2. Cost And Management Accounting

Question 1

Differentiate between planning, control and decision making.

Answer 1

Planning is the setting of goals and the selection of the means of achieving those goals. As businesses become large, these procedures need to be formalised.

Control means checking that an organisation is on track to meet its long- and short-term objectives, and taking action to correct any deviations from these.

Decision making usually involves using the information provided by the costing system to make decisions.

Question 2

How are fixed costs and inventory valuation treated under marginal costing?

Answer 2

Fixed overheads are not included in unit costs but are treated as a period cost (ie written off in full in the statement of profit or loss in the period in which they occur).

Inventory valuation includes only the variable costs of production.

Question 3

What is a cost driver?

Answer 3

A factor which can cause a change in the cost of an activity.

Question 4

Outline the steps of activity based costing.

Answer 4

1. Identify major activities within each department which create cost. E.g. production scheduling.
2. Create a cost centre/cost pool for each activity. E.g all production scheduling costs.
3. Determine what causes the cost of each activity (cost driver). E.g number of batch set-ups for production scheduling.
4. Calculate the absorption rate for each cost driver. E.g. cost per batch set-up.
5. Calculate the total overhead cost for manufacturing each product. E.g. no or batch setups for product Z * cost per batch set-up.
6. Calculate the overhead cost per unit. E.g o/h cost per unit = y/no. of Zs produced.

Question 5

What are the advantages of ABC?

Answer 5

• The costs per unit are more accurate, as overhead costs are apportioned to products based on their use of the cost drivers rather than using some arbitrary blanket rate as used for absorption costing.
• better decision making - companies will have a more accurate knowledge of the cost per unit, and therefore profit per unit. They can evaluate whether to stop producing loss-making products.
• where cost plus pricing is used, the use of ABC means that the price will be more likely to achieve desired margins.
• there is a better understanding of what causes costs because of the identification of the cost driver. This enables managers to make more informed decisions on actions to reduce cost.
• Control of overheads is easier, as responsibility for incoming costs must be established before ABC can be implemented.
• more accurate performance measurement leads to better performance management.

Question 6

What are the disadvantages of ABC?

Answer 6

1. ABC is still based on budgeted overheads on the current period, which may be unsuitable for future strategic decisions.
2. It is more complex and the selection of cost drivers may not be straightforward.
   - there may be more than one possible cost driver for a particular overhead, so some judgement is required in selecting an appropriate driver.
   - not all costs will be easily identified with particular cost pools, so some allocations will be arbitrary.
3. Additional time and cost will be incurred in setting up and administering the system.