Module 4, Chapter 13 - Management Accounting

Question 1

What is ‘management accounting’?

Answer 1

Management accounting is the sourcing and analysis of financial and non-financial information for a business’s
management to help them run the business effectively and efficiently.

Question 2

What should you consider when choosing a management accounting system?

Answer 2

When choosing a management accounting system, it is most effective to select one that integrates with the
business’s financial accounting system to increase the timeliness of management reports and eliminate redundant
work or duplication.

Question 3

How should management accounts be presented?

Answer 3

Like financial accounts, management accounts need to be presented in a format that is accurate; understandable;
allows comparisons; and is either timely or up-to-date.

Question 4

True or false? Unlike financial accounts, management accounts are not constrained by legislation on how to prepare or present them.

Answer 4

True!

Question 5

Who primarily uses management accounts, and how does this differ from financial statements?

Answer 5

Management accounts are primarily used by internal stakeholders and ‘look forwards’ to inform future strategy, as opposed to financial statements which ‘look backwards’ at an accounting period that has passed.

Question 6

What does cost accounting analyse?

Answer 6

Cost accounting looks at a business’s expenses to determine the fixed and variable costs associated with making
a product or providing a service sold by the business.

Question 7

List the 3 methods of cost accounting.

Answer 7

The various methods of this are:

1. Standard costing, which estimates the planned unit cost of the product, component or service for the period in question.
2. Normal costing, which is like standard costing except actual values are used for direct costs of a unit but not the indirect costs.
3. Actual costing, which goes one step further than normal costing and uses actual values to calculate both the direct and average indirect costs of a unit.

Question 8

What is activity-based costing?

Answer 8

Activity-based costing (ABC) is like actual costing but attempts to allocate indirect costs to products in a more
proportional way.

Question 9

What is meant by ‘life cycle costing’?

Answer 9

Life cycle costing looks at costs accumulated over the entire life of a product which may cover several accounting
periods.

Question 10

Define ‘target costing’.

Answer 10

Target costing is where the company plans its targets for price points, product cost and margins in advance, but
cancels the project if these cannot be attained.

Question 11

What does ‘KPIs’ stand for?

Answer 11

Key performance indicators (KPIs)

Question 12

Define ‘key performance indicators (KPIs)’.

Answer 12

Key performance indicators (KPIs) are values that can be used to evaluate how successful something has been
in meeting performance or business objectives.

Question 13

How are key performance indicators measured?

Answer 13

KPIs are often measured by comparing against one of four types of benchmark:

1. Internal benchmarks compare against another operating unit or function within the business.
2. Functional benchmarks compare and internal function against the best external practitioners of that function.
3. Generic benchmarking compares a process to a conceptually similar process or metric in another (often unrelated) business
   or industry.
4. Competitive benchmarks compare against direct competitors.

Question 14

What do balanced scorecards analyse?

Answer 14

Balanced scorecards analyse financial, customer, learning and growth (or innovation), and internal business
perspectives to help develop and monitor KPIs.

Question 15

Define ‘cost allocation’.

Answer 15

Cost allocation is where a business identifies and assigns indirect costs to a cost object (something the business
wants to separately measure costs for).

Question 16

Define ‘cost tracing’.

Answer 16

Cost tracing is when direct costs are allocated to cost objects.

Question 17

What is financial modelling?

Answer 17

Financial modelling involves creating a mathematical representation of a business’s financial relations to examine
how different economic situations or events would affect the business.

Question 18

Financial models can include a calculation of the weighted average cost of capital (WACC). What is meant by the ‘weighted average cost of capital’?

Answer 18

The weighted average cost of capital (WACC) is the minimum return to satisfy its creditors, owners and other providers of capital, with cost of equity defined as the rate of return the company pays to its equity investors.

Question 19

Define ‘cost of debt’.

Answer 19

Cost of debt is the interest rate on debt or the coupon rate on the company’s bonds.

Question 20

Financial models can also be based on scenario planning. What is scenario planning?

Answer 20

Scenario planning is where management considers a range of possibilities for what may happen in the future so they can be prepared should one of those possibilities occur.

Question 21

Financial models can also include business valuation of projects or investments to determine how attractive an
investment is by looking at present values, found by working backwards from an investment project’s future amount
to see how much that would equate to today. How are these typically assessed?

Answer 21

Typically, these are assessed using discounted cashflows and net present values.

Question 22

What does variance analysis compare?

Answer 22

Variance analysis compares the differences (called variances) between what was budgeted for and what the actual
value turned out to be.

Question 23

Provide 5 examples of variances found in variance analysis.

Answer 23

Examples of variances include:

1. Sales volume variance
2. Sales price variance
3. Direct material price variance
4. Direct material usage variance
5. Fixed/variable overhead variances

Question 24

Why is forecasting key?

Answer 24

Forecasting is key as it allows a business to plan and make decisions to ensure future profitability and cashflow.

Question 25

How might management forecast?

Answer 25

Management can utilise break-even analysis to calculate when a business will break-even and includes a margin of safety (the amount at which revenues should exceed the break-even point). They can also use cashflow forecasting to estimate the amount of money the business expects to come in and pay out and demand forecasting where historical data, trends, market research and any other relevant information are used to predict customer demand for a product or service.

Question 26

What is the equation for cost?

Answer 26

Cost = pre-determined standard price or rate used per unit × standard input

Question 27

What is the equation for direct costs?

Answer 27

Direct costs = actual price or rate of direct cost item per unit × actual input

Question 28

What is the equation for indirect costs?

Answer 28

Indirect costs = pre-determined or budgeted indirect cost per unit × actual input or quantity of overhead allocated

Question 29

Finish the sentence. The cost of all the resources used to produce an item of output or activity is also known as the ......

Answer 29

absorption cost.

Question 30

How is an ABC system set up?

Answer 30

An ABC system is set up in the following way: 1. Identify the main activities that create indirect costs (overheads). 2. Determine the cost drivers, which are the factors that lead to these costs arising (for example, if product packaging is an activity that creates costs, the number of products sold is likely to be the main cost driver). 3. Group the costs for these activities into ‘cost pools’ (sometimes referred to as cost centres). 4. Allocate overheads to products according to how much of each cost pool that each product uses.

Question 31

What are the pros and cons of the ABC system?

Answer 31

Pros: 1. It helps with cost control by controlling the factors that create costs. Cons: 2. ABC is costly, time-consuming and not as effective at controlling costs and profits as its proponents assert.

Question 32

What steps are involved in a target costing system?

Answer 32

The steps in a target costing system typically involve the following: 1. Conduct market research and develop a product that will satisfy potential customers. 2. Choose a target price that customers are likely to be prepared to pay for and calculate maximum cost to get a targeted gross or operating profit margin that the product must earn. 3. Design and create the product to meet the targeted cost. Design iterations may be needed to decide which design costs the least, as well as sourcing and purchasing components, and outsourcing to reduce costs if necessary. 4. Perform ongoing evaluation of all aspects of the costs during the product’s life cycle, aiming to reduce costs (possibly by reducing waste in the production process) for the rest of the project’s life.

Question 33

What is the equation for WACC?

Answer 33

WACC = (total debt × cost of debt) + (total equity × cost of equity) ---------------------------------------------------------------------------------- (total debt + total equity)

Question 34

Define 'budget'.

Answer 34

A budget is a plan of what management intends or wants to happen in the future regarding financial items such as sales (or income), costs, expenditure and profits.

Question 35

Define 'budgetary control'.

Answer 35

Budgetary control is the process of applying control over a business’s activities and resources by preparing a budget and then comparing the business’s actual performance against the targets set out in the budget.

Question 36

What is the equation for sales volume variance?

Answer 36

Sales volume variance = (actual units sold – budgeted units sold) × budget unit price

Question 37

Define 'sales volume variance'.

Answer 37

The sales volume variance is the difference between the actual and budgeted number of units sold, multiplied by the budgeted price per unit.

Question 38

Define 'direct material price variance'.

Answer 38

The direct material price variance is the difference between the actual cost of direct materials purchased or consumed, and the budgeted cost of the quantity purchased or consumed.

Question 39

Define 'direct material usage variance'.

Answer 39

The direct material usage variance is a variance used in a standard costing system and represents the difference between the actual and expected quantity of units that was used to make the business’s product.

Question 40

Define 'fixed overhead expenditure variance'.

Answer 40

The fixed overhead expenditure variance – sometimes called the fixed overhead spending variance – is the difference between the actual amount spent on fixed overheads and the budgeted amount.

Question 41

What is the 'variable overhead expenditure variance'?

Answer 41

The variable overhead expenditure variance looks at the expenditure per hour that was incurred on variable overheads (such as indirect labour costs or electricity costs where electricity usage is dependent on business activity rather than fixed and unchanging).

Question 42

What are the potential consequences of inadequate planning?

Answer 42

Poor financial management – and inadequate planning and analysis of internal information – causes many businesses to fail. For example, without demand forecasting, businesses risk making poor decisions about their products and target markets. Without cashflow forecasting, management cannot know where the business can expect to obtain cash from and without an idea of which level of output or sales the business expects to break even, a business will struggle to determine how to be profitable – and thus, how they can obtain the positive cashflow needed to maintain operations.