Semester 1 Exam Flashcards
Cost unit (definition)
a measurement of output, e.g., a ton of steel, a litre of paint, a kg of sugar.
Cost centre (definition)
a part of the business for which a measurement of cost is required.
What is the difference between direct costs and indirect costs?
Direct costs
- can be specifically and exclusively identified with a given cost object.
Indirect costs
- cannot be specifically and exclusively identified with a given cost object.
- are assigned to cost objects on the basis of cost allocations.
Cost allocation (definition)
- the process of assigning costs to cost objects that involve the use of surrogate, rather than direct measures.
The distinction between direct and indirect costs depends on …?
The distinction between direct and indirect costs depends on what is identified as the cost object.
Product costs (definition)
those that are identified with products and included in the stock (inventory) valuation
Cost object (definition)
any activity for which a separate measurement of cost is required (e.g. cost of making a product or providing a service)
Period costs (definition)
Not?
Treated as?
- not specifically related to the product and are not included in the inventory valuation.
- They are treated as expenses in the period in which they are incurred
Figure 2.2 - Treatment of period and product costs
- Manufacturing cost is a product cost
- Non-manufacturing costs are period costs
When a product cost is unsold it is recorded as an asset in the balance sheet but becomes an expense when the product is sold in the profit and loss account
A period cost is recorded as an expense in the profit and loss account in the current accounting period
Why is cost behaviour important?
- to predict costs and revenues at different activity levels for many decisions.
Variable costs (definition)
Costs that vary in direct proportion with activity.
Fixed costs (definition)
Costs that remain constant over wide range of activity
Semi-fixed costs (definition)
Costs that are fixed within specified activity levels, but they eventually increase or decrease by some constant amount at critical activity levels
Semi-variable costs (definition)
Costs that include both a fixed and a variable component (e.g. telephone charges)
Variables Costs diagrams
Fixed Costs diagrams
Step-fixed costs diagram
Sunk costs (definition)
Opportunity costs (definition)
Incremental cost (definition)
Marginal costs (definition)
Sunk costs
- costs that have been incurred and cannot be changed by any decision in the future
Opportunity costs
- Costs that measure the opportunity that is sacrificed when the choice of one course of action requires that an alternative course of action is given up
Incremental cost
- the difference between costs of alternative courses of action
Marginal costs
- the cost of one extra unit of output
A cost and management accounting system should generate information for meeting the following requirements: (4)
- Inventory valuation for internal and external profit measurement.
- Provide relevant information to help managers make better decisions.
- Provide information for planning, control, and performance measurement.
A database should be maintained, with costs appropriately coded and classified so that relevant information can be extracted to meet each of the above requirements.
There are three main costs that businesses incur:
- Materials
- Labour
- Expenses
Correctly identifying these, working out the right amount of cost and treating them correctly is critical for all
businesses
There are two reasons why knowing the cost of inventory is vital:
- Value of goods ‘issued’
- Value of goods held
Material costs – valuation
- Actual cost
- The First In First out method FIFO (what is it?)
- The Last in First out method LIFO (what is it?)
- The Weighted Average Cost method WAS (what is it?)
FIFO:
- assumes that the oldest items are used first, so that inventory is VALUED at the most recent prices
LIFO:
- assumes that the latest items are used first, so that inventory is valued at the oldest prices
- (this method is not allowed by IAS Inventories 2)
WAS:
- assumes no pattern of the order in which items are used, so all are VALUED at the same value, which is the average one.
Labour costs
This can be one of the most expensive elements within the cost of unit, especially for service industries.
Labour costs can be worked out per hour or per unit – read the question carefully.
For example, a question could state that each unit has a labour cost of £20. Or, the question could state that each unit takes 2 hours to make and labour costs are £10 per hour
What factors can affect labour costs? (5)
- Wages rates paid by other businesses
- National / living wages imposed by Government
- Government incentives
- Local employment conditions – availability of unskilled and / or skilled workforce
- Employer costs above gross salaries (about 20%)
What is the difference between relevant/avoidable costs & revenues and irrelevant/unavoidable costs & revenues
Relevant/ Avoidable costs and revenues:
- are changed by a future decision
Irrelevant/ unavoidable costs and revenues:
- are not changed by a future decision
Costs incurred in a manufacturing business diagram
Prime cost (definition)
the direct cost of a commodity in terms of the materials and labour involved in its production, excluding fixed costs
Eg. Direct materials + Direct labour = Prime cost
Examples of production overheads (5) and non-production overheads (3)?
Production overheads:
- Rent and rates
- Factory power
- Factory heat and light
- Factory expenses
- Depreciation of plant
Non-production overheads:
- Selling and distribution
- Advertising
- Admin expenses (salaries of office staff and office expenses)
Features of manufacturing, merchandising and service organisations
What type of materials are held by businesses will depend on the type of business
Manufacturing:
- Raw materials
- Work in progress
- Finished goods
Merchandising/retail:
- Tangible products for resale i.e. finished goods inventory
Service organisations:
- Provide a service that cannot be stored, but may have work in progress
A cost collection system normally accounts for costs in two broad stages:
- Accumulates costs by classifying them into certain categories (e.g. labour, materials and
overheads); - Assigns costs to cost objects.
Type of expenses diagram
Graph of fixed and variable costs
Separating Fixed and Variable costs
It is important to be able to identify the amount of fixed and variable costs. Sometimes the information is given to you but sometimes it is not.
Where total costs are known for two levels of output, the amounts of fixed and variable costs can be worked out using the ‘high/low’ method
Separating Fixed and Variable costs
Where total costs are known for two levels of output, the amounts of fixed and variable costs can be worked out using the ‘high/low’ method.
Example of High / Low method:
- At output of 1,000 units, total costs are £7,000
- At output of 2,000 units, total costs are £9,000.
What are the fixed costs?
What is the variable cost per unit?
(Note that this only works when the variable cost per unit is constant)
Variable cost per unit - £2000/1000 = £2.00
For 1,000 units:
Total cost = £7,000
Variable cost = 1,000 x £2 = 2,000
Fixed cost = 5,000
Costing systems
Going to consider the situation in manufacturing where the cost
object is a product
What are the 2 types of costing systems?
Job-order costing:
- Assume that there are individual products or batches of products
- The products or batches incur different costs so that there is a need to keep track of each product or batch
Process-order costing:
- Used in industries where masses of the same product are produced in a flow process
Cost assignment methods
What happens to direct costs vs indirect costs?
- Direct costs - Direct tracing to - Cost Objects
- Indirect costs - go under cost allocations to either: - cause and effect allocations (the more we purchase, the more the cost will increase) or - arbitrary allocations (like direct labour hours or machine hours)
Overhead absorption
The number of units produced can be used to work out the
overhead per unit.
But this only works if there are static units produced which
are uniform.
In most manufacturing environments, that is not the case, so
another way to allocate overheads is either: (2)
- Firstly, the overhead absorption rate (OAR) needs to be
found. - Then this can be applied to the units.
Arbitrary Allocations
- Based on direct labour hours or
- Based on machine hours
OAR – Plant wide rate/blanket overhead rate
This is the ___________ of all methods and applies overheads direct to a production department.
This method is only valid for more _______ businesses who do not
have _________ departments or _________ ________.
What are advantages (2) and disadvantages (3) of this method?
This is the simplest of all methods and applies overheads direct to a production department.
This method is only valid for more simple businesses who do not
have complex departments or multiple products.
Advantages:
- Simple to calculate,
- low cost to implement
Disadvantages:
- Arbitrary,
- simplistic,
- inaccurate
OAR – 2 stage allocation process
This is a more complex method of allocating overheads.
Applies to both traditional methods and ABC systems
Traditional costing system: (4)
Stage 1
- Assign all manufacturing overheads to production and
service centres - Reallocate the costs assigned to service cost centres to
production centres
Stage 2
- Compute separate overhead rates for each production
cost centre - Assign cost centre overheads to cost objects
What might be used as cost centres in a traditional costing system?
What might be used as an activity cost centre in an activity-based costing system?
What might be used as cost centres in a traditional costing system?
- Mattress line – border added
- Building section – where fillings are added, may include tufting and tape edging.
- Delivery
What might be used as an activity cost centre in an activity-based costing system?
- Steel frame
- Adding border, hand stitching
- Building bed – adding fillings
- Tufting
- Tape Edging
OAR – ABC (Activity Based Costing)
This is a much more complex method of allocating overheads.
It identifies activities within a business and assigns costs based on those activities. (3)
Stage 1
- Activities are divided into activity cost centres.
- The total cost associated with each activity is allocated to
the relevant activity cost centre.
Stage 2
- The total cost in each cost centre is then charged to output using a cost driver.
Methods of costing (2)
- Direct costing = Direct cost tracing only assigns direct manufacturing costs, not fixed manufacturing costs, to products or services
- Overhead absorption costing = involves allocating production overheads to
cost objects:- Plant wide / Blanket Overhead Absorption Rate – OAR based on machine hours and labour hours – different overhead allocation to the 2 jobs. - 2 – stage allocation process for both traditional absorption costing systems and Activity Based Costing systems
Under or Over Absorption of overheads in absorption costing
What is the issue? (3)
- The OAR is based on budgeted overheads and budgeted activity e.g. number of labour hours.
- At the end of the period, we know what the actual activity was and apply the OAR to the actual activity.
- The difference between the absorbed overheads and the actual overheads is a period cost adjustment in the financial accounts. The period may be a month, quarter, or year for example.
OAR Issues: Budgeted Overheads
There are problems in using actual overheads:
There is a delay in finding product costs, so essential information for decision making is not available until the end of the accounting period
- Monthly profit calculations
- Inventory valuation
- Basis for setting prices
- If this is done monthly, then fluctuations in OAR will occur
Seasonality – changes in activity, customers want to know the price
- Need to use an estimated normal product cost based on average long-run activity rather than an actual product cost
- Establish a budgeted overhead rate based on annual estimated overhead expenditure and activity
Under and over recovery of
overheads
It is very unlikely that the actual overheads and / or production levels are the same as the budgeted overheads and production levels used to calculate the OAR
Therefore, overheads will be under or over recovered
- Under or over recovery of overhead due to the activity level being different to the budgeted activity level is called a ______ ___________ __________ ____________
- Under or over recovery of overhead due to the actual fixed overhead expenditure being different to the budget is called a _______ __________ _______________ __________
- Financial accounting regulations require that under or over recovery of overheads is treated as a ______ _____ ____________
It is very unlikely that the actual overheads and / or production levels are the same as the budgeted overheads and production levels used to calculate the OAR
Therefore, overheads will be under or over recovered
- Under or over recovery of overhead due to the activity level being different to the budgeted activity level is called a FIXED OVERHEAD VOLUME VARIANCE
- Under or over recovery of overhead due to the actual fixed overhead expenditure being different to the budget is called a FIXED OVERHEAD EXPENDITURE VARIANCE
- Financial accounting regulations require that under or over recovery of overheads is treated as a period cost adjustment
Non-Manufacturing overheads
Financial accounting regulations specify that only ____________ ________ should be allocated to products.
Non-manufacturing costs should be assigned to products for __________-_________ (particularly cost-plus pricing).
Some non-manufacturing costs may be a ________ _____, of the product
Examples: (3)
Generally, aim to select an allocation base/_____ ______ that corresponds to the ___________ of non-manufacturing overhead
For many non-manufacturing overheads, it may be hard to determine an appropriate basis for allocation. A widely used approach is to allocate based on the product’s production costs
Financial accounting regulations specify that only manufacturing overheads should be allocated to products.
Non-manufacturing costs should be assigned to products for decision-making (particularly cost-plus pricing).
Some non-manufacturing costs may be a direct cost, of the product
Examples:
- Delivery costs,
- Sales commission,
- Travel costs
Generally, aim to select an allocation base/cost driver that corresponds to the causation of non-manufacturing overhead
For many non-manufacturing overheads, it may be hard to determine an appropriate basis for allocation. A widely used approach is to allocate based on the product’s production costs
Aims of costing
One of the main aims of costing is to establish the cost of one cost unit of work, whatever the work is.
Examples of a cost unit could be:
- Manufacturing: per item made
- Chemical business: kilogram of chemical
- Transport company: passenger mile
- Nursing home: resident day
- University: student
Methods of costing – job costing
- Job costing is used where each job can be separately identified from other jobs and costs are charged to that specific job.
- All direct costs are easy to identify, and the overheads are added on a predetermined basis, such as labour hours or machine hours.
- The overheads are allocated on a predetermined OAR basis.
Methods of costing – continuous work – Process Costing
- Used where masses of similar products or services are produced in a flow process.
- In the manufacturing industry, this could be making food. In this case, process costing is the method used.
- In this situation, the total costs of the process for a given period of time are collected together and averaged per unit of output for that period.
Marginal and absorption costing
These two costing systems are often used in cost accounting, but for different purposes:
Marginal (variable) costing – ?
Absorption costing – ?
The use of each system is dependent on the informational needs of the business:
- ‘can we afford to sell 1,000 units of our product at a discount of 20%?’ – this is _________ costing
- ‘what profit have we made this year?’ – __________ costing
Marginal and absorption costing
These two costing systems are often used in cost accounting, but for different purposes:
- Marginal (variable) costing – helps with short-term decision making.
- Absorption costing – is used to calculate inventory valuations and profit calculations.
The use of each system is dependent on the informational needs of the business:
- ‘can we afford to sell 1,000 units of our product at a discount of 20%?’ – this is marginal costing
- ‘what profit have we made this year?’ – absorption costing
Marginal costing (Variable Costing)
What is marginal costing?
What are costs classified by and what is the effect of this?
What is the marginal cost of a unit usually but not always?
What does knowing this cost allow?
The contribution is:…?
Marginal costing is effectively the cost of producing one extra unit of output.
Cost are classified by their behaviour (variable, fixed) so that it is easy to work out the cost of producing one extra unit.
The marginal cost of a unit is usually (but not always) the total of the variable costs of producing a unit of output.
Knowing this cost allows managers to consider the contribution to the business by each unit.
The contribution is: selling price less variable cost.
Marginal costing (4,2) vs Absorption costing (3,2)
Marginal costing
Variable costs:
- Variable direct materials
- Variable direct labour
- Variable direct expenses
- Variable overheads
Fixed costs:
- Fixed direct expenses
- Fixed overheads
Absorption costing
Direct costs:
- Direct materials
- Direct labour
- Direct expenses
Indirect costs:
- Variable overheads
- Fixed overheads
Marginal costing vs Absorption costing
Main use?
How does it work?
Main focus?
Usefulness?
Limitations?
Marginal costing
Main use?
- To help with short term decision
making
How does it work?
- Costs are classified as either variable or fixed
- Contribution towards fixed costs
is calculated as selling price less
variable costs
Main focus?
- Marginal cost
- Contribution
Usefulness?
- Concept of contribution is easy to understand
- Useful for short term decision
making
Limitations?
- Costs must be identified as either fixed or variable
- All overheads must be recovered, or a loss will be made
- Not acceptable under IAS 2
Inventories
Absorption costing
Main use?
- To calculate profit
- To calculate inventory
How does it work?
- Overheads are charged to output through an overhead absorption rate, often based
on labour hours or machine hours
Main focus?
- All production overheads charged to output
- Calculating profit
- Calculating inventory valuation
Usefulness?
- Acceptable under IAS 2
- Appropriate for traditional industries where overheads are charged to output based on direct labour or machine hours
Limitations?
- Not as useful for short term decision making
Marginal costing – Contribution
- Once the contribution per unit has been established, the total contribution for the period can be established.
- The fixed costs are then ___________ , to arrive at the _________ for the period.
- Once the contribution per unit has been established, the total contribution for the period can be established.
- The fixed costs are then deducted, to arrive at the profit for the period.
Advantages to a marginal costing statement (4,5)
- Contribution per unit is clearly identified
- Effect on changes to costs easily identified
- Effect on changes to selling price easily identified
- Helps with short-term decision making such as:
- Break even analysis - Margin of safety - Target profit - Contribution sales ratio - Limiting factors
Absorption costing
This method answers the question … ‘What does it cost to make one unit of output?’
The absorption cost of a unit of output is made up of:
This method answers the question … ‘What does it cost to make one unit of output?’
- Direct materials
- Direct labour
- Direct expenses
- Production overheads (variable and fixed)
- Absorption cost
Absorption costing vs variable costing diagram
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Marginal and absorption costing
What do they treat differently and what is the effect of this therefore?
Why is this because?
What does IAS 2 Inventories do?
What does absorption costing have to be used for?
Marginal and absorption costing treat fixed overheads differently; therefore, the two methods will produce different levels of profit when there is closing inventory.
This is because:
- under marginal costing the closing inventory is valued at variable production cost.
- Whereas under absorption costing, there is a share of fixed production costs in closing inventory.
IAS 2 Inventories – provides guidance for determining the cost of inventories and the subsequent recognition of the cost as an expense
Absorption costing has to be used for external reporting
Budgets serve several purposes (6)
- Planning annual operations
- Coordinating activities
- Communicating plans
- Motivating managers
- Controlling activities
- Evaluating performance
Developing budgets
Different organisations will produce budgets in different ways: (4)
- Participatory – managers at all levels are involved.
- Zero based budgeting – justify every figure in the budget (can be time-consuming)
- Incremental budgeting – start with prior period and adjust the figure (with percentages) (could add budgetary slack and become inaccurate)
- Rolling budgets – always have a budget for the next time period e.g. next 12 months
Stages in the Budgeting Process
- Communicate details of budget policy and guidelines to those people responsible for preparing the budget.
- Determine the factor that restricts output.
- Preparation of the sales budget.
- Initial preparation of budgets.
- Negotiation of budgets with higher management.
- Coordination and review of budgets.
- Final acceptance of budgets.
- Ongoing review of the budgets.
Types of budgets
- Sales
- Production including inventory levels
- Materials usage
- Materials purchase
- Labour utilisation
- Production overhead budget
- Functional budgets - eg. finance, admin
- Capital expenditure
- Cash flow
- Master, budgeted profit or loss and balance sheet
Budgetary control
We have already looked at why budgets are produced – the main reason is for _________ ___________.
So, once the budgets are completed, what happens?
The difference between the budget figures and the actual figures can be either a favourable variance or an adverse variance. (what do these mean)
We have already looked at why budgets are produced – the main reason is for control purposes.
They are compared to actual figures over the period so that those responsible can understand how they are performing.
Favourable = sales price increase = increase net profit
Adverse = cost of materials increase = decrease net profit
Budgetary control
There can be a variety of reasons for variances:
- Poorly set budget
- Inaccurate cost behaviour assumptions
- Change in suppliers
- Government changes – e.g. living wage
- International changes – e.g. price of oil
- Bad management
- High wastage
Budgetary control
So, once the budgets are completed, what happens? (2)
So, once the budgets are completed, what happens?
- They are compared to actual figures over the period so that those responsible can understand how they are performing.
- The difference between the budget figures and the actual figures can be either a favourable variance or an adverse variance.
Favourable or Adverse variance (2)
From the perspective of Net Profit
- Favourable
- Adverse (unfavourable)
What is a standard cost?
What is a budget? What is standard?
How do we establish standard cost?
- Standard costs are target costs for each operation that can be built up to produce a product standard cost.
- A budget relates to the cost for the total activity, whereas standard relates to a cost per unit of activity
Establishing standard costs: Two approaches:
- past historical records; Labour and Material usage
- engineering studies
What does Standard Hours Produced mean?
Standard (target) times: X = 5 hours, Y = 2 hours, Z = 3 hours
Output = 100 units of X, 200 units of Y, 300 units of Z
What is the Standard Hours Produced?
Standard Hours Produced
- Used to measure output where more than one product is produced.
Example
Standard (target) times: X = 5 hours, Y = 2 hours, Z = 3 hours
Output = 100 units of X, 200 units of Y, 300 units of Z
What is the Standard Hours Produced?
(100 × 5 hours) + (200 × 2 hours) + (300 × 3 hours) = 1,800 hours
- If actual DLH are less than 1,800 the department will be efficient,
- If hours exceed 1,800 the department will be inefficient.
Note: Different activity measures and other factors (besides activity) will influence cost behaviour.
Standard Hours Produced
Fixed and flexed budgets
What’s the difference?
- Once the flexed budget is produced…?
Fixed budgets remain the same irrespective of the level of activity.
A flexed budget changes with the level of activity. This is commonly used inmanufacturing businesses because if the level of activity changes, then every comparison between budget and actual will have variances – but this variance could be mainly due to activity levels being different.
- Once the flexed budget is produced, the variance analysis can be carriedout.
Note we are looking at variance analysis with a variable costing system
Sales volume variance
What is it?
A reduction in sales volume would lead to?
An increase in sales volume would lead to?
This variance handles the change from original budget to flexed budget.
As the only difference between these budgets is the level of activity, this variance considersthat in one figure.
- A reduction in sales volume would lead to an adverse variance.
- An Increase in sales volume would lead to a favourable variance
Direct labour efficiency variance
What is this?
- A reduction in the number of hours taken would lead to …?
- An increase in the number of hours taken would lead to …?
This variance compares the number of hours budgeted against the actual number of hours taken.
This difference is then shown at the budgeted hourly rate.
- A reduction in the number of hours taken would lead to a favourable variance.
- An increase in the number of hours taken would lead to an adverse variance
Direct labour rate variance
What is this
- A reduction in the cost per hour would lead to …?
- An increase in the cost per hour would lead to …?
This variance compares the budgeted cost per hour with the actual cost per hour.
- A reduction in the cost per hour would lead to a favourable variance.
- An increase in the cost per hour would lead to an adverse variance.
Direct material usage variance
What is this?
- A reduction in the cost per hour would lead to …?
- An increase in the cost per hour would lead to …?
This variance compares the quantity of materials budgeted against the actual
quantity used.
This difference is then shown at the budgeted material cost
- A reduction in the quantity of materials usedwould lead to a favourable variance.
- An increase in the quantity of materials used would lead to an adverse variance.
Materials price variance
What is this?
- A reduction in the cost per hour would lead to …?
- An increase in the cost per hour would lead to …?
This variance compares the budgeted cost per unit of material with the actual cost per unit of material.
- A reduction in the cost per unit would lead to a favourable variance.
- An increase in the cost per unit would lead to an adverse variance
Break Even Analysis
- In Marginal costing costs are classified as either ________ or ____________.
- Companies need to know how many units need to be sold to cover all the fixed costs
What is the formula for contribution?
What is the formula for profit?
- In Marginal costing costs are classified as either fixed or variable.
- Companies need to know how many units need to be sold to cover all the fixed costs
Contribution per unit (CPU) = Selling price – variable cost
Profit = Contribution per unit x number of units sold) – Fixed costs
Break even analysis or CVP Analysis
What does CVP stand for?
What is BEP? (2)
What is the formula for BEP?
C = cost of the unit
V = volume of the unit
P = profit made
Breakeven Point (BEP) is the point at which neither a profit nor a loss is made
BEP is the number of units that need to be sold to cover the fixed costs
- BEP = Fixed costs / contribution per unit
Margin of safety
This is…?
It can be expressed as:
This is the amount by which the sales exceed the BEP.
It can be expressed as:
- Number of units
- Sales revenue amount
- Percentage: current output – break even output/current output x 100 = % margin of safety
Contribution sales ratio
What is it?
How is it calculated?
What can we use it for?
What is the formula for Break even sales revenue
Contribution expressed as a % of the selling price.
Contribution sales ratio % = Contribution / Selling price
We can use the CS ratio to find the sales revenue at which the company breaks even, or the sales revenue to give a target profit
Break even sales revenue = Fixed cost / CS ratio
Target profit
What is it for?
What is the formula?
Some companies will want (need) to make a certain amount of profit, so this can be inbuilt into the
breakeven analysis to ensure that the right amount of units are produced.
Fixed costs + target profit / CPU = number of units
When is break even analysis used? (5)
- Before starting a new business
- When making changes
- To measure profits and losses
- To answer ‘what if’ questions
- To evaluate alternatives
Limitations of break-even analysis
- Assumes all output is sold
- All costs and revenues can be represented by a straight line
- Fixed costs remain fixed – and not stepped
-There is a direct relationship between revenue and cost- in some case the more that is produced the cheaper it is per unit - Only applies to the relevant range
Limiting factors
What are limiting factors?
Examples (5)
When they are none, what should the business focus on?
What if there are?
Limiting factors are those aspects of a business which affect output.
- Lack of availability of materials
- Lack of availability of labour (especially skilled)
- Lack of availability of capital resources (machinery)
- Finance
- Volume of units that can be sold
Where there are no limiting factors, company should concentrate on the product
making the highest CS ratio
However, when there are limiting factors, production should be based on the highest
contribution from each unit of the limiting factor
Reconciliation statements
What are they used to show?
What is more complex when using standard costing?
Reconciliation statements can be used to show the differences between the standard cost of production and the actual cost.
Computing the differences for variable and fixed costs is more complex when using standard costing.
Fixed costs – marginal costing
What are ignored under marginal costing?
What is the overhead variance?
Example?
Under marginal (variable) costing – fixed costs are ignored.
Therefore, where there is a difference between projected and actual fixed costs, the overhead variance is simply the difference between the two figures.
* i.e. Fixed Overhead Expenditure Variance
Fixed costs – absorption costing
What is one advantage?
What is all cost estimates are reasonably accurate?
What if this doesn’t occur?
Under absorption costing – one advantage of standard absorption costing is that the cost for a unit will be a ‘full’ cost and will incorporate a portion of all the costs of production.
- If the actual production level is close to the projected level, and all cost estimates are reasonably accurate, then standard cost will be close to the actual full cost
However if this does not occur, fixed overhead variances will need to take into account:
- Production volumes and
- Overhead costs
Fixed costs – absorption costing
As we know, the OAR is worked out before production is underway. The OAR is worked out so that…
- So, what happens if:
- Fixed overheads change?
- The measure (labour hours, machine hours) change?
- Volume of units produced / sold change?
As we know, the OAR is worked out before production is underway. The OAR is worked out so that, based on a measure, the total fixed overheads are covered by the volume of units expected to be made.
- So, what happens if:
- Fixed overheads change?
- The measure (labour hours, machine hours) change?
- Volume of units produced / sold change?
These changes will provide two fixed overhead variances:
- Fixed overhead expenditure variance – this is the difference in the actual amount spent on fixed overheads.
- Fixed overhead volume variance – this is the difference in the actual volume of output.
The combination of these two variances will result in an overall total fixed overhead variance.
Fixed costs – the absorption base
Remember that fixed overheads can be apportioned uses a variety of measures. The three main ones are:
How the OAR has been worked out will change the way that the fixed overhead variances are worked out.
Remember that fixed overheads can be apportioned uses a variety of measures. The three main ones are:
- actual units,
- labour hours
- machine hours.
How the OAR has been worked out will change the waythat the fixed overhead variances are worked out.
Fixed costs – sub-variances
What are the sub-divisions and what are their formulas?
For deeper analysis, the volume variance can also be sub-divided into efficiency variance and capacity variance.
Volume Capacity variance
- this compares the time the budgeted production should have taken with the actual hours worked.
- (actual hours taken – budgeted hours) x OAR
Volume Efficiency variance
- this compares the time the actual production should have taken with the time it actually took to make.
- (std hours for output – actual hours for output) x OAR
The American Accounting Association define accounting as:
the process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by users of the information
The users of accounting information can be divided into two categories:
- internal users within the organization (management accounting).
- external parties outside the organization (financial accounting).
(Drury, 2020)
What’s the difference between Financial Accounting (3) and Management Accounting (3)?
- Financial Accounting (not Finance):
- provide information to those external to the organisation. Shareholders would be a typical user of this information.
- mainly uses historical data and is essentially backward-looking.
- very heavily regulated and controlled by parties external to the organisation, such as the IASB.
- Financial accounting reports describe the whole of the business
- Management Accounting:
- seeks to provide information which is for those internal to the organisation.
- Managers would be a typical user of this information.
- mainly concerned with future planning and is very forward-looking. (Key term: decision making)
- not regulated at all. (Although there are guidelines)
- Financial accounting reports describe the whole of the business
The decision-making, planning and control process. (diagram)
(Drury, 2020)
Functions of management accounting
A cost and management accounting system should generate information to meet the following: (3)
- allocate costs between products sold, and fully and partly completed products that are unsold.
- provide relevant information to help managers make better decisions.
- provide information for planning, control, performance measurement and continuous improvement
(Drury, 2020)
Cost object (definition)
Any activity or output for which a separate measurement of costs is desired.
2 Stages:
Classify costs into ___________ e.g., by type of ________ , by cost behaviour, then assign costs to cost objects.
Choosing an appropriate cost unit is _________ within a business as it is to this object that ___ _____ are ___________.
Classify costs into categories e.g., by type of expense, by cost behaviour, then assign costs to cost objects.
Choosing an appropriate cost unit is critical within a business as it is to this object that all costs are allocated.
Stakeholders and the information they require
- Managers
- Shareholders
- Employees
- Creditors and the providers of loan capital
- Government agencies such as the Central Statistical Office
- Managers require information that will assist them in their decision-making and control activities; for example, information is needed on the estimated selling prices, costs, demand, competitive position and profitability of various products/services that are provided by the organization.
- Shareholders require information on the value of their investment and the income that is derived from their shareholding. Likewise, potential investors are interested in their potential returns.
- Employees require information on the ability of the firm to meet wage demands and avoid redundancies, their potential for continued employment.
- Creditors and the providers of loan capital require information on a firm’s ability to meet its financial obligations.
- Government agencies such as the Central Statistical Office collect accounting information and require such information as the details of sales activity, profits, investments, stocks (i.e. inventories), dividends paid, the proportion of profits absorbed by taxation and so on. In addition, government taxation authorities require information on the amount of profits that are subject to taxation. All this information is important for determining policies to manage the economy.
