Definitions Flashcards
Business Organisation
An individual or group working together to achieve common business goals.
Examples are sole traders, partnerships, companies, and not-for-profit organisations
Management Information
Information used by managers to help organisations achieve their goals.
Financial (for example, numbers relating to sales or costs)
Non-financial (for example, customer reviews about a product or social trends that might affect sales).
Planning
Managers plan a course of action for the future.
Setting objectives, such as a sales target for a product
Selecting the best method of achieving the objectives.
Plans can be financial, like a budget
Control
Managers use information to check how the organisation performs compared to their plans.
Comparing actual results with planned results (variance)
Reviewing strategic plans when circumstances change.
Decision-making
Managers use information to help them make decisions about the organisation:
Preparing information for investment decisions (such as whether to invest in new plant and equipment)
Making decisions on actions to take: how much of the product to make, what price to set, how to reduce costs etc.
Accurate
Information provided to managers should be free from significant errors.
Complete
info should include all relevant information
Cost-effective
The financial benefits or value of the information must outweigh the costs of obtaining that information
User-targeted
Info should be tailored to meet the needs of the recipient
Relevant
Only information directly related to the decision being considered should be provided
Authoritative
the source of info should be reputable and reliable
Timely
in time to influence a decision
Easy to use
should be concise, presented clearly, communicated using an appropriate communication channel
Bookkeeping
Recording financial transactions
Management accounting
provision of information to managers to operate efficient and effectively
financial accounting
recording, analysing and reporting the organisation’s financial transactions
Accounting system
system used to initiate, gather, process, store and analyse accounting data
files
data files are collections of records with similar characteristics eg. the general ledger, receivables ledger, payables ledger
Records
a record in a file consists of data relating to one unit of information. a record consists of several fields. For example, a supplier account in the payables ledger
Fields
a field is an item of data relating to a record
eg. a supplier record includes separate fields for their account number, name and credit limit
Key fields
Each record in a file includes a key field - an item of data used to identify it. eg. this might be a unique supplier code
Transaction files
a transaction file contains records related to individual transactions, such as invoices
master files
contains ‘standing’ or reference data (such as supplier names, and addresses) and cumulative transaction data (such as year-to-date figures)
accounting software packages
All computerised accounting software packages have several functions and features:
- Enforces accountancy rules
- Separate modules
- Real-time processing
- Links between modules
- Automates period-end routines
- Queries and reporting
Advantages of Computerised Systems
Speed and efficiency
- accuracy
- availability
- easier to produce reports
- up to date information
Data input
typed entries
- barcode readers
- online banking
- smart cards
- mobile devices
Data storage and processing
servers
- portable data storage - external memory devices eg. memory sticks
Data output
- Reports
- dashboard
- remote access
Role of the trainee accountant
Trainee accountants often work within an organisation’s finance function or accounting department while studying with a professional accountancy body (such as ACCA).
Ideally, a trainee accountant will be involved in various tasks, including routine processing and higher-level analysis, providing them with a rounded experience to help them progress in their careers.
Responsibility accounting
Accounting method for costs according to the manager responsible for those costs.
Responsibility Centre
An activity or area of responsibility in an organisation a manager is responsible for and has control over.
Controllable cost
a cost that is within control of a manager
Uncontrollable cost
a cost that is beyond the control of a manager
Cost centre
An activity or area of responsibility in an organisation that generates costs but is not responsible for generating revenue or producing direct profit.
can be a
- function (or department)
- activity eg. storekeeping
- project
- person
- process
- production or service location
- equipment or machinery
Profit Centre
An activity or area of responsibility in an organisation to which costs and revenue can be attributed.
Identifying profit centres allows profitability to be measured as a product of costs and revenues, which is impossible for a cost centre.
key features of profit centres:
- organisational hierarchy
- the seniority of profit centre managers
- External and internal revenue
- from cost centre to profit centre
INVESTMENT centre
An activity or area of responsibility in an organisation to which costs and revenue can be attributed and capital deployment.
The distinguishing feature of an investment centre is that its manager is also responsible for making investment decisions regarding the assets available for use (asset investment), such as the purchase and sale of non-current (long-term) assets.
Business unit
A particular activity or area of responsibility in an organisation that has a degree of autonomy in deciding plans and processes for generating profits.
Responsibility Centre structure
- investment centre
- profit centre
- cost centre
COST
The amount paid to buy or make something.
COSTING
Method of understanding the costs of an item.
COST UNIT
A unit of product or service with which costs are associated.
Cost unit information used to
- determine a selling price
- decide what to produce
- help with cost control
- to plan and budget
BUDGET
A plan expressed in monetary or quantity terms.
Cost categories
- Function
- Responsibility
- Behaviour
- Type
- Traceability
Responsibility accounting
– accounting method for costs according to the manager responsible for those costs.
Responsibility centre
an activity or area of responsibility in an organisation a manager is responsible for and has control over.
Controllable cost
a cost that is within the control of a manger
Uncontrollable cost
a cost that is beyond the control of a manager
Cost centre
an activity or area of responsibility in an organisation that generates costs but is not responsible for generating revenue or producing direct profit.
Revenue centre
an activity or area of responsibility in an organisation that generates revenue. May also be responsible for directly attributable selling costs.
Profit centre
an activity or area of an organisation responsible for costs and revenue.
Investment centre
an activity or area of an organisation responsible for costs, revenue, and capital investment.
Function
- Production - costs incurred in the production of goods and services
Non-production - other costs not attributable to production of goods and services
Cost behaviour
The changes in cost according to the level of activity
Variable costs
Costs that change according to the level of activity
fixed costs
costs that remain constant despite changes in activity level
Mixed costs
Costs that have both variable
Stepped fixed costs
Costs that remain constant for a range of activity, will increase to a higher constant for a higher range of activity
Direct costs
Costs that can be measured reliably and directly traced to a specific cost unit.
all other costs are indirect costs
Prime costs
The total sum of direct costs, also known as the total direct cost
Indirect costs
Costs that are not directly traceable to a cost unit; also known as overheads
Cost card
A record of the costs associated with producing and selling a single product or service
producing a cost card:
1. allocate direct costs to cost unit
2. including indirect production and non-production costs
3. Calculate overhead cost per unit
4. Calculate the total cost per unit
Absorption costing
Values production at full inventory cost, inc fixed production overheads
Marginal costing
Values production at marginal (variable) production costs
Job costing
Cost jobs that have unique criteria
Batch costing
Costs batches, which have homogenous units in each batch
Process costing
Costs units produced from a continuous process
An accounting system
- Sales - The sales system captures sales details from orders received and provides information to pick goods, deliver them, and issue customer invoices.
- Purchases - The purchases system enables employers to requisition and authorise purchases and monitor payables to ensure payments are made on time and discounts are fully utilised.
- Labour - The labour system enables employees to record their work, linking directly with payroll to calculate earned gross pay and necessary deductions automatically. Deductions and employer contributions are posted to the ledgers directly.
Payroll is authorised electronically, and payment orders automatically sent to finance for payment. - Cash/Bank - The cash system may automatically link up with the entity’s bank or finance provider to have a real-time overview of available cash balances and sources of finance. Payments may be authorised digitally via authorisation tokens or transaction codes
Purchase requisition (internal request for purchase to be initiated)
When a person (or an automated system) within an organisation identifies the need to purchase materials, goods or services, a purchase requisition must be completed.
Its primary purpose is to control the purchases made by the organisation, ensuring that only authorised purchases are made.
info needed on it:
- purchase requisition number
- inventory code
- details of goods or services required
- usual supplier
- requested by
- approved by
- budget code
Purchase order (sent digitally to external supplier)
Once a supplier has been selected – usually by considering a combination of price, service and quality – the person responsible for purchasing then prepares and sends a purchase order (PO) to the supplier, formally ordering the goods or service.
Procedures may differ across organisations, but generally, the PO is created in the system and internal access to it is made available to:
1. The accounts department (to compare with the invoice when it arrives)
2. The person who initially raised the purchase requisition (so they know their request has been actioned)
3. The storekeeper who is responsible for the inventory held in the stores or warehouse (if the PO is for materials used in production)
4. The purchasing department (responsible for buying and making purchases)
Information included in a purchase order
- purchase order nummber
- address
- product or service required
- quantity
- price
- supplier product code
- electronic authorisation
Goods received
- check against record of goods received
- apply general ledger codes and debit relevant accounts
- check sales tax rate
- deduct relevant discounts
- check total amount
- make payment
Types of labour costs
labour costs are the costs incurred to pay the workforce for the work performed.
They include:
- wages (paid periodically)
- salaries
- overtime payments
- bonuses
- sick pay
- holiday pay
other incentives
Info in a payslip
- identification
- tax codes
- other contributions
- gross pay
- deductions
- year-to-date figures
- net pay
Employee records
- employee payroll record
- employee attendance record
- employee swipe cards
- employee timesheets
- job cards
Code
unique set of characters used to identify an item, consisting of numbers, letters, or other symbols
Coding system
system by which codes are created, managed, used
- logical
- concise
- consistent
- unique
- expandable
Chart of accounts
A document that contains comprehensive details on the classes of codes and the accounts and items they identify.
The coding system used by an organisation is often determined by the computerised accounting software package, which may come with a ready-made chart of accounts and suggested codes.
Five different coding systems are examined:
Sequential
Block
Faceted
Hierarchical
Mnemonic
Sequential
Sequential (or progressive) coding systems allocate a standard numeric code to each item in a sequence.
Block (or group classification)
Block (or group classification) coding systems group similar items together in a block. This system is often applied to the chart of accounts in an accounting system.
can accommodate 999 items within each category
Faceted
A faceted code is broken down into facets (or groups), each representing a different characteristic.
eg. 02 DM 0070
Hierarchical
A hierarchical coding system is like a faceted system because each code is broken down into facets; the difference is that each facet is a sub-category that represents a subset of the previous category. The code grows in length as more detail is provided.
Mnemonic
eg. LAX
Items classified using codes include:
- Customers
- Suppliers
- General ledger accounts
- Products
- Cost centres
- Employees
- Jobs
- Materials
CH3: COST BEHAVIOUR
Fixed cost
A cost that remains the same irrespective of the output level
Variable cost
A cost that changes in direct proportion to the output level.
(increases as output increases)
Mixed (semi-fixed) costs
A mixed cost has both variable and fixed costs. It is also known as semi-variable or semi-fixed cost.
Stepped Fixed Costs
A stepped-fixed cost is fixed within a range of output (activity) and increases to a higher fixed constant when that range is exceeded.
The High-Low Method
method to separate semi-variable costs with fixed and variable methods
- and predict how these costs will behave at different activity levels
Limitations of high low method
The high-low method provides a quick way of getting an approximate cost when you do not have access to more detailed information. There are some limitations to the approach:
- The high-low method only estimates the costs: the actual costs might differ.
- We also must assume that each unit of material costs the same, whereas, in reality, the supplier might offer a discount for large volumes.
- If possible, the costs should be analysed based on quotes from the supplier, which show the fixed and variable amounts, so that the figures you use are more accurate.
- The high-low method uses the most extreme figures observed, which may not be typical of how most production costs behave.
- Making projections using high-low or any method using historical information assumes that the cost rates in the future will be the same as they were in the past. Inflation, technological improvements and many other factors may make this untrue.
Fixed costs into stepped-fixed costs
Over the long term, with a wide range of activity, fixed costs may behave as stepped fixed costs
eg. rent in the short term would behave as a fixed cost, as shown on the total cost graph below
Stepped-fixed costs into variable costs
The various steps in fixed costs may be likened to a variable cost in the long term.
In this example, as output increases in the long term, so does rent cost, exhibiting variable behaviour
CAPPED CHARGES
There is a maximum limit on the cost incurred
eg. maximum day rate (cost plateaus)
Minimum charge
The minimum cost that must be incurred. cost will remain constant until threshold activity is reached, after which it behaves as a variable cost
eg. taxi fare
Volume discount
A discount is given upon reaching a certain activity threshold (units purchased), reducing the cost per unit on all units purchased. the discount will also apply to any additional units purchased
Labour Overtime
When labour is scarce, employees may be required to work additional hours. These extra hours may be paid at a higher rate.
Ch4 - budgets and variances
Budget – A financial plan; that shows income and costs for a period.
Budgets let us:
Communicate the activities of the organisation
Coordinate the plans of the organisation
Control the performance of the organisation.
Creating a Budget
Budgeting relies on the principle budget factor - element that limits the activities of the organisation
Several different budgets:
- sales
- production
- cash
Collate costs (cost card), then create a budget
Forecast
An estimate of future performance, usually created referring to actual results for the period.
Whereas a budget is a financial plan, a forecast predicts the future. It is the expected financial results for a future period
- further a prediction is into the future, less reliable
Flexible Budget
A budget that can change to reflect multiple activity levels.
A flexible budget can be adjusted for factors where the actual outcome differs from what was initially expected.
For example, if sales volume is higher than expected, the costs contained within the budget that would be expected to vary with sales volume would be updated.
Comparisons - managers compare sets of information to put that information into context
Comparisons can be:
- Financial - such as a comparison of budgeted costs versus actual costs (what the organisation thought it would spend versus what it spent)
- Non-financial - such as comparing customer awareness of two brands (is the T-Shirt Co brand more famous than the Gucci brand?)
Comparator:
- Budget
- Forecast
- previous periods
- corresponding period
Variance
A difference between budgeted and actual results
Flexing budgets
If the actual and budgeted activity level (output) is different, it is not meaningful to directly compare actual results to the budget.
The budget may be flexed to actual activity levels to make the comparison more meaningful. This would mean adjusting costs that change with activity level.
- cost card can be used to recalculate the budget based on actual activity level
Recalculate the budget
Multiply the cost card figures by the number of units produced to flex the budget. The overheads are fixed, so they do not change when activity levels change
Compare flexed budget to actual results
Direct materials and direct expenses have favourable variances – they were cheaper than expected. All the other costs were more expensive than expected in the budget, but the flexed budget variance is much lower than the unflexed budget.
Comparing budget data with actual data
If the actual is less than budget
For sales revenue, this is an adverse variance: the business has earned less money
For costs, this is a favourable variance: the business has had to pay less.
Impact of favourable and adverse variances
Variances let managers know that things are not going according to plan.
Adverse variances should be investigated,
and favourable variances are not always beneficial for the organisation.
Exception reporting
ensures that managers only get the information they need to act on by reporting the significant variances
Controllable and non-controllable variables
factors beyond the manager’s control cause non-controllable variances.
investigating variances:
- When the variance is significant (exceeds the threshold %)
- When the variance is controllable
- When the variance investigation is cost-beneficial – in other words, it would not cost more to investigate than the cost implications of the variance
Planning and control cycle
Set goals
Set objectives and action plans
Budget
Implement
Monitor
Review and Forecast
Feedback control
Managers compare actual results with relevant control data, analyse the variances and act to bring future results into line with the plan. Feedback action occurs after something has gone wrong, and variance has already happened. Most budgetary systems provide feedback.
An example of feedback control is comparing actual to budget and resolving issues that have already affected past performance and will affect future performance.
Feedforward Control
Budget figures could be compared with a forecast. This is useful because it lets managers know where expected future variances will likely occur. This allows them to act to prevent an adverse variance in the future or at least alert management to the need to be ready to explain adverse variances by the period-end. This type of control, which helps prevent future problems, is known as feedforward control.
An example of feedforward control is comparing budget to forecast and resolving issues that will happen in the future and affect future performance.
DATA
Raw, unprocessed facts, figures, characters, or words
INFORMATION
Data that has been processed to have meaning.
Communicating management information in the company is vital for two reasons. First, everyone needs to know what’s going on and who’s making decisions; second, to make robust decisions.
Methods of communication
Visual
written
Oral
Considerations when communicating
- recipient
- timeliness
- complexity [Complex information may be more easily absorbed in a written document such as a report, email or letter. However, it might be better first to introduce it in a face-to-face meeting or telephone conversation to answer questions and correct misunderstandings.]
- confidentiality
- Evidence - is proof of communication required?
- how to ensure the retention of appropriate evidence?
- ## cost
Emails
- CC and BC
- Signature [role, disclaimers]
CC and BCC
In addition to the recipient, emails may be distributed via CC (carbon copy) and BCC (blind carbon copy).
To BCC someone is the send a copy of the email to that person, who is not the intended recipient, but should be kept in the know, without the knowledge of the intended and CC’d recipients.
BCC recipients know to whom the email has been sent and CC’d; the intended and CC’d recipients will not be aware the email has been sent to BCC recipients.
Memorandums (Memos)
Memorandums are concise formal statements issued to communicate something important to the intended recipient. They may be public or confidential.
Memos are usually written in plain English, with efforts to reduce jargon and clearly state their contents and next course of action.
The elements of a memo are like a report.
reports - can be standard or ad hoc
elements
- distribution list and date
- introduction
- sections
- summary
When writing a report, consider if any information can be presented in these ways to help non-financial managers understand the information more easily.
Line chart
useful for showing trends over time, such as sales and revenue growth
bar chart
bar charts show comparisons. eg. comparing budget expectations against actual results
pie chart
pie charts can show a relative comparison to a whole, such as sales in different regions
scatter diagram
show results over two axes, which helps identify correlations and trends
table
show precise numerical data, such as financial statements
Effective charts - chart title, axis title, legend (key), gridlines
wrong chart type will be misleading and may lead to dysfunctional decision-making eg. the use of a line to connect the data points suggests change over time
Ch6
Materials are classified in 4 main ways:
RAW MATERIALS - goods purchased to be made into products for sale
BOUGHT-IN COMPONENTS - parts purchased from an external supplier for assembly
WORK IN PROGRESS (wip) - products partly made but unfinished
FINISHED GOODS - products ready for sale
Direct materials - materials directly attributable to a production unit.
Raw materials are direct materials: for example, cotton cloth can be seen in a specific t-shirt
Indirect materials - not directly attributable to a production unit.
economies of ordering
suppliers often offer discounts on large orders of materials, reducing purchasing costs
purchasing process
- request for materials - stores dept request materials using authorised purchase requisition
- find supplier - purchasing department source suitable supplier
- order goods - PURCHASE ORDER
- receive goods - warehouse record goods received
- pay for goods - finance team would check the invoice against purchase order and delivery note and process payment for materials
accounting entries for materials - materials control account
- purchases - materials control
- issues to production (direct) - work in progress
- issues to production (indirect) - production overhead
- returns from production - materials control
- returns to supplier - payables
Calculating Material requirements -> material for product and waste accounting for -> MATERIAL INPUT REQUIREMENT
material input requirement = output material + expected waste
controlling wastage
Managers measure wastage in several ways:
- Monitoring actual input wastage: This is the figure calculated earlier. It is the amount of material wasted in producing a finished product.
- Monitoring output wastage: This is the number of items rejected because they are not up to standard, usually represented as a percentage of the total number of products made.
- Monitoring rework: This is the number of items requiring corrections, usually represented as a percentage of the total number of products made.
If it is identified that wastage is avoidable, managers will need to take steps to reduce the wastage. For example, they might:
- Arrange training to ensure that workers are operating correctly and efficiently
- Review the quality of the materials being purchased
- Replace old equipment.
There are several different methods of calculating inventory value:
First-in, first-out (FIFO)
Last-in, first-out (LIFO)
Cumulative weighted average pricing (CWA)
Periodic weighted average pricing (PWA)
FIFO assumes that the inventory purchased first is sold first. So, the materials in stock at the end of a period are valued using the most recent prices paid to suppliers.
LIFO assumes that the inventory purchased last is sold. So, the materials in stock at the end of a period are valued using the oldest unit prices paid to suppliers.
cumulative weighted average approach calculates the average cost per unit every time a new material receipt occurs by dividing the total cost of held inventory by the total number of units in stock. This price is used to value all issues to production until another delivery is received. The closing inventory is valued using the most recently calculated weighted average price.
periodic weighted average calculates a single weighted average cost per unit at the end of each accounting period (rather than whenever inventory is purchased). This single weighted average price is used to value all the issues to production and the closing inventory for the period.
Ordering ‘just in time’ reduces inventory holding costs.
Production should only make as many units as can be sold. There will be no inventory of raw materials or finished goods.
However, this increases the risk of “stock-out”, where no inventory is available for production or sales.
To mitigate this risk, companies build robust, integrated relationships with their suppliers or diversify their sources of supply.
Buffer inventory - common to hold some reserve inventory to accommodate variable demand or delays in receiving raw materials. buffer inv also held it cheaper to buy in large quantities, as suppliers often give discounts for bulk purchases
COST OF SALES (CoS) affects profit calculations and is also known as the cost of goods sold (CoGS)
Sales (Revenue) - Cost of sales = gross profit
opening inventories + purchases or costs of production - closing inventories = cost of sales
COST OF PRODUCTION - cost of making the products
Cost of production = direct production costs + Production overheads
[[assuming absorption costing]]
FIFO - Advantages
- Used in statutory accounts (IAS2)
- reflects actual practice. the first items purchased will probably be the first items used in the produciton process
- easy to understand and explain
- closing investor value based on most recently purchased items, so will be close to the cost of replacing the inventory
- Disadvantages
- awkward to administer as each set of items purchased needs to be identified separately
- managers are charged varying prices for same materials at different time - comparisons difficult
LIFO - Advantages
- issue price clost to the current market value as the last items purchased are assumed to be the ones used first
Disadv
- arkward to administer as each consignment needs to be identified separately
- does not reflect actual practice - more likely that the first items purchased will be used first in production process
- managers are charged different prices for same materials at different times
Weighted average - adv
- easy to administer as each consignment of purchases does not need to be identified separately
- using weighted average pricing means that price fluctuations are smoothed out, making it easier for managers to use the information
Disadv
- issue price will not be actual price that has been paid
INFLATION - sustained increase in the price of goods and services over time.
increased price of raw materials:
FIFO - closing inv valued at a cost close to the current market value
LIFO - issues materials at a cost close to the current market value. Closing inventories are valued at a cost lower than the current market value
CWA - time delay between the issue cost and current market value. values closing inv at cost that rises with inflation, but there is a time delay between the issue cost and current market value
PWA - issues materials at a cost LOWER than the current market value. Values closing inventories at a cost lower than current market value
Inventory costs
- Purchase cost - price paid for inventory. inc taxes
- Ordering cost - costs for ordering inventory. includes transport and administration costs
- Holding cost - costs incurred for holding inventory eg. storage, finance costs, insurance, obsolescence, deterioration, spoilage, theft
- Stockout cost - costs incurred if inventory is unavailable. inc. price
OBSOLESCENCE
Reduction in inventory value due to it becoming irrelevant to the organisations needs
eg. tech products surpassed by new tech and lowers in value
DETERIORATION
Reduction in inventory value due to degradation in its qualities. eg. fresh produce
Obsolete or deteriorating inventory eventually discarded and written off
Managing Inventory Costs
- order size -buying in bulk
Stockout costs:
- If it maintains too little inventory, there is a risk of running out, known as a stockout.
Stockout costs include:
Loss of sales during the stockout period
Loss of reputation
Customers switching to competitor products and continuing to buy from competitors in the future
Cost of production stoppages (machinery and workers are idle)
Extra ordering costs for urgent orders.
Balancing Inventory costs:
Holding the right amount of inventory
Valuing inventory issued and remaining
Ordering goods
Receiving and storing goods.
inventory control levels - lead time and how much to order
Lead time - the waiting time to receive goods after placing an order
Reorder level calculation
= maximum usage x Maximum lead time
Minimum level calc
= Reorder level - (average usage x average lead time)
Maximum level calc
= Reorder level + reorder quantity - (minimum usage x Minimum lead time)
Average level calc
= Minimum level + reorder quantity / 2
Economic order quantity (EOQ) -> order quantity where holding costs and ordering costs are equal, assuming no buffer inventory
assumptions
- holding cost per unit is constant
- average inventory is held = minimum or buffer inventory + (reorder quantity / 2)
EOQ = square root of (2 x cost of ordering from supplier x demand during period) divided by cost of holding one unit of inventory for one time period
Two methods of stocktaking:
- Period: materials in inventory are counted once a year
- Continuous: Materials are checked regularly throughout the year (this method less disruptive for organisations and more accurate)
Inventory discrepancies (compared to records)
- quantity of goods delivered differs from quantity recorded as being received -> all inventory should be counted as received and signed off
- actual quantity of inventory issued to production differs from that shown in the records -> inventory issued to production should be carefully counted and signed off
- production returned excess inventory without any documentation -> all movements of inventory should be recorded
- theft of inventory by employees -> security mechanisms and regular inventory checks will prevent this
- inventory damaged or obsolete and thrown away without being documented -> damaged or obsolete items should be recorded
Storing goods - system for keeping inventory accessible and secure:
- frequency of use and location in the warehouse
- dangerous items and chemicals
- special needs such as light, temp, clean air, hygiene
- security for valuable or high risk items
labour costs
The employer’s contribution to the employee’s pension
Employee benefits such as company cars and private health insurance
Training costs
Recruitment costs
- DIRECT LABOUR - work directly attributable to producing a product or service
- INDIRECT LABOUR - not directly attributable to production of product or service
the basic pay of direct workers is a direct cost, and all other costs of direct workers are indirect costs. All costs of indirect workers are indirect costs.
Only hours spent directly producing a product/service are considered direct labour costs.
All other costs are indirect, even if paid to direct workers.
A bonus paid to direct workers is an example of an indirect cost paid to direct workers.
idle time -> indirect cost
general overtime premium -> indirect cost
overtime worked for customer request -> DIRECT cost
- active basic hours of direct workers are direct costs
- idle time of direct workers is an indirect cost
- basic pay earned from overtime hours is a direct cost
- overtime premium of direct workers is an indirect cost
- cost of indirect workers is indirect
renumeration for work
methods:
- time-based
- output or performance -based
for exam *assume labour costs are variable unless specified otherwise
time-based schemes (renumeration)
- Salary - agreed amount per month
- Wages - waged employees paid based on agreed hourly rate, depending on how many hours they work
- overtime premiums - work longer hours than normal, in addition to standard pay rate
Adv
- time based payments simple to administer
- one standard rate applied to all employees in same role (fairer)
Disadv
- no incentive for employees to be efficient
- everyone paid same regardless of performance
- more supervision needed bc employees not as highly motivated as they are when working under an incentive scheme
Incentive type
- Piecework - payment is a fixed amount for each item completed - efficiency
- monetary incentive based on performance
- commission paid based on successful outcome eg. sales
- profit-sharing schemes - employees are given a share of the profit made by the organisation in the year
Adv
- help to increase production while controlling costs per unit, which helps the accuracy of planning
- more efficient employees paid more
- may attract more skilled workers
Disadv
- incentive schemes more expensive to administer
- quality control needed to ensure output meets standards
Labour cost records should contain the following:
The identities, roles, and payment information of the employees.
The agreed wages and salaries
The hours worked by employees
The work that has been done.
HR system - primary source of data
Payroll system - info drawn from HR for use within payroll system
Financial accounting system - payroll transactions automatically posted to the financial accounting system - summarised version of payroll system
management information system - access info from all systems. no personal details
Paying Wages
Payment of net pay to employees
Dr Wages control
Cr Bank / Cash (net pay)
Payment of employee deductions and employer contributions to external entities
Dr Wages control
Cr tax PAYE / employee benefits
[Pay-as-you-earn (PAYE) are monthly deductions from employee paycheques remitted to external entities. PAYE may be required for income tax and mandatory insurance contributions.]
Accounting for Labour Costs in Wages Control
Accounting for costs of labour (including employer contributions)
Dr Work-in-progress / production overheads / employer contributions
Cr Wages control
Labour costs are then accounted for using the same principles applied to direct and indirect materials costs.
Direct labour costs are debited to the work-in-progress account
Indirect labour costs are debited to the production overhead control account
Both direct and indirect labour costs are credited to the wages control account.
Accounting for direct labour costs associated with PRODUCTION:
Dr Work in progress
Cr Wages control
Accounting for Indirect Labour costs
Indirect labour costs would be transferred into a Production overheads account for subsequent absorption into work-in-progress.
Transfer of indirect labour costs to production overheads
Dr Production overheads
Cr Wages control
Absorption of Production Overheads
Production overheads (which include all indirect production costs) would be absorbed into production.
Absorption of production overheads into production
Dr Work-in-progress
Cr Production overheads
Costs of labour turnover
- Preventative costs (incentives, training)
- Replacement costs - recruiting and hiring (loss of output due to time gap, advertising, training courses, lower production w new staff)
Labour turnover rate = Replacements / av number of employees in period x 100%
Average number of employees = (opening employees + closing employees) / 2
employer actions to reduce labour turnover include
Paying higher salaries and offering better benefits
Creating a better working atmosphere
Offering development training
Offering clear career progression
Offering flexible working arrangements.
3 ratios for measuring labour performance:
- efficiency ratio
- capacity utilisation ratio
- production volume ratio
capacity utilisation ration
(measures whether total direct labour hours worked were greater or less than budgeted)
= (actual hours worked / hours budgeted) x 100%
ratio of >100% indicates more labour hours were worked than budgeted
Production volume ratio (measures how the actual production output for a period (in direct labour hours) compares with the budgeted output)
= (expected hours to make actual output / hours budgeted) x 100%
ratio of >100% indicates higher than budgeted performance
Relationship between labour ratios:
efficiency ratio x capacity utilisation ratio = production volume ratio.
(labour ratios are based on direct labour hours)
IDLE TIME RATIO -> shows the proportion of available hours lost due to idle time
Idle time ratio = (idle hours / total hours) x 100%
**Pay for idle time is an indirect cost (including direct workers)
Expense - decreases in economic benefits during the accounting period in the form of outflows, depletion of assets, or incurrences of liabilities
Expenses result in either:
The decrease in an asset such as cash in the bank account when items are paid for immediately, or
The increase in a liability – such as an account payable or creditor when items are paid for on credit.
Classifying expenses by function:
buildings management eg. rent, utility bills
- production department
- selling and distribution
- finance and legal
Direct expenses - incurred on a specific product and part of the direct (or prime) cost of the product
Indirect expenses - cannot be attributed to a specific product (overheads)
Direct expenses are recorded by coding them directly to the product, job or client
Indirect expenses are recorded by allocating them to cost centres and apportioning or absorbing them into the areas of the organisation that have used the resource.
authorising expense invoices
Invoices usually are stamped so that the person authorising payment must fill in some vital information, including:
Date
Signature
Cost code (for allocation to production unit or function)
Asset expenditure - new non-current asset is bought or existing non-current assets are improved
Accounting entry:
Dr Asset [So Financial Position]
Cr Cash/Bank/Payables [So Financial position]
Expenses - ongoing costs of running the organisation. expensed in the period revenue is generated from it (matching concept)
Accounting entry:
Dr Expense (Statement of Profit and Loss)
Cr Cash/Bank/Payables (Statement of Financial Position)
Expenses reflected in the Statement of Profit or Loss immediately, reducing profit
Asset expenditure does not affect the calculation of profit
If asset expenditure is incorrectly classified as an expense, expenses will be overstated. This means that profit will be understated.
Depreciation: way to match expenditure on non-current assets to the period when the assets are used (matching concept)
- expense shown on the statement of profit or loss in the period the asset is used to generate revenue
- non-cash item (no cash is paid when charging depreciation)
The period depreciation is charged should match the asset’s useful life (years used)
Calc depreciation:
- straight line method
- reducing balance method
- machine hour method
- product units method
Residual value - value of the asset after the end of its useful life aka scrap value
Depreciable amount is the asset’s value to be deprciated over its useful life:
Depreciable amount = cost of asset - residual value or scrap value
Annual depreciation - depreciation charge for the year on the asset
Accumulated Depreciation - total depreciation charged up to a point in the asset’s useful life
Carrying amount - asset’s value reflected in the accounts. cost of the asset less accumulated depreciation
Carrying amount (NBV) = cost - accumulated depreciation
straight line depreciation - annual dep charge same throughout asset’s useful life:
Annual deprec = (cost - residual value) / useful life
reducing balance method - recalcs annual depreciation by applying a percentage to the carrying amount
Annual depreciation = carrying amount x depreciation rate %
Machine hour method:(calc according to how much the asset used each year)
Depreciation per machine hour
= (cost - residual value) / useful life in hours
Annual depreciation = depreciation per machine hour x Actual usage hours
Product Units Method
Depreciation per production unit = (cost - residual value) / expected production units
Annual depreciation = depreciation per production unit x actual units produced
In the product units or machine hours method, the depreciation charged each year would be according to the actual levels of production or machine hours used. Note that:
If production levels or machine hours are higher than expected, then the asset will be fully depreciated earlier than planned
If production levels or machine hours are lower than expected, the asset will be fully depreciated later than planned.
In these methods, depreciation stops when the carrying amount equals the asset’s residual.
Ch9 job costing ->
process of calculating the costs of a specific job
A job is a cost unit that consists of a single order or contract. Compared to continuous production, it is usually limited in scope and period.
A job may be a single physical product, several products or a service
Job costing process
Customer specifies requirements
Specification and delivery date agreed
Supplier estimates pricing
Pricing agreed
Job scheduled for production
Job records
1 each job given a unique code
2 All direct costs associated with the hob are coded directly to the job code
3 A share of overheads calculated and charged to the job
4 Job cost is calclulated, usually on job cost card
5 difference between actual costs and agreed selling price is the profit
Job cost cards are usually created and held electronically in the computerised accounting system.
When job is planned, cost cared prepared with expected costs. Cost card will be used to create a budget for the job. The actual costs will be recorded in the accounting system
Cost-plus pricing method adds the required profit to the total cost of the product or job
The required profit may be expressed as:
Mark-up %
A percentage of the cost.
Margin %
A percentage of the selling price.
*Note that although markup is usually calculated as a percentage of the total cost, it may have other bases (such as a percentage of total direct costs).
Margin is always expressed as a percentage of the selling price (which is 100%).
Batch Costing Principles - several units rather than single unit
Used in manufacturing - large numbers of items or liquids made
eg. computer chips, inks, tshirts
Cost per unit = total batch cost / number of units in a batch
Set Up costs
- cleaned and set up for next batch to be processed
Set up costs can be high, so they are included in the batch cost as a direct expense
cost control strategies
- focus on highest costs and what drives them
- reviewing supply chains and buying as close to the source as possible
- renegotiate contracts
- invest in mechanisation
- invest in training of labour
- examine and improve remuneration processes
- evaluate asset expenditure carefully
- examine variances and their relationships
- use budgets effectively
- implement strong financial controls
Cost control in job costing:
- materials
- labour
- equipment
- management
Cost controls in batch costing
- area to focus on is set up costs
- the more different batches are, the more significant the set up costs and downtime
Reducing set up costs:
- keeping subsequent batches as similar as possible to the initial batch, minimising changes to the set up
- regular maintenance of production machinery, reducing downtime
- increasing batch size produces more unit per set up
- examining the set up requirements and designing the process to reduce set up costs and downtime
Characteristics of Services - SHIP
- Simultaneity - service provider cannot be separated from the service, ‘inseparability’
- Heterogeneity - each instance of the service is unique, unique approach
- Intangibility - services not tangible
- Perishability - services cannot be stored for future use - only relevant at moment of time
also have involvement - customer involved in service delivery eg. client vital to the legal case - wouldn’t exist without them
No transfer of ownership - service is not owned, and cannot be sold to a third party
Problems in service costing
- Difficult to identify a cost unit to which costs are allocated
- Indirect costs often a more significant percentage of a service’s cost than a physical product. this makes a meaningful and fair allocation of shared cost necessary
- the number of inputs for each cost unit may be unique
Service cost units:
- Simple cost unit - similar service provided to one customer at a time
- Composite cost unit - made of two parts related to the service’s extent
- Complex services (by job or engagement) - service is unique, personalised, complex, with many cost elements
Service cost card would be like a job cost card, with each cost element separately identified
Calculating total cost per service unit:
Cost per service unit = (total cost for period / number of service units in the period) x100
Labour cost in services is usually higher than materials, and indirect costs are likely to make up more of the total cost of services than for physical products
Unit costs in not-for-profit organisations:
Often calculate a cost per unit for the following reasons:
- to demonstrate efficiency
- to help measure performance and improvements over time
- to help control costs
Absorption costing principles - sharing and absorbing indirect costs (overheads) into the total cost of a unit of product or service
Include overhead costs in the total cost per unit of a product or service to ensure that the total cost per unit is accurate. This is necessary for two reasons:
- to calculate a reasonable selling price and determine whether a product is profitable
- to calculate inventory value accurately
ABSORPTION COSTING PORCESS
- ALLOCATION (of entire cost items to cost centres)
- APPORTIONMENT (sharing of common costs to production cost centres)
- ABSORPOTION (absorbing shared costs into cost units)
The organisation’s production site might have several cost centres.
Non-production departments might include sales, distribution and delivery, finance (the accountants!), and human resources. These departments are not directly involved in making or storing the organisation’s products and could be in a different location to the factory and warehouse.
Inventory Valuation
Inventory consists of raw materials, bought-in components, work in progress (partially completed products/goods) and finished products/goods. Including overheads in the cost per unit results in a more accurate unit cost, resulting in a more accurate inventory valuation. An accurate inventory value is needed for the following:
Including an accurate inventory figure in the financial statements
Correctly calculate the cost of sales figure, which is used to calculate gross profit or loss in the statement of profit or loss.
*Cost of sales = Opening inventory + Cost of production – Closing inventory
Cost centres - department or division that incurs costs
Production Cost Centre
A production cost centre is a department or activity directly producing the cost unit.
Production cost centres in a manufacturer are likely to include activities such as:
Assembly
Mixing
Painting
Packaging
Ageing (holding products to mature)
Molding
Service Cost Centre
A service cost centre is a department or activity that provides ancillary services to support production cost centres.
In a manufacturer, these may include the following:
Logistics and warehouse services
Security
Staff canteen and other human resource services
Maintenance
Cleaning
Whole Costs
Whole cost items are overheads (indirect costs) attributable to a single cost centre. They are allocated to a single cost centre.
For example, at T-Shirt Co, the salary of the warehouse manager is a whole cost item as it relates only to the warehouse cost centre.
Common Costs
Common costs need to be shared among different cost centres.
For example, the cost of electricity to power the whole factory site is a common cost because it relates to all the cost centres – including the warehouse, assembly centre, cleaning department, purchasing offices, etc.
An apportionment base must be selected to determine how much of a typical cost is to be charged to a cost centre. For example, kilowatt-hours might be the basis for apportioning electricity costs among cost centres.
Remember the absorption costing steps:
- allocation, apportionment, absorption
Allocation involves charging whole overhead cost items to cost centre
Apportionment, the second stage in absorption costing, is sharing common overheads between cost centres.
Examples of common costs:
Building lighting (shared by all cost centres in the building)
All the cost centres also share rent, insurance, and utilities (water and electricity) in the building.
There are two parts to the apportionment stage:
1. apportion all common costs across each production and production service cost centre;
2. reapportion all service costs between the production cost centres. (so all overheads are fully charged to production cost centres).
The aim is to eventually establish the total overhead costs for each production cost centre.
Basis of Apportionment
- an apportionment base must be identified to apportion common costs among cost centres
- an apportionment base measures how much the cost centre should be charged for the common cost. it should be fair and measureable.
Examples of bases for apportioning shared overhead costs to different cost centres might include:
eg. floor area - rent, cleaning , utilities
eg. number of employees - canteen, health and safety, training
In the exam, read the question carefully to select the most appropriate apportionment base.
Changing apportionment base:
As processes and methods of manufacturing change, the most appropriate apportionment base may also change.
For example, a business has a car park that all staff use: the costs might be shared by apportioning them based on the staff in each department.
If the business were to sell part of the car park and the remaining few parking spaces were reserved for visitors, then the basis for apportionment would need to change from staff per department to visitors per department.
Calculating apportionment
- Identify cost centres, whole costs, and common costs.
- Allocate whole costs to cost centres.
- Select an appropriate base for common costs
- Apportion common costs on the proportion of the apportionment base used by the cost centre.
Reapportionment - process of dividing the costs that have been allocated and apportioned from service cost centres to production cost centres
All overheads (including those allocated and apportioned to service cost centres) must be charged to the production cost centres to calculate the total production overhead per cost unit.
Similar to apportionment, a suitable reapportionment base is chosen to share the costs using that base.
MA2 requires an understanding of two methods:
Direct
Step-down
Direct Reapportionment Method
The direct reapportionment method is when service cost centre overheads are only apportioned to production cost centres. Services provided to other service cost centres are ignored.
Step down Reapportionment method
In the step-down method, the costs of one service centre (CS1) are reapportioned to the production cost centres and the other service centre (CS2).
The costs of the other service centre (CS2) are then reapportioned to the production cost centres.
The cost centre with the highest total costs, or that carries out the most work for the other service centre, is reapportioned first.
** Read the exam question carefully if it requires step-down reapportionment.
The service cost centre that does not provide services to other service cost centres is reapportioned last.
If this is the above does not apply, and the question does not specify the order of reapportionment, reapportion the service cost centre with the highest cost first.
OVERHEAD Absorption rate (OAR)
- final step of absorption costing is to charge the production overheads to output
The overhead absorption rate is the rate at which total production overhead costs are added to the cost per unit of each product.
An absorption base must be determined to calculate the absorption rate. This base, also known as the cost driver, should be linked to the main activities that incur the overheads.
Generally, in absorption costing, two cost drivers are considered:
Direct labour hours would be the driver for production that is labour-intensive.
Machine hours would be the driver for production that is machine-intensive.
OAR (approximates overheads incurred) typically calculated using BUDGETED ACTIVITY AND OVERHEADS
Overhead Absorption rate = total overheads of production cost centre / total cost driver
OAR is most fair in simple manufacturing activities where actual output is close to budget, and the labour and machine hour cost drivers account for most of the overhead costs
Determining the OAR
- estimating overhead costs
- estimate total activity
- calculate OAR
- charge OAR to output (per unit)
Over- or under-absorption occurs when actual overheads are not as budgeted.
Over absorption: more might be charged in overhead costs than the organisation incurs
Under absorption: less might be charged in overhead costs than the organisation incurs.
The amount of overheads calculated as being either over or under absorbed is directly reflected in the statement of profit or loss at the end of the period so that the correct profit or loss, based on the actual overheads incurred, is shown.
Over-absorbed overhead is an addition to profit, whereas under-absorbed overhead is shown as a cost, thereby reducing profit.
summary:
- identify overheads and cost centres
- estimate overhead costs
- estimate total activity
- calculate OAR
- Charge OAR to output
- Compare with actual overheads
Non-production overheads are not related to the production of goods and services. Examples are finance, sales and marketing, human resources, and administrative overheads.
They are not absorbed into the product costs and are expensed against profit for the period.
For decision-making purposes, non-production costs will be considered when setting the selling price of products, as they also need to be covered.
Non-production overheads may also be included in these calculations at a specific absorption rate (i.e. 25% of production costs).
**Under the accounting standard IAS 2 inventories, the cost of non-production overheads should not be included in inventory valuation.
process of including non-production overheads is like that of production overheads:
- estimate overhead costs
- estimate total activity
- Calculate OAR
- charge OAR to output
same steps for absorbing costing for services
From the earlier activities, support department costs (Housekeeping, Finance and administration) are Reapportioned to the service delivery centres (Front office and guest services, the hotel restaurant and the function room hire department) using either the direct method or the step-down method.
Absorption
Service delivery costs are absorbed into the service cost units using an appropriate absorption rate:
Remember that services often have composite cost units, such as a ‘guest-night’.
For services, a cost driver is often labour hours. The average staff hours spent on each service unit (hotel guest-night) must be determined.
Predetermined overhead absorption rate (based on direct labour hours)
= Total budgeted overheads for the cost centre/Total budgeted direct labour hours
Marginal costing
Marginal costing is a costing method used for short-term decision-making. It facilitates this by recognising costs according to their behaviour.
This means that fixed and variable costs are treated differently, especially in inventory valuation.
Fixed costs
Marginal costing expenses fixed costs against profit for the period, not retaining any fixed costs in the inventory valuation. This is because fixed costs do not change in the short-term and are irrelevant to short-term decision-making (they would be incurred regardless of the decision).
Compare this to absorption costing, where fixed costs are allocated, apportioned, and absorbed into inventory. Any unsold inventory would carry a portion of these fixed costs into the next period.
Variable costs
**Under marginal costing, inventory is valued at only marginal (variable) production costs.
Under marginal costing, only variable (marginal) costs are included in inventory valuation.
This is because the marginal cost of a product is the increase in expenses required to produce an additional unit, which is usually its variable cost.
For example, if it costs $60,000 to make 10,000 units and $60,003 to produce 10,001 units, the marginal cost of the additional unit is $3.
The marginal cost of a product usually consists of the following:
Prime costs:
Direct materials
Direct labour
Direct expenses
Variable production overheads
Contribution = portion of revenue after subtracting variable costs
it covers fixed costs costs, with any remainder being the profit earned
total contribution = total revenue = total variable cost
