Introduction To Management Accounting Notes - Lecture notes, lectures 1 - 10 - part 1, compleet PDF

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102

Introduction to management accounting (102) Nature and scope of management accounting Definition of management accounting: Wilson and Chua 1993 “Encompassing techniques and processes that are intended to provide financial and non-financial information to people within an organisation to make better decisions and thereby achieve organisational control and enhance organisational effectiveness”. Definition of accounting: “Process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information” Users may be: - External parties - an outside organisation (financial accounting) - Internal parties – within an organisation (management accounting) Purpose of accounting systems 1) Formulating overall strategies and long range plans – internal non routine reporting 2) Resource allocation decisions eg product and cost emphasis and pricing – internal routine reporting 3) Cost planning and control of operations and activities – internal routine reporting 4) Performance measurement and evaluation of people – internal non routine reporting 5) Meeting external regulatory and legal reporting requirements – external reporting

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Distinction between financial accounting and management accounting

Nature of reports Amount of detail Regulations Reporting intervals Horizon time Range and quality of information

Financial General Broad overview Subject to accounting regulations Annual Backward Quantifiable information in monetary terms

Management Specific Considerable detail No specific regulations Frequency as required Backward and forward Financial and nonfinancial information

Management accounting is less constrained than financial accounting Cost accounting vs cost management Cost accounting – provides information for both management accounting and financial accounting. It also measures and reports financial and nonfinancial data that relates to the cost of acquiring or consuming resources by an organisation. Cost management – describes activities of managers in short run and long run planning and control of costs. It also includes the continuous reduction of costs. It is a key part of general management strategies and their implementation. Value of management accounting to a business Role of a management accounting: Planning – formulate plans to different activities and coordinate plans into budget for business as a whole Controlling – produce performance reports that compare actual outcomes with planned outcomes Organising – develops accounting reporting systems that are closely related to organisational structure

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Communicating – aid communications functions by installing and maintaining an effective communication and reporting system (eg budget and performance reporting process) Motivating – budget and performance reports produced by accountants have an important influence on motivation of managers and employees Decision making – providing guidance for decision making and problem solving in order to achieve optimal results or maximise investors value Example of a performance report: Revenue Cost of goods sold Wages General Fixed costs Operating income

Budget £ 57000 40000 6700 1300 5000 4000

Actual £ 60000 43400 7000 900 5000 3700

Variance £ 3000 F 3400 U 300 U 400 F 300 U

The fact the variance is overall £300 unfavorable means it may entice the company to investigate why this may have occurred or ask the question Did the purchasing department pay more than expected for merchandise? The figures show that cost of goods sold were 72% of revenue instead of 70%, thus meaning a lower gross margin. Contemporary business environments

Increased global competition

Advances in manufacturing technology

Advances in information technology

Focus on the customer

New forms of management organisations

Social, political and cultural changes

r satisfactio

ement ap

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1. Key success factors - Cost efficiency – increased emphasis on accurate product costs and cost management - Quality – total quality management and quality measures - Time – reduce cycle time and focus on non-value added activities - Innovation – responsiveness in meeting customer requirements - Product comparisons - Feedback on customer satisfaction – in order to continually improve themselves ABC costing and management This is a product costing method that is useful in all industries where overheads is higher relative to other costs. ABC

Allocation base

Traditional

“cost drivers” Products

Products

Life cycle costing This identifies and monitors costs through product life cycles: - Research and development costs - Product design and testing costs - Manufacturing, inspecting, packaging and warehousing costs - Marketing, promotion, and distribution costs - Sales and service costs Total quality management

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2. Continuous improvement - Static historical standards are no longer appropriate - Benchmarking 3. Employee empowerment - Delegate more responsibility to people closest to operating processes and customers 4. Value chain analysis - Suppliers, R&D, design, production, marketing, service, customers

distribution, customer

- Internal customer perspective 5. Social responsibility and corporate ethics - CSR - Sustainable development Benchmarking Identify an activity that needs to be improved. Find an organization that is the most efficient at this activity. Study its process, and utilize that process. Value chain

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Target costing Identify product opportunity Determine price competitive Determine if product can be made cost sufficiently low to provide desired profit Strategic management accounting “Provision of information to support strategic decisions in organisations” (Innes 1998) Review of literature by Lord (1996) identified the following strands: 1. Extension from internal focus of management accounting to include external information about competitors. 2. The relationship between the strategic position chosen by the firm and the expected emphasis on management accounting 3. Gaining competitive advantage through exploiting linkages in the value chain 4. Formulating and supporting the overall strategy of an organization by developing an integrated framework of performance measurement What is a cost? A cost is a resource sacrificed or foregone to achieve a specific objective. It is the expenditure incurred. Cost accumulation and classification Direct cost – cost object are those that are related to a given cost object (eg production dept) and that can be traced to it in an economically feasible way Indirect cost – are related to the particular cost object but can’t be traced. Eg a company may have: 2 production depts. – assembly (£70000) and finishing (£50000) 2 service depts. – maintenance (£40000) and personnel (£24000) Assume that the maintenance dept costs are allocated equally among the production dept but by how much? We would assume equally so £20000 each.

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Manufacturing costs are often combined as follows: Direct materials

Direct labour Prime cost

Factory overheads

Conversion Cost Manufacturing costs

Production costs – are those costs that are attached to products and included in stock valuation. Eg raw materials, labour or production overheads Period costs – are NOT attached to products and are not included in stock valuation. Eg marketing and admin expenses Treatment would be as follows: Manufacturing cost

product code

unsold Sold

Non manufacturing cost

product code

Recorded as an asset in balance sheet and expense in income statement when sold

Recorded as an expense in current account period

For example Production cost (cost of goods sold ) = £200,000 Period cost (marketing and admin) = £70,000 We will assume that 60% of output is sold for £250,000 with no opening stock

Sales

£250,000

Cost of goods sold Production cost

200,000

Less closing stock (40%)

80,000

Cost of goods sold (60%)

120,000

Gross profit

130,000

Less period costs (100%)

70,000

Net profit

60,000 7

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Cost behaviour patterns Costs are either variable, fixed, semi variable or semi fixed. Variable costs will vary in direct proportion with activity Fixed costs remain constant over the range of activities Semi fixed costs are fixed within specified activity levels, but they eventually increase or decrease by some constant amount at critical activity levels Semi variable costs include both a fixed and a variable component (e.g. telephone charges)

CVP- the study of the

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interrelationships between costs and volume and how they impact profit, that is a basic planning tool available to managers CVP analysis examines: the behaviour of total revenues, total costs, and operating profit as changes occur in the output level, selling price, variable costs per unit, or fixed costs. CVP aids management in . . . - setting prices for products and services. - introducing a new product or service. - replacing a piece of equipment. - make or buy decisions. - performing strategic “what if?” analyses.

1 Changes in the level of revenues and costs arise only because of changes in the number of product (or service) units produced and sold. 2 Total costs can be divided into a fixed component and a component that is variable with respect to the level of output. 3 When graphed, the behaviour of total revenues and total costs is linear (straight-line) in relation to output units within the relevant range (and time period). 4 The unit selling price, unit variable costs, and fixed costs are known and constant. 5 The analysis either covers a single product or assumes that the sales mix when multiple products are sold will remain constant as the level of total units sold changes. 6 All revenues and costs can be added and compared without taking into account the time value of money.

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Cost volume profit (CVP) analysis This looks at break-even points, where the formula is as follows: Profit = Revenue – Total Costs

Revenue= Total Cost + Profit

This would then be subdivided to: Revenue = Fixed cost + Variable Cost + Profit

(units sold x price)= fixed costs + (units sold x variable cost per unit) + Profit CVP Model (QxP) = F + (QxV) + N

(QxP)-(QxV)= F+N

Qx(P-V)=F+N

So we would assume that the profit was zero in order to see how many units would need to be produced in order to break even making neither a profit or loss and so we would define the formula as follows: Q=

FC MC (P−V )

This would give the unit contribution margin

For example: Q=

£ 60,000 (75−35)

= 1500 units to be produced to make neither profit/loss

To work out break-even revenue we would take the break-even point and times it by the selling price BEP X SP = BEP REVENUE

1500 units x £75 = £112,500

Graph showing break-even graph

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Marginal costing for short term decisions Types are as follows: - Trade-offs between fixed and variable costs - Accept or reject a special order - Dropping a product or closing down a loss making dept - Limited factor analysis/theory of constraints - Make or buy decisions / outsourcing decisions But we must also consider not only financial factors, but non-financial factors as well. Financial factors would be revenues and costs, whereas non-financial factors may be staff motivation, environment, government policies etc. Cost planning – trade-offs between fixed and variable costs example Management is considering buying a new piece of equipment that will: reduce variable costs but also increase fixed costs by $27,000 per year. Annual sales are currently 2,700 units at $75 per unit. Annual fixed costs are currently $60,000. How much will unit variable cost have to fall to maintain the current level of profit ($48,000), assuming sales volume and other factors remain the same? Total revenue = 2,700 X $75 = 202,500 TR – (TFC + TVC) = Profit

TR – (TFC + Profit) = TVC

202,500 – (60,000 + 48,000) = 94,500 Variable cost per unit = 94,500 / 2700 = 35 So using the new variable cost per unit: Total sales = Total VC + Total FC + Profit (Q x P) = (Q x V) +

F

+

N

(Q x V) = (Q x P) – (F + N) v =p−

f +n q

v =$ 75−

87000 + 48000 27000

= $25

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Special pricing decisions Typically these may be one off orders or orders below prevailing market price. You would usually take any order below the market price as long as it still made positive contribution to enable that the costs are covered. Other factors - Do we have spare capacity for this order? Will staff work overtime? - What will the reactions be of the other customers? - What are their intentions of the reduction in cost? Is it a one off? Or will they sell in the sae market and compete? - Are there any hidden costs? Marginal costing statement sales less

(variable costs)

=

contribution

Less

(fixed costs)

=

profit (loss)

Never drop a dept or product if it still makes contribution as it could lead to the company making a bigger loss as that proportion of fixed costs has to be shared to the remaining depts/ products which would subsequently lead to those making a loss. Outsource decision example Direct Materials (DM)

£10

Direct Labour (DL) (2 hours)

£12

Variable overheads (VO Head)

£4 £26

Budgeted annual fixed costs

£80,000

The normal activity level for a period is 4000 units. The company has received a quotation from an outside supplier to supply the product at £30 per unit. If the part is outsourced, the fixed cost for the period 12

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will be reduced by £30,000. However £2 per unit will be incurred on transport cost. Here we would analyze whether it is cheaper to make or buy the product and so take the cheaper option, this would be known as sensitive analysis. Product mix decisions under capacity constraints This is where there might be a limiting or scarce factor that could restrict output. We would concentrate on the product/service that yields the largest contribution per limiting factor. For example: A company is only able to yield 12,000 machine hours Products

X

Estimated sales demand (units)

2,000

2,000

2,000

12,000

4,000

2,000

£12

£10

£6

Machine hours per unit

6

2

1

Contribution per machine hour

£2

£5

£6

Required machine hours Contribution per unit

Y

Z

So we would make the most of product Z From this we can work how the ratio of hours used by a production plan: Product Z – 2000 hours, making 2000 units Product Y – 4000 hours, making 2000 units Product X – 6000 hours, making 1000 units Absorption costing Overheads – all costs which are not direct materials, direct labour or direct expenses. They are usually divided by function: - Production overheads - Selling and distribution overheads - Research and development - Administration overheads 13

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They can be: - Fixed - Variable - Semi variable There are 4 main steps to dealing with overheads in a traditional system: 1. Collection 2. Classification 3. Allocation and apportionment 4. Absorption Assuming we have already done steps 1 and 2. We then must think how we decide to share the overheads amongst the depts. Allocation= whole items of cost can be charged to a cost centre Apportionment = overheads must be shared between more than one cost centre Example 1 We have 3 service dept and 1 production dept 1. Trace all the costs to all depts 2. Allocate service dept to production dept 3. Allocate production dept to products

Units demanded Direct labour Direct materials

Regular (dept 1) 2000

Deluxe (dept 2)

30 60

Indirect materials Area Value of plant Number of staf

Dept 1 5000 1500 1200 10

Indirect materials

12,500

60

Rent Repairs

60,000 30,000

70

Total

102,500

3000

Dept 2 7500 1000 1000 15

Dept 3 0 500 800 5

Total 12,500 3000 3000 30 14

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Allocation: Over head Indirect material Rent Repairs Total Reapportion Canteen Total

Basis Allocate Area Plant value Staff

Regular (1) 5000 30,000 12,000 47,000 7200 54,200

Deluxe (2) 7500 20,000 10,000 37,500 10,800 48,300

Canteen (3) 0 10,000 8000 18,000 (18,000) 0

From these figures we can then work out the overhead absorption rate: 54200

For dept 1 = 2000 units =£ 27.10 48300

For dept 2 = 3000 units =£ 16.10 Now we can calculate total costs for each product: Direct material Direct labour Total direct cost OAR Total cost

Regular 60 30 90 27.10 117.10

Deluxe 70 60 130 16.10 146.10

Analysis 1. List the overheads 2. Identify the cost centres 3. Allocate to cost centre to all depts 4. Decide basis of apportionment and apportion the overheads 5. Total overheads to all cost centres 6. Reallocate and reapportion service dept to production dept

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Example 2 We are already given the first 3 steps of the process: Dept 1 production = 7500 Dept 2 production = 20,000 Stores = 3000 Maintenance = 2000 Total = 32,500 We can use the same materials and labour figures from the previous example, however maintenance has no service to store, but production dept use it equally. Overhead Reapportion stores Total Reapportion maintenance Total

Prod 1 7500 1000

Prod 2 20,000 1000

Stores 3000 (3000)

Maintenance 2000 1000

8500 1500

21,000 1500

0 0

3000 (3000)

10,000

22,500

0

0

Absorption This is the charging of overheads to cost units passing through production depts. We may also wish to find the base and the rate for this. Bases = should reflect demand made by cost unit on production facilities for example labour hours, machine hours, cost of direct materials, number of cost units or prime costs. total overhead

£ 10,000

Overhead absorption rate = overhead base = 10,000 units =£ 10 per unit We may calculate the overhead absorption rate for the whole factory (blanket rate) or for each individual dept (departmental rate) Different bases will lead to different rates

ABC costing systems 16

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Emergence of ABC Traditional systems were appropriate when: - Direct costs were dominant costs - Indirect costs were relatively small - Information costs were very high - Lack of intense global competition - Limited range of products were produced Developed the new costing system to reflect objective costs: - New technology means that overhead costs can be higher than dir...