Management Accounting

Question 1

three rationales of management accounting

Answer 1

planning, decision-making, and controlling

Question 2

define a relevant cost

list the three criterias a cost must qualify to be relevant

Answer 2

a cost that is going to be affect by a particular decision

its for one-off decisions

For a cost to be relevant it has to satisfy three criteria:

1. Has to be a cashflow
2. Has to be in the future
3. There has to be a difference (increment)

Examples:

• an additional cash inflow
• an additional cash outflow
• an existing cash inflow lost
• an existing or potential cash outflow saved or avoided

Question 3

non-relevant costs

+ examples

Answer 3

a cost will remain unaltered regardless of the decision

• Sunk or past costs
• Fixed overheads
• Committed costs
  
  • you’ve already signed a contract, hence can’t change it
• Depreciation
  
  • because it is not cashflow

Question 4

opportunity cost

Answer 4

the loss of other alternatives when one alternative is chosen

a special type of relevant cost

Question 5

avoidable costs

Answer 5

if it can be avoided, it’s a relevant cost

(Costs of an activity or sector of a business which would be avoided if the activity or sector did not exist.)

Question 6

differential / incremental cost

Answer 6

• The difference in total costs between alternatives
• Useful to highlight the consequences

It’s the difference between the cost of two alternative decisions, or of a change in output levels. The concept is used when there are multiple possible options to pursue, and a choice must be made to select one option and drop the others.

Question 7

analysing the cost of an item (formula)

Answer 7

a physical quantity measurement x a price measurement

Example

To manufacture Product X, we need 200 hours of labour time at a rate of £4 per hour. Labour cost = £800

(physical quantity is hours)

Question 8

Variable costs vs. Fixed Costs

Answer 8

Variable costs increase in direct proportion to the increased level of activity.

Fixed costs do not vary whatever the level of activity, in the short-run.

Question 9

Direct Costs vs. Indirect Costs

Answer 9

• Direct costs are directly traceable to an activity of the business
  
  • Costs directly related to a product, or a service, or a location
• Indirect costs are spread over a number of activities of the business
  
  • Costs not directly related to a product, or service, or location and have to be apportioned on a basis

Question 10

Product Costs vs. Period Costs

Answer 10

Product costs (manufacturing costs) are costs associated with goods or services purchased, or produced, for sale to customers.

• These include direct materials, direct labour, and indirect manufacturing costs such as salaries for timekeepers, supplies of materials for repairs and maintenance

Period costs (non-manufacturing costs) are those costs which are treated as expenses in the period in which they are incurred.

• These costs are not included in the cost of sales (like a temporary external consulting task force)
• Examples: administrative and marketing costs

Question 11

cost centers

Answer 11

• Something you want to find a cost for.
• A unit of organisation in respect of which a manager is responsible for costs under his or her control
• A location, or a function, or a group of machines
• Must be a homogeneous unit carrying out a single form of activity

Question 12

profit centers

Answer 12

• Something you want to find out the cost and revenue.
• A unit of organisation in respect of which a manager is responsible for revenue and costs

Question 13

investment centers

Answer 13

• Where the manager has autonomy on where and how the finance of an activity takes place.
  
  • Should I expand oversees, open a new factory?
• A unit of organisation in respect of which a manager is responsible for capital investment decisions, revenue and costs

Question 14

prime costs

Answer 14

costs directly traceable to the relevant jobs / each unit of product

(cutting glass for the phone)

Question 15

aim of (traditional) absorption costing

Answer 15

Trying to attach indirect costs to the product.

• rent
• supervisor’s salary

The manufacturing overheads will be spread across a range of jobs, not directly traceable to each individual job.

Problems arise when we try to allocate the production overheads to the jobs.

Question 16

absorption costing: allocate

Answer 16

assign a whole item of cost/revenue to a single cost unit, centre, account

Allocating should be the first thing to do, if enough information is available.

Question 17

absorption costing: apportion

Answer 17

where there isnt enough data to allocate, spread costs over two or more cost units, centres, accounts

Question 18

absorption costing: absorb

Answer 18

absorb (take onboard) overhead costs into products or services

Question 19

absorption costing: three steps overview

Answer 19

1. allocate/apportion indirect costs/production overheads to the cost centres
2. apportion service cost centre to production cost centre
3. absorb overhead costs into product

Question 20

Limitations of Absorption Costing

Answer 20

• Major difficulty in traditional costing is the inclusion of fixed costs (attaching the heating cost to the product)
• Methods used to apportion these costs are arbitrary/subjective
• Different O/H base resulted in different O/H rates, resulted in different departmental costs and product costs

Question 21

marginal costing aka. variable costing

Answer 21

Marginal costing assigns only the marginal costs (direct costs), costs which vary with the level of production, to the products.

Marginal costing is about decision-making, especially concerning short-term decisions - a lot better than absorption costing.

The main difference between absorption costing and marginal costing approach is the way we treat the Indirect Manufacturing Costs.

For absorption costing, we will apportion and absorb the Indirect Manufacturing Costs into the product to arrive at the Production Costs.

But for Marginal Costing, the Indirect Manufacturing Costs are treated as Period costs, not as part of the Product Costs.

Under marginal costing, the indirect manufacturing costs will be treated as ‘Other Expenses’, and will not be charged to the product to form part of the ‘Cost of good sold / Production Costs’

Question 22

marginal costing and production costs

Answer 22

Marginal Costing will only take into account the PRIME COSTS as the PRODUCTION COSTS. Because prime costs are all directly traceable to each unit of product, in other words, each time when there is a change in the level of production, the direct costs will change. So we can also say that the marginal costing only takes into account all the variable costs, all the fixed costs will be treated as period costs rather than as the indirect manufacturing costs.

So marginal costing emphasises on differentiating between fixed and variable costs, product and period costs.

Question 23

variable costing and break-even point

Answer 23

It emphasises the behaviour of fixed and variable costs, helps to predict cash flows in relation to sales volume, helps to correlate fluctuations in cash flows with fluctuations in sales volume

Question 24

break-even point: why seperate fixed and variable costs

Answer 24

Fixed and variable costs need to be separated so that volume and variable costs can be manipulated to determine the changes in profit.

And because fixed costs remain the same at least in the short term, the fixed and variable costs are separated so that managers can play with the production and sales volume and variable costs to find out how much revenue they have to earn to make a profit.

Question 25

calculating break-even point

Answer 25

1) break-even point (units) = fixed costs / contribution per unit

• to calculate much revenue do you need to make: break-even point units x selling price

2) break-even point (monetary) = fixed costs / contribution margin ratio

Question 26

assumptions during break-even analysis

Answer 26

• Fixed costs remain constant
• Variable costs vary proportionally with volume of output
• All other factors remain unchanged.
  
  • E.g., selling prices remain constant,
  • methods and efficiency of production unchanged,
  • volume is the sole factor affecting costs
• All units produced are assumed to be sold.
• All fixed costs must be stable in a CVP analysis.
• All changes in expenses occur because of changes in activity level.

Question 27

affect of changing fixed costs on A) contribution margin ratio B) net profit

Answer 27

only net profit is affected

using this formula:

break-even point = fixed costs / unit contribution margin*

*selling price per unit - variable cost per unit

Question 28

affect of changing variable costs on A) contribution margin ratio B) net profit

Answer 28

both net profit and contribution costs affected

using this formula:

break-even point = fixed costs / unit contribution margin*

*selling price per unit - variable cost per unit

Question 29

affect of changing selling price on A) contribution margin ratio B) net profit

Answer 29

both net profit and contribution margin

using this formula

break-even point = fixed costs / unit contribution margin*

*selling price per unit - variable cost per unit

Question 30

margin of safety (MOS)

Answer 30

measures the difference between current sales, where you are right now, and the break-even point, expressed as a %

(current sales - break-even point) / current sales

x 100

Question 31

Limitations of Break-even analysis (CVP)

Answer 31

• The relationship between sales income and activity (quantity sold) may not be linear.
  
  • Discounts, for example, influence the analysis
• The relationship between total costs and activity (quantity produced) may not be linear.
  
  • economies of scale is not linear often
• It is dangerous to use CVP analysis outside the relevant range of activity. (fixed costs remain constant with a certain level of units)
  
  • fixed costs only stay constant within a relevant range
• It is assumed that costs are matched to income, i.e. there is no increase or decrease in stock levels over the period. (everything you made you sold, which is unrealistic)
  
  • the analysis assumes everything is sold
• With multi-product businesses there may be different breakeven points are produced for different sales mixes.
  
  • can be done, but more complicated
• It is difficult to measure activity for ‘jobbing’ businesses where every item produced is different (e.g. construction of houses) firm).
  
  • when building a house

Question 32

operating gearing

Answer 32

refers to the proportion between Variable and Fixed Costs within Total Costs

Where fixed costs are high, greater volume activity is required for profits to increase. A small fall in sales will cause a disproportionately greater fall in profits.

Thus, a fall in sales of say 5% could, where fixed costs are high, result in profits falling by substantially more than 5%.

When sales are booming, profits will rise to a greater extent.

Question 33

decisions using variable costing

(how to decide go-no-go)

Answer 33

The question is not does it make a profit or not, but does it make a positive contribution.

• Close down or continue operations
• Scarce resource and choice of activities
• Make-or-buy

The underlying basic assumption is that fixed costs cannot be eliminated in the short term.

• It would be wrong, as a general principle, to cease an activity that is making an accounting loss provided it is making a positive contribution.
• Stopping an activity would mean that less of the fixed costs were covered by contribution and the loss would be greater than before – in the short term.
• In cost terms, only close down if fixed costs saved are greater than contribution lost.

To maximise profit, maximise contribution.

Question 34

formula for contribution per unit

Answer 34

contribution per unit = selling price per uni — variable cost per unit

Question 35

limiting factor

Answer 35

any factor in short supply stopping the organisation from expanding its activities

• sales volume
• machine supply
• skilled labour
• raw materials

Question 36

single limiting factor

Answer 36

Decision rule when introduced a single limitig factor:

Maximise the contribution per limiting factor (not per unit)

SEE EXAMPLE IN PPT LECTURE 8

Question 37

The internal/external dilemma
Sub-contract or do it in-house?
Make or Buy?

Answer 37

The core principle is to compare the variable cost of manufacturing with the cost of buying the item from an outside supplier.

Other considerations include reliability of supply, quality of manufacturing, future price changes, etc.

Question 38

budgets

Answer 38

In accounting, a budget is a plan for 12 months or less expressed in monetary terms (income & expenditure). It’s an allocation of scare resources.

A long-term plan leads on to a collection of short-term operational budgets.

Question 39

how is budgeting related to planning and control

Answer 39

Management accounting is about planning, decision making and control.

Planning - co-ordinated and comprehensive plan for the whole business

Control - budgets guides managers, and enables comparison between planned/actual

Question 40

limiting factors and budgeting

Answer 40

The first thing to establish is what the limiting factors are in the firm (probably the sales and production levels can’t be pushed above certain levels)

2 ways to estimate the sales / revenue (sales budget)

• Make a forecast based on the current economic conditions, goods sold by the company, and the actions taken by the competitors
• Internal forecast: ask the salesperson to estimate the sales in their own areas, then prepare the total estimation

Question 41

production budget

Answer 41

Sales – Opening Stock + Closing Stock* = Production​

*buffer stock

Production budget comes after sales budget

When preparing the production budget, the first thing to be settled is the level of closing stock

Question 42

cash budget

Answer 42

A cash budget is needed to inform us about:

• Whether there will be a deficiency / shortage
  
  • will the cash receipts are enough to cover all the cash payments
• When it will occur
• How much cash is needed to cover the shortage

The timing of all the cash receipts and cash payments are rarely at the same time

Question 43

master budget

Answer 43

links the various budgets together at the end

including

• sales budget
• production budget
• cash budget
• administration expense budget
• manufacturing overhead budget
• direct labour budget
• purchases budget

Question 44

Static vs. Flexible Budget

Answer 44

static budget - what was planned

flexible budget - adjusting for what actually happend

• taking the actual output (e.g. sales) and multiplying them with the rest of the budget elements

Question 45

developing a flexible budget

Answer 45

1. Identify the actual quantity of output
2. Calculate the flexible budget for revenues based on budgeted selling price and actual quantity of output
3. Calculate the flexible budget for costs based on budgeted variable cost per output unit, actual quantity of output, and budgeted fixed costs

Question 46

Benefits of Budgeting

Answer 46

• Strategic planning and implementation of plans (milestones)
• Framework for judging performance (comparing planned vs. actual)
• Motivating managers and employees (budget targets not too easy, not too difficult)
• Co-ordination and communication (everyone orientates according to the budget goals)

Question 47

Problems of Budgeting

Answer 47

Unrealistic targets de-motivate managers and employees (zero-sum challenge)

Participating in budgeting encourages a sense of belonging (motivation theory: more responsibility –> performance)

Problems arise when people see negative feedback as criticism of their work
Budget slack - managers tend to build in spare resources that allows lapse from actual performance (to get bonus)

(No cohesion within the group, individual performance will be affected

Politics - power struggle and rivalry actions when formulating the budgets)

Question 48

the steps to calculate the optimum production plan when a single limiting factor is present

Answer 48

1. identify the limiting factor (scarce resource)
2. calculate the contribution per unit for each product
3. calculate the contribution per unit of the limiting facotr for each product
4. rank the products according to step 3
5. allocate resources according to the ranking

alternatively

1. determine maximum sales
2. determine limiting factor
3. calculate the contribution per unit of output for each product
4. calculate the contribution per unit of the limiting facotr for each product
5. rank products
6. cacluclate production quantities

Question 49

what is the decision rule when a single limiting factor is present

Answer 49

If a company sells multiple products and there exists a single limiting factor, which products should be produced at what quantities to maximise profit?

Maximise the contribution per limiting factor, not simply by unit.

Question 50

other words for absorption costing

Answer 50

full costing

full absorption method

Question 51

define absorption costing

Answer 51

Absorption costing means that all the indirect costs (fixed overhead, supervisor salary, etc.) will be inlcluded in the cost of unit.

Hence the name, full costing.

Question 52

Reasons why managment would want to know the full cost of their products

Answer 52

1. More realistic pricing for the products, as all costs are included
2. More accurate profit calculation in the case of future sales, compared to variable costing
3. Required for preparing external financial reports and valuing the inventory
4. Avoids the seperation of costs into fixed and variable
5. Uncovers inefficiencies of utilising resources (under-absorption, over-absorption of overheads)
6. Aids managers identify cost centers
7. Helps calculate gross profit and net profit seperately in the income statemtent

Question 53

Problems associated with absorption costing

Answer 53

1. Difficulty in comparison and control of costs:

Absorption costing is dependent on level of output; so different unit costs are obtained for different levels of output.

An increase in the volume of output normally results in reduced unit cost and a reduction in output results in an increased cost per unit due to the existence of fixed expenses.

This makes comparison and control of cost difficult.

2. Not helpful in managerial decisions:

Absorption costing is not very helpful in taking managerial decisions such as selection of suitable product mix, whether to buy or manufacture, whether to accept the export order or not, choice of alternatives, the minimum price to be fixed during the depression, number of units to be sold to earn a desired profit etc.

3. Cost carried over because of fixed cost included in inventory valuation:

In absorption costing, a portion of fixed cost is carried forward to the next period because closing stock is valued at cost of production which is inclusive of fixed cost.

4. Fixed cost inclusion not justified:

Many accountants argue that fixed manufacturing, administration and selling and distribution overheads are period cost and do not produce future benefits and, therefore, should not be included in the cost of product.

5. Apportionment of fixed overheads by arbitrary, subjective methods:

The validity of product costs under this technique depends on correct apportionment of overhead costs.

But in practice many overhead costs are apportioned by using arbitrary methods which ultimately make the product costs inaccurate and unreliable.

6. Not helpful for preparation of flexible budgets:

In absorption costing no distinction is made between fixed and variable costs. It is not possible to prepare a flexible budget without making this distinction.

Question 54

Cost-Volume-Profit Analysis

Answer 54

Break-even analysis: it looks at the impact that varying levels of costs and volume have on operating profit.

fixed costs / contribution margin