diversity in overhead costs. CHAPTER 7: A closer look at Overhead costs (Q7.1; 7.24; 7.25; 7.32 & P7.35) Q. Explain the differences between manufacturing overhead, upstream and downstream costs, and the indirect costs of responsibility centres. When we refer to manufacturing overhead costs we are describing the indirect manufacturing costs of products. These are the factory costs that are incurred in producing products but cannot be traced directly to them. They include all manufacturing costs other than direct material and direct labour, such as the costs of supervision, power, factory security and so on. From a product costing perspective, we can expand our definition of overheads to include all product-related costs other than direct costs as managers may require comprehensive estimates of product costs for making product-related decisions. However, as Australian accounting standard AASB 102 Inventories requires that inventory valuations in external reports of manufacturing businesses only include manufacturing costs, a distinction is drawn between indirect costs within the manufacturing area, called manufacturing overhead, and other indirect costs incurred along the value chain, upstream and downstream, of the manufacturing or production area. Upstream costs and downstream costs, regardless of whether the entity is a manufacturer or a service provider include costs incurred before and after the production process, such as research and development, design and supply costs, marketing, distribution and customer service costs. The indirect costs of responsibility centres are costs assigned to a unit in an organisation such as a department or division where a manager is held accountable for performance. Indirect costs cannot be traced directly to the centre so they need to be assigned instead. Q. Which approach would you recommend to management -quarterly overhead rates or annual rate? Explain your answer. The annual rate is preferred, as it averages out (that is, normalises) the effects of fluctuations in overhead costs and cost driver volumes over the year. Notice that with quarterly overhead rates, the firm may underprice or overprice the product. Note also that

an increase in prices of the year could further decrease demand for the product, which would then further increase its cost and price per unit. CHAPTER 8: Activity-based costing (Q8.6, 8.23, P8.33, 8.35, 8.37 & 8.38) Q. You and your boss have just attended a presentation by the consulting firm., Always Better Costing, which explained how every organisation can benefit from adopting activity-based costing. Your boss is very keen to proceed with activity-based product costing. How you advise her? The first step would be to consider whether the business is currently experiencing any problems with its existing costing system and whether ABC might help address these problems. For example, the benefits of ABC will be greatest when the existing costing system is seriously distorting the estimated costs of products. This is most likely to happen when overhead costs are a significant portion of total costs and a large part of overhead is not directly related to production volume, the business has a diverse product range and individual products’ use of support resources differs from their use of volume-based cost drivers, production activity involves diverse batch sizes and product complexity, and the proportion of product-related costs incurred outside of manufacturing is increasing relative to manufacturing costs. In addition it is necessary to consider to what extent management actually relies on information about product costs in making key strategic decisions. There are likely to be high ‘costs’ associated with making inappropriate decisions based on inaccurate product costs in a highly competitive environment where product cost is a key input to strategic decision making and where competitors have accurate product cost information. It is also important to consider the cost of designing, implementing and maintaining the ABC system, which is likely to be influenced by the extent of IT support within the firm. Having identified the issues with the existing costing system, it is necessary to consider what sort of ABC system is required (a simple activity-based system that only includes manufacturing costs, a more detailed system that includes non-manufacturing costs, or a comprehensive system that includes all costs except direct material), as this will influence both the benefits that can be obtained from the ABC system and the resources required to implement and maintain the system. Q8.23.2 Before introducing activity-based costing, Brian had estimated the average cost of all trip at $97.50 per person per day. (This was based on the previous year’s costs, adjusted for any expected changes.) Explain how the activity-based system results in more accurate service cost estimates. The flat rate of $97.50 per person per day fails to recognise the different resource requirements for the different trips. For example, the Flinders Ranges trip requires a National Park permit. It also involves more walking each day and, therefore, has a higher cost for the walking guide per day. On the other hand some costs are a flat charge regardless of the number of days. Hence the Flinders Range tour is cheaper per person per day. The flat

rate of $97.50 does not cover the costs of the El Questro Gorge trip which is being subsidised by the walkers going to the Flinders Ranges. Q.8.33.5 Explain why these two product costing systems result in such widely differing costs. Which system do you recommend? Why? The production of film development chemicals entails a relatively large number of machine setups, a large amount of hazardous materials and several inspections. Thus, they are quite costly in terms of driving overhead costs. Use of a single predetermined overhead rate obscures(confuses) this characteristic of the production job. Underestimating the overhead cost per box could have adverse consequences for Snappy. For example, it could lead to poor decisions about product pricing. The simple activity-based costing system for overhead will serve management much better than the system based on a single, predetermined overhead rate. Q.8.27.3 Explain the treatment of the costs of the activity ‘Design player’. The costs of the activity ‘Design player’ are product level costs. These are the costs of designing this particular product and they are assigned directly to the product. Q.8.34.3b Is it possible that overcosting and undercosting (i.e cost distortion - misuse) and the subsequent determination of selling prices are contributing to the company’s profit woes(sufferings)? Explain. Yes, especially since the company’s selling prices are based heavily on cost. An overcosted product will result in an inflated selling price, which could prove detrimental in a highly competitive marketplace. Customers will be turned off and will go elsewhere, which hurts profitability. With undercosted products, selling prices may be too low to adequately cover a product’s more accurate (higher) cost. This situation is also troublesome and will result in a lower income being reported for the company. Q. 8.35.5 Assume that the current selling price of a Deluxe Cabinet is $390 and the marketing manager is contemplating a $45 discount to stimulate sales. Is this discount advisable? Briefly discuss. No, the discount is not advisable. The regular selling price of $390, when compared against the more accurate ABC cost figure, shows that each sale provides a profit to the firm of $24.75 ($390.00 – $365.25). However, a $45 discount will actually produce a loss of $20.25 ($345 – $365.25), and the more units that are sold, the larger the loss. Notice that with the less accurate, machine-hour-based figure ($322.50), the marketing manager will be misled, believing that each discounted unit sold would boost income by $22.50 ($345 – $322.50). Q.8.37.2 In the light of your answers to requirement 1, evaluate the firm’s pricing policy. The pricing policy is too low for business tax returns as the set price of $300 per return does not even cover the costs of preparing the return. For business tax returns it may be better to charge time for each one rather than use an average fee. Also, Mel may be overcharging for wage and salary returns, although this will depend on the price charged by competitors. If the business is still attracting wage and salary returns, then the current pricing could be

retained. Before using this information for decisions, Mel must make sure that all overheads are picked up in the above figures. Q. 8.38.1 Activity-based costing (ABC) is said to result in improved costing accuracy when compared with traditional costing procedures. Briefly explain how this improved accuracy is attained. Activity-based costing results in improved costing accuracy for two reasons. First, companies that use ABC are not limited to a single driver when allocating costs to products and activities. Not all costs vary with units and ABC allows users to select a host of non-unit level cost drivers. Second, consumption ratios often differ greatly among activities. No single cost driver will accurately assign costs for all activities in this situation. Q.8.38.4 Same Whincup, one of the firm’s partners, doesn’t care where his professionals spend their time because, as he notes, ‘Many clients have come to expect bothe services and we need both to stay in business. Also, information system and e-commerce professionals are paid the same hourly rate’ Should Whincup’s attitude change? Explain. Yes, his attitude should change. Even though both services are needed and professionals are paid the same rate, the income percentages show that e-commerce consulting provides a higher return per sales dollar than information systems services (18.88% vs 3.40%). Thus, all other things being equal, professionals should spend more time with e-commerce. Q8.38.5 Is an aggressive expansion of either consulting service desirable? Briefly discuss. Probably not. Although both services produce an attractive return, the firm is experiencing a very tight labour market and will likely have trouble finding qualified help. In addition, the professional staff are currently overworked, which would probably limit the services available to new clients. CHAPTER 12: Managing and reporting performance (Q. 12.4, 12.21, 12.22, Self-study P2, E12.29, E12.30, 12,31, P12.36, 12.37 & 12.39)

Transfer price

=

outlay cost

+

opportunity cost

= Selling price per unit = variable cost per unit + contribution margin per unit Opportunity cost: Contribution margin = Selling price – Variable cost Outlay cost = direct material + direct labour + variable overhead Q. What is the major challenge in a decentralized organization? Answer: Goal congruence Q. Discuss the costs & benefits of decentralization Decentralisation: the restricting of the organisation into units, such as divisions and departments, each with specific operations and decision-making responsibilities

Benefits include:  Managers of units have better local information about markets and operations to enable them to manage their areas more effectively  Provides managerial training for future higher-level managers  May lead to greater motivation and job satisfaction for unit managers  Allows corporate managers more time for strategic issues  Delegation allows the organisation to react more quickly to opportunities and problems as they arise Costs include:  Managers may focus too narrowly on their own unit’s performance rather than on attaining the organisation’s overall goals  Some tasks and services may be duplicated unnecessarily Q.12.29.3. What transfer price would you recommend if there was no outside market for the transferred component, and the Assembly Division had spare capacity? If the Assembly Division has spare capacity and no outside market exists for the transferred component, the transfer price should be based on the variable cost per unit, $450, plus a small profit margin to provide an incentive for the Assembly Division to manufacture and transfer the component to the Electrical Division. Q.12.31 Identify at least two behavioural advantages and potential problems that could arise for: 1. Responsibility accounting System and 2. Participatory budgeting system 1 Responsibility accounting system Two potential behavioural advantages if Reliable’s managers accept the philosophy of responsibility accounting are as follows:  They may be motivated to plan ahead and promote goal congruence.  They may be pleased to be responsible only for those items they can control. Two potential problems that could arise if the managers do not accept the change in philosophy are as follows:  They could dislike being measured on an individual basis, since they may be responsible for costs over which they have no control.  They could focus too much on their own department’s goals to the possible detriment to the organisation as a whole (suboptimisation). If the managers support the new system, and most of the disadvantages pointed out above are avoided, the responsibility centre system will enhance the alignment of organisational and personal goals. Since Commercial Maintenance Ltd (CML) took the time to fully explain and communicate the system to Reliable’s managers, by pointing out the advantages and encouraging their participation, organisational and personal goals will likely become aligned. 2 Participatory budgeting system Two potential behavioural benefits are the following:  Reliable’s managers are likely to accept the system and be motivated to attain the budget targets, since they were actively involved in setting the goals and understand what is expected of them.

Communication and group cohesiveness may be improved, because the managers would feel part of a team. Two potential problems that could arise are as follows:  The managers could be motivated to ‘pad’ their budgets, building slack into the plan to ensure that they will meet the targets.  An overemphasis on departmental goals could hurt cross-departmental employee relations. Participatory ...