F2- Management Accounting Part B Class

F2 ACCA Phi Thanh Tu

- BPP text and revision kit- Lecture note- Slides and exercise sheets - ACCA student website

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F2- Management accounting


Syllabus

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Cost card- – Cost statement of total cost of 1 unit of product

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Direct labour

Direct material

Direct expense

PRIME COST Production cost

Variable production overheads

MARGINAL PRODUCTION COST

Fixed production overheads

TOTAL PRODUCTION COST

Non production overheads

Admin cost

Selling cost Non-production cost

Distribution cost

Finance cost

TOTAL COST

Profit (marked up 10%)

Selling price

30

20

10

60

10

70

30

100

10

10

10

20

150

15

165


Part BCost accounting techniques

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I. Material costII. Labor costIII. OverheadsIV. Marginal and absorption costingV. Job, batch and service costingVI. Process costingVII. Alternative costing techniques


Part B-1- Material cost

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I. Ordering and accounting for inventoryII. Order quantities and reorder levels


I. Ordering and accounting for inventory

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1. Inventory2. Accounting procedures for ordering and

issuing inventory3. Recording of Inventory4. Physical inventory and book inventory


1. Inventory

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Types of inventory: RM, FGs, WIP, consumables/tools & supplies

Control over inventory: OrderingPurchasingReceiptStorageIssue Maintenance of Inventory at the most

appropriate level


2. Accounting procedures for ordering and issuing inventory

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Ordering

•Departments requires new material by sending Purchase request to Purchasing department

•< authorized purchase request>

Purchase order

•Purchasing department send PO to:•Suppliers•Accounti

ng department

•Good receiving departments (stores)

Goods delivery

•Suppliers receive Pos to prepare to deliver goods

•Suppliers deliver the Goods with Delivery Notes

•Goods receiving department will check the Goods received with Delivery notes and PO. Good receipt Notes are updated and then the copies are sent to Purchasing and accounting departments

•Purchasing department will monitor GRNs with PO to supervise the PO status

Invoices

•Invoice sent from suppliers directly to accounting department for payment

•Invoice, GRN and PO are matched (3-way match) to ensure proper quantity and price


2. Accounting procedures for ordering and issuing inventory

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Inventory issuing:

Material requisition

notes• Authorize

store keepers to release RM

• To update store records

Material returned notes

• Record unused RM returned to stores


Material transfer notes

• Transfer materials from one department to another



3. Recording for inventory

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Debit Inventory a/c: Purchase, Return to storesCredit Inventory a/c: Issuing, Return to suppliers

Inventory valuation: FIFO, WAC, LIFOFIFO: assumes that materials are issued to out of

stock in the order in which they were delivered into inventory

WAC: values all items of inventory and issues at an average price. The average price is calculated after each receipt of goods.

LIFO: assumes that materials are issued out of inventory in the reverse order to which they were delivered into inventory



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The following transactions occur during May 2008 related to item A: Opening balance + Purchasing = Issuing +Closing

Quantity unit cost Total cost

units £ £Opening balance, 1 May 100 2.00 200

Receipts, 7 May 400 2.10 840

Issues, 11 May 200Receipts, 16 May 300 2.12 636

Issues, 21 May 400Closing balance, 31 May 200

Total 1676



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FIFO method- the cost of issues and closing inventory value would be:


units $ $

Issues, 11 May 200100 at $2

100 at $2.1 $410

Issues, 21 May 400300 at $2.1100 at $2.12 $842

Closing balance, 31 May 200 200 at $2.12 $424

1676



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LIFO method- the cost of issues and closing inventory value would be:


units £ £

Issues, 11 May200 200 at $2.1 $420

Issues, 21 May400300 at $2.12100 at $2.1 $846

Closing balance, 31 May 200

100 at $2.1100 at $2.0 $410

1676



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WAC method- the cost of issues and closing inventory value would be:

Quantity unit cost

Total cost

Inventory balance

Inventory balance

units $ $ units $

Issues, 11 May 200

$1040/500= $2.08 416 300 624

Issues, 21 May 400

$(624+636)/600= $2.1 840 200 420

Closing balance, 31

May 200 $2.1 420 200 420

1676



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Exercise Exercise\FIFO WAC LIFO.docx


4. Physical inventory and book inventory

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4.1. Perpetual inventory vs. Periodic inventory

Perpetual inventory: Inventory is continuously updated. It is the recording as they occur of receipts, issues and the resulting balances of individual items of inventory in ether quantity or quantity and valueInventory records are updated using stores ledger cards and bin cards, which show the records of receipts, issues and balances of the quantity (bin cards) and value (stored ledger cards).

Periodic inventory: Inventory is counted at the end of period and then recorded accordingly. It records inventory purchase or sale in "Purchases/sales" account.

“Sales, Purchases" accounts are updated continuously Inventory subsidiary ledger is not updated after each purchase or sale of inventory. Inventory quantities are updated on a periodic basis.



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4.2. Stock taking

Definition: Stocktaking process involves: checking the physical quantity of inventory held on a certain date and check this balance against the balances on the store ledger (record) cards or bin cards.

Method:Period stocktaking: count every item of inventory at the same date (usually at the balance sheet date)Continuous stock taking: count selected items of inventory on a rotating basis. Each item is checked at least once a year with a valuable items being checked more frequently



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4.2. Stock taking

Physical count

•Stock count is carried out

Inventory discrepancies

•It is the difference between book inventory vs. physical inventory

•<bin cards/ store ledger cards vs. inventory count>

Adjust book inventory

•Investigate the inventory discrepancies

•Adjust store ledger cards/bin cards to reflect the true physical inventory count

Slow

moving and obsolete items

•Identifying “slow moving” and obsolete item to bring attention to management•Slow

moving: items take long time to use up

•Obsolete: out of date, no longer required

•Management solutions on the slow moving and obsolete items



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4.3. Control procedures to minimize discrepancies and loss of inventory

Problems control proceduresOrdering goods at inflated prices(higher/unreasonable)

use standard costs for Purchase quotation (for special items)

Fictitious purchase

Segregation of ordering and purchasingPhysical controls over materials receipt, usage and inventory

Shortage on receiptsCheck in all goods inwards at gatesDelivery signature

Losses from inventoryRegular stock takingPhysical security procedures

Writing off obsolete or damaged inventory which is good

control of responsible officers over all written-offs

Losses after issue to production department

Record all issuesStandard usage allowance


II. Order quantities and reorder level

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1. Costs of holding inventory2. Economic order quantity3. Gradual replenishment of inventory4. Inventory control levels


1. Cost of holding inventory

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1.1. Reasons of holding inventory Sufficient goods available to meet expected

demand Prevent hold-ups in the production process Meet future shortages Take advantage of bulk purchases discounts



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1.2. Holding costsCosts associated with holding inventory are known as

holding costsHolding cost included:

Interest on capital tied up in inventoryCost of storage spaceCost of insuranceRisk of obsolesceDeterioration: disposal cost for unusable inventory

Holding cost can be distinguished between fixed holding costs and variable holding costs

It is often stated as being valued at a certain percentage of the average inventory held



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1.3. Ordering/procurement costsOrdering/procurement costs: are the costs associated with placing orders. They include:

Administrative costs: are usually a fixed cost per order. The total admin costs of placing orders will increase in proportion to the number of orders placed. >>> Variable costs

Delivery costs: are usually a fixed charge per delivery (order). The total delivery costs will also increase in direct proportion to the number of deliveries in the period. >>> Variable cost



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1.4. Stock out costsStock-out costs: are the costs associated

with running out of inventory and they include loss of sales, loss of customers and reduced profit



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1.5. Stock control and inventory holding costIf inventory level is too low, there is a danger

that the number of stock-outs will increase, and there will increase in the number of order placed

An increase in the number of order placed will cause a corresponding increase in ordering costs

So, it should maintain inventory at a level (optimum level) where the total of holding costs, ordering costs and stock-out costs are at minimum. This is the main objective of stock control


2. Economic order quantity

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EOQ is the reorder quantity which minimizes the total costs associated with holding and ordering stock = holding cost + ordering costs are at a minimum at the EOQ

Graph:Holding cost= ordering cost

EOQ= √(2CoD/Ch)D= demand per annumCo= cost of placing one orderCh= cost of holding one unit for one yearQ= Reorder quantity



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EOQ assumptions:Average inventory= EOQ/2The number of orders in a year= expected

annual demand/EOQTotal annual holding cost= EOQ/2*holding cost

per unit of inventoryTotal annual ordering cost = number of

orders*cost of placing an orderTAC= CO * D/Q + ChQ/2



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EOQ with discountDiscount for bulk ordersEffect of quantity discount:

The annual purchase price will decreaseThe annual holding cost will increaseThe annual ordering cost will decrease

To establish whether the discount should be accepted or not:Calculate the TAC with the discount (including the purchase cost)Compare with the annual costs without the discount at EOQ point

Steps:Calculate EOQ ignoring discount If EOQ< min purchase quantity to obtain bulk discount, calculate the

total cost for the EOQ (= the annual stockholding costs+ stock ordering costs + stock purchasing costs)

Recalculate the total cost for a purchase order size that is only just large enough to qualify for the bulk discount = TAC of the bulk quantity

Compare the total costs when the order quantity is the EOQ with the total costs when the order quantity is just large enough to obtain the discount. Select the min cost alternative

F2 ACCA Phi Thanh Tu30

EOQ: inventory to be replenished immediately when organization buy inventory from suppliers

EBQ: inventory to be replenished gradually by manufacturing their own products internally

Setup cost replaces ordering cost of EOQ Average inventory held in EOQ is greater than average held

in EBQ for the same size of batch EBQ = √(2CoD/[Ch(1-D/R)]

Q= batch sizeD= Demand per annumCh= cost of holding one unit for one yearCo= cost of setting up a batch ready to be producedR= annual replenishment rate

3. Gradual replenishment of inventory


Producing large batches at long interval will lead to low machine setup costs (as fewer machines setups will be needed) and high holding costs (as more inventory)

Producing small batches at short interval will lead to high machine setup costs (as more machine setups will be needed) and low holding costs (low average inventory levels as less inventory held)

3. Gradual replenishment of inventory


Reorder level: when inventory reaches the reorder level, a replenishment order should be placed

RL= usage*lead-time (when demand in the lead time is constant)

RL= max usage* max lead time (when demand in the lead time is not constant)

o Lead time= this is the time expected to elapse between placing an order and receiving an order for inventory

o Reorder quantity: when the reorder level is reached, the quantity of inventory to be ordered is known as the EOQ

o Demand: this is the rate at which the inventory is being used up = inventory usage

4. Inventory control level


Max inventory- this is a warning level when inventory are dangerously high.

Max inventory level = reorder level + reorder quantity – min usage*min lead time

Min inventory- this is a warning level when inventory are dangerously low and that stock-outs are potential threat. It is know as buffer inventory/safety inventory

Min inventory level = reorder level – average usage*average lead-time

Average inventory= Reorder quantity/2+ min inventory

Free inventory= physical inventory + inventory on order- inventory requisitioned (not yet issued)

4. Inventory control level


Part B-2- Labor cost

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1. Direct and indirect labor cost2. Recording, calculating and accounting for

Labor cost3. Remuneration method4. Labor turnover and Measuring labor activity


1. Direct and Indirect labor cost

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Direct Indirect

Make up part of the prime cost of a product

Make up part of overheads

Include basic pay of direct workers Include basic pay of indirect workers

<Pay to employees who are directly involved in making a product>

<Pay to employees who are not directly involved in making products>

Bonus payment

Idle time: workers are paid but not making any products

Sick pay

Pay for time spent by direct workers doing indirect jobs


1. Direct and Indirect labor cost

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Overtime and overtime premium of direct employees

Overtime paid = basic element + overtime premium

Direct cost Indirect cost

Overtime premiums are treated as direct labor cost if it is at the specific request of a customer.

Shift allowance/premium >>>> similar to overtime premium


2. Recording, calculating and accounting for Labor cost

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2.1. Recording and calculating Labor cost Recording time spent doing jobs

Time records: for payment, determining cost to be charged

E.g.: Attendance record- show days absent or attend. E.g.: Time cards (gate or lock cards)- record time of

arrival and departure. To be used in manufacturing industry

Activity time record: Period related timesheets: commonly used in service

industries, cover days/weeks/longer period Task related activity time records (job sheets,

operation charts, piecework tickets)



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2.1. Recording and calculating Labor cost Organization for controlling and measuring labor cost:

Personnel department Production planning department Time keeping department Wages department Cost accounting



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2.2. Accounting for labor cost

Wages payment: Dr wage control account

Cr Bank account

Direct labor: Dr WIP account

Cr Wages control account

Indirect labor: Dr Production overhead account

Cr Wages control account


3. Remuneration method

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Remuneration methods

(1) Time work (2) Piecework scheme

(3) Bonus/incentive scheme

Wages = Hours worked x rate of pay per hour

Wages = Units produced x rate of pay per unit

(a) High day rate system

(b) Individual/discretionary bonus schemes

(c) Time saved bonus scheme

(d) Group bonus schemes

(e) Profit sharing schemes

(f) Incentive schemes involving shares

(g) Value added incentive schemes



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(3) Bonus/ incentive schemes (a) High day rate system is a system where employees are paid a high hourly rate in the expectation that they will work more efficiently than similar employees on a lower hourly rate in different company.

(b) Individual bonus schemesIndividual employees can qualify for a bonus on top of their basic wage, which each person's bonus being calculated separately.The bonus is unique to the individual. It is not a share of a group bonusThe individual earns a bigger bonus with the greater his efficiency. quality safeguard.



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(3) Bonus/ incentive schemes

(c) Time saved bonus schemes:Employees are paid for the time saved in completing the job The bonus encourage employees to do work at a faster rate.

(d) Group bonus schemes is an incentive plan which is related to the output performance of an

entire group of workers, a department, or even the whole factory. (e) Profit sharing schemes is a scheme in which employees receive a certain proportion of their

company year-end profits. Possible criteria of this scheme: position of employees and employment time.


3. Remuneration

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(3) Bonus/ incentive schemes

(f) Incentive schemes involving shares A share option scheme is a scheme in which gives its members the right to buy shares in the company for which they work at a set date in the future and at a price usually determined when the scheme is set up. (g) Value added incentive scheme It is an alternative to profit as a business performance measureValue added = Sales - cost of brought-in materials and servicesTarget value added should be set, some of any excess value added earned would be paid out as bonus.


4. Labor turnover and measuring labor activity

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4.1. Labor turnover To measure proportion of people leaving relatively to the

average number of people employed Causes:

Avoidable causes: poor remuneration/working conditions, lack of training opportunities/promotion prospect

Unavoidable causes: retirement, illness, death, family reasons



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4.1. Labor turnover Costs of labor turnover:

Replacement costs: advertisement, selection, training costs, efficiency decreases

Lower the performance of current employeesPreventative costs: incurred to minimized Labor

turnover, associated with escaping the avoidable causes:Increase wagesImprove working conditionsIncrease training programsPromotion schemeInvestigate high LT rate

Labor turnover rate = Number of leavers who require replacement / average number of employees



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4.2. Measuring labor activity Efficiency ratio (Productivity ratio)=

(Expected hours to make output)/(Actual hour taken) x 100%If the ratio > 100%: productivity is greater than expectationIf the ratio < 100%: less than expectation, inefficient labor

Capacity ratio= (actual hours taken)/(budgeted hours) x 100%If the ratio >100%: work above capacityIf the ratio <100%: work below capacity

Production volume ratio/ Activity ratio = (Expected hours to make output)/(Budgeted hours) x 100%

Production volume ratio = efficiency ratio x capacity ratioIf the ratio >100%: produce more than budgetIf the ratio <100%: produce less than budget


Part B-3- Overheads

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1. Overheads and cost categories review2. Absorption costing3. Under and over absorption of overheads4. Accounting entries5. Non-production overheads


1. Overheads and cost categories review

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Overheads is the cost incurred in the course of making product, providing a service or running a department but cannot be traced directly and in full to the product/service/department Categories: Indirect Materials + Indirect labor + Indirect expense:

Production OH: can be fixed or variableAdministration OHSelling & distribution OH


1. Overheads and cost categories review

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Why should OH be included in the total cost of product?

Stock valuationsClosing stock figure in the balance sheetCost of sales figure in the P&L account

Pricing decisionsIf companies follow “full cost plus pricing” strategy.

Establishing the profitability of different products.


2. Absorption costing

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2.1. What is absorption costing? It is a method of sharing overheads between a number of different products an a fair basis. Objective: to include in the total cost of a product (unit or job) an appropriate share of the organization’s total overhead

By an appropriate share, an amount that reflects the amount of time and efforts has gone into producing a unit or completing a job Closing stock in the balance sheet and the COGS in the P&L a/c must be valued at full in PRODUCTION COST



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2.2. Absorption costing procedures

Stage 1: Allocation

Stage 2: Apportionment

Stage 3: Absorption



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STAGE 1: Allocation

Allocation is the process by which whole cost items are charged direct to a cost unit or a cost centre.

Indirect materials, Indirect labors, Security guard, Depreciation, Rent, etc.

Canteen Maintenance

AssemblyMachining



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STAGE 2: ApportionmentApportionment is a process whereby indirect costs are spread fairly between cost centers. 2 stages:

Apportionment Re-apportionment



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STAGE 2: ApportionmentBasic of apportionment: apportion OH to Cost centers (production+service cost centers)

Overheads Basic of apportionment

Rent, rates, heating and light, repairs and depreciation of buildings

Floor area occupied by each cost center

Depreciation, insurance of equipment

Cost of book value of equipment

Personnel office, canteen, welfare, wages and cost office

Number of employees or labor hours worked in each cost center

Heating and cooling Volume of space occupied by each cost center



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STAGE 2: ApportionmentBasic of re-apportionment- apportioning service cost centers’ overheads to the production cost center using appropriate bases

Service departments Basic of apportionment

Stores Number of cost/value of material requisitions

Maintenance Hours of maintenance work done for each cost centers

Production planning Direct labor hours worked in each production cost center



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STAGE 2: Apportionment- reapportionmentService cost centre costs may be apportioned to production cost centers by using one of the following methods:

Direct methodReciprocal methodStep method



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STAGE 2: Apportionment- Direct method Costs of each service costs centre are apportioned only

to production cost centers

Service Department

(Canteen)

Service Department

(Maintenance)

Operating Department

(Machining)


(Assembly)

Interactionsbetween service departments areignored and all costs are apportioned directly to operating (Production)departments.

DIRECT METHOD



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STAGE 2: Apportionment- Step method Costs apportionment are performed in a step-down

fashion, using predetermined ranking procedures (e.g., degree of support)

Once a servicedepartment’s costsare apportioned,

other servicedepartment costsare not apportionedback to it.

Service Department

(Canteen)

Service Department

(Maintenance)


(Machining)


(Assembly)

STEP METHOD



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STAGE 2: Apportionment- Reciprocal method Recognizes interactions of service costs centers prior to

apportion to production cost centers Costs of each service costs centre are apportioned not

only to production cost centers, but also to other service cost centers which make use of its services.

The results of the reciprocal method may also be obtained using algebra and simultaneous equations.



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2.2. Absorption costing proceduresSTAGE 2: Apportionment- Reciprocal method

Interdepartmentalservices are givenfull recognitionrather than partialrecognition as withthe step method.

Service Departmen

t

(Canteen)

Service Department

(Maintenance)

Operating Departmen

t

(Machining)

Operating Departmen

t

(Assembly)

RECIPROCAL METHOD



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STAGE 3- Absorption Overhead absorption is the process whereby overhead costs

allocated and apportioned to production cost centers are added to cost units, jobs or process costs using an appropriate basis

A product cost can now be determined:

Direct materials

+ Direct labor

+ Absorbed overhead

Product cost



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STAGE 3- Absorption OH are usually added to cost units using a predetermined

overhead absorption rate.Step 1: Estimate the OH likely to be incurred during the

coming period.Step 2: Estimate the activity level for the period. This

could be total hours, units, or direct costs of whatever it is upon which the OH absorption rates are to be based.

Step 3: Divide the estimated OH by the budgeted activity level --> the OH absorption rate.

Step 4: Absorb the OH into the cost unit by applying the calculated absorption rate.

Overhead absorbed = predetermined OAR x Actual level of activity

OH absorption rate

=Total budgeted overhead costs

Total budgeted act. level



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STAGE 3- Absorption Possible bases of absorption rate:

Rate per unitRate per machine hourRate per direct labor hourPercentage of direct material costPercentage of direct labor costPercentage of total direct costPercentage of factor cost (for admin overhead)Percentage of sales or factory cost (for selling and distribution overhead)



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STAGE 3- Absorption3 methods of Absorbing Overhead Costs:

Overhead can be absorbed into cost units in one of three ways:

Blanket absorption rate (Single plant-wide

rate)

Separate absorption

rates (Departmenta

l overhead rates)

Activity-based

costing (later)



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STAGE 3- Absorption3 methods of Absorbing Overhead Costs- Method 1- Blanket absorption rate

Overhead CostIndirect

Costs

Cost

Absorption

Base

Blanket absorption rate

Cost

ObjectsProduct

1Product

2Product

3



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STAGE 3- Absorption3 methods of Absorbing Overhead Costs- Method 2- Separate absorption rate

Overhead Cost

First

Stage

Second

Stage

Department A

Indirect

Costs

Cost

Objects

Absorption Base

Cost

Objects

Department A

Overhead Rate

Department

B

Department B

Overhead Rate

Product 1

Product 2

Product 3


3. Under/Over absorption of overheads

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Normal costing involves using the predetermined absorption rate in order to establish the actual cost of

production.

Direct materials xxx

Direct labour xxx

Overheads xxx

(based on the predetermined absorption rate)

Actual cost of production xxx



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Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.

.Overhead is

over absorbed

Overhead is over

absorbed

Overheadabsorbed to

Work in Process

(OAR × Activity)

Actualoverhead

costsincurred

Over absorption means that the OHs charged to the cost of sales are greater than the OH actually incurred.

Actual OH 1000

Absorbed OH (1200)

Over absorbed OH 200



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Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.

. Overhead is under

absorbed

Overhead is under

absorbed

Actualoverhead

costsincurred

Overheadabsorbed to

Work in Process

(OAR × Activity)

Under absorption means that inssufficient OHs have been included in the cost of sales.

Actual OH 1000

Absorbed OH (900)

Under absorbed OH 100



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Adjusting of Over absorbed and Under absorbed Overhead:--->Adjusting Cost of sales for under absorbed or over absorbed overhead

Overhead is:

Cost of salesis:

Adjustment will:

Actual overhead > absorbed overhead

Under-absorbed Too low Increase Cost

of sales

Actual overhead < absorbed overhead

Over-absorbed Too high Decrease Cost

of sales


4. Accounting entries

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Occurrence of overheadDr Production overhead accountCr Inventory/ Wages control /Cash/Creditor accounts

Absorption of overheadDr WIP accountCr Production overhead account

Over-absorption of overheadDr Production overhead accountCr under/over absorbed overhead (P&L)

Under-absorption of overheadDr under/over absorbed overhead (P&L)Cr Production overhead account


5. Non-production overheads

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Method 1: Choose a basic for the overhead absorption rate which most closely matches the non production overhead. E.g.: direct labor hours, direct machine hours and so on.

Method 2: Allocate non-production overheads on the ability of the products to bear such cost. One possible approach is to use the production cost.

OAR=

Estimated non production overheads

Estimated production costs


5. Non-production overheads

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Other bases for absorbing overheads

Types of overheads Possible absorption rate

Selling and marketing Sales value

Research and development Consumer cost (= pro.cost – cost of direct materials)

Distribution Sales value

Administration Consumer cost


Part B-4- Marginal and absorption costing

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1. Recap of absorption costing2. Marginal costing definition and principles3. Absorption costing vs. Marginal costing4. Reconciling the profit figures given by 2

methods


1. Recap of absorption costing

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Absorption costing (Full costing):The cost of a unit of product consists of:

Direct materialsDirect laborManufacturing overheads


2. Marginal costing definition and principles

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Marginal cost is the variable cost of one unit of product or service >>>> would be avoided if that unit were not produced or provided

The cost of a unit of product consists of only variable (marginal) manufacturing costs:

Direct materials Direct labor Variable manufacturing overhead

Contribution = sales revenue – variable costs of sales Fixed costs are treated as period costs and are charged

in full to the PL account of the accounting period in which they are incurred


2. Marginal costing definition and principles

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No extra fixed cost incurred when output is increased By selling an extra item of product or service, the

following will happen: Revenue will increase by the sale value of item sold Costs will increase by the variable cost per unit Profit will increase by the amount of contribution

earned from the extra item


3. Absorption costing vs. Marginal costing

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Direct Materials

Direct Labor

Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Variable Selling and Administrative Expenses

Fixed Selling and Administrative Expenses

Variable

Costing

AbsorptionCosting

Product

Costs

PeriodCosts

Product

Costs

PeriodCosts


3. Absorption costing vs. Marginal costing

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Manufacturing Cost Flows

Variable costing

Income StatementExpenses

Cost of GoodsSold

Selling andAdministrativePeriod Costs

Work in Process

FinishedGoods

Raw Materials

VariableManufacturing

Overhead

Material Purchases

Direct Labor

Selling andAdministrative

FixedManufacturing

Overhead

Absorptio

n costing

Balance Sheet

InventoriesCosts


4. Reconciling the profit figures given by 2 methods

80

The difference is due to the difference stock valuation method used

Relation between production and

salesEffect on inventory

Relation between marginal and

absorption profit

Production > Sales

Inventory increases

Absorption > marginal

Production < Sales

Inventory decreases

Absorption < Marginal

Production = Sales

No change

Absorption = marginal


4. Reconciling the profit figures given by 2 methods

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$'000 $'000 $'000 $'000Sales X XLess COS+ Opening inventory X X+ Add production cost X X-Less Closing inventory (X) (X)Subtotal COS (X) (X)Add/less Under/Over absorbed O/H XLess other variable costs (X)Contribution XGross profit XLessFixed production O/H (X) NILFixed selling O/H (X) (X)Net profit X X

Marginal costing Absorption costingIncome statements

Phi Thanh, Tu (EXT-Other - VN/ Hanoi):At variable production cost

Phi Thanh, Tu (EXT-Other - VN/ Hanoi):At full production cost


Part B-5- Job, batch and service costing

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1. Job costing2. Batch costing3. Service costing


Costing system

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Specific order costing

• Work done by an organization consists of separately identifiable jobs or batches

• Job, batch costing

Continuous operation costing

• Goods or services are produced as a direct result of a sequence of continuous operation or processes

• Process costing


1. Job costing

84

JobCosting

Used for production of large, unique, or high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.

Used for production of large, unique, or high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.


1. Job costing

85

Work in Progress

Cost of SalesLabor

Materials

Indirect

Indirect

FinishedGoods

FactoryOverhead

Direct

Direct

Apportion


1. Job costing

86

Receive order from customers

Predict cost to complete job

Negotiate a sales price and decide whether to

pursue the job.

Schedule the job


2. Batch costing

87

BatchCosting

Similar to Job costingWithin each batch are number of identical units but each batch will be differentCost per unit in batch =

Similar to Job costingWithin each batch are number of identical units but each batch will be differentCost per unit in batch =

Total production cost of batch

Number of units in batch


2. Batch costing

88

Total production cost of batch

Number of units in batch

JOB

&

BATCH

The units of a particular

job/batch are easy to identify.

Individual goods or services have

very different characteristics

and costs.

Value of WIP at the year end is the sum of the

costs incurred on incomplete job/batch.


3. Pricing the Job/Batch

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Pricing the Job

Cost plus method

Mark-up

%Cost of job 100+ Profit 25

= Selling price 125

Profit Mark-up: 25% on job cost

Margin

%Cost of job 100+ Profit 25

= Selling price 125

Profit Margin: 20% on selling price


4. Service costing

90

Different characteristics of services: Simultaneity, Heterogeneity, Intangibility, Perishability

Difficulty in defining cost units. It is usually a composite cost unit

E.g.: tones-miles for haulage companiespatient days for hospitalguest days for hotel services

passenger miles for public transport companies

Direct materials will be relatively small compared to labor & OH.

However, service costing techniques are quite similar to job/batch costing:

Cost per service unit

Total costs for period

Number of service units in the period

= -----------------------------------------


Part B-6- Process costing

91

1. Process costing2. Losses in process costing3. Dealing with scrap value4. Losses with a disposal cost5. Valuing WIP6. Joint products & By-products


1. Process costing

92

A form of continuous operation costing To be used in mass production of many identical

products Output of process 1 forms the materials input of the next

process Average cost per unit is calculated for each process

Average cost per unit

Costs of production

Expected or normal output

= -----------------------------------------


1. Process costing

93

Differences Between Job-Order and Process Costing

Job order costingMany jobs are worked during the period.

Costs are accumulated by individual jobs.Job cost sheet is the key document.Unit costs are computed by job

Process costingA single product is produced for a long period of time/ and/or going through different processes.Costs are accumulated by departments. Department production report is key document. Unit costs are computed by department (each process)


1. Process costing

94

Direct labor and manu. OH are often combined into one

product cost called conversion.

DirectMaterial

s

Type of Product Cost

Dollar Amount

DirectLabor

Overhead

DirectMaterial

s

Type of Product Cost

Dollar Amount

Conversion


2. Losses in process costing

95

Framework for dealing with process costing

Step 2: Calculate cost per unit of output, losses & WIP

Step 1: Determine output & losses

Step 3: Calculate total cost of output, losses & WIP

Step 4: Complete accounts



96

Step 1: Determine output & losses Normal loss:

The loss is expected in a processExpressed as a % of material input to the processIf Normal loss does not have a scrap value, It is valued

in the process account as NILIf Normal loss has a scrap value, it is valued in the

process account at this value. Revenue from scrap value is used to reduce the input cost of the process



97

Step 1: Determine output & losses Abnormal loss and gains

If the actual loss/gain in the process is different to what we are expecting, it is an abnormal loss or an abnormal gain

Actual loss > normal loss = Abnormal lossActual loss < normal loss = Abnormal gainCost of abnormal loss and gain:

not absorbed into the cost of good outputShown as loss and gain in the process accountValue is the same as cost of unit of good output



98


Input: 1000 units Production Process

Normal loss rate: 10%

Output: 860 units

Normal loss: 100 units

(10% x 1000 units)

Abnormal loss: 40 units

(140 units - 100 units)

Actual Losses: 140 units



99


Input: 1000 units Production Process

Normal loss rate: 10%

Output: 960 units

Normal loss: 100 units

(10% x 1000 units)

Abnormal gain: 60 units

(100 units - 40 units)

Actual Losses: 40 units



100

Step 2: Calculate cost per unit

Rule: Unit cost of output is calculated based on expected output

Example:

For both case 1 & 2 above, if total costs of input is $4,500,

Cost per unit of output is:

$4,500/ 900 units = $5 per unit



101

Step 3: Calculate total cost of output and losses Rule:

Normal loss: No cost

Abnormal loss: given a cost (equal to unit cost of out put)

Abnormal gain: given a negative cost (equal to unit cost of out put)

Case 1Normal loss: NILAbnormal loss= 40units x $5 = $200Output = 860units x $5 = $4300

Case 2Normal loss: NILAbnormal gain= 60units x $5 = $300Output = 960units x $5 = $4800



102

Step 4: Complete accounts Case 1:

INPUT Units $ OUPUT Units $Cost incurred 1000 4500 Normal loss 100 0

Output 860 4300Abnormal loss 40 200

PROCESS ACCOUNT



103


Units $ Units $Process account 40 200 Income statement

ABNORMAL LOSS ACCOUNT



104


INPUT Units $ OUPUT Units $Cost incurred 1000 4500 Normal loss 100 0Abnormal gain 60 300 Output 960 4800

PROCESS ACCOUNT



105


Units $ Units $Income statement Abnormal gain 60 300

ABNORMAL GAIN ACCOUNT


3. Dealing with scrap value

106

Losses or spoilage may have scrap value.

Basic rule:

Revenue from scrap is not treated as an addition to sales

revenue, but as a reduction in costs.Scrap value

Normal loss/gain Abnormal loss/gain

Deduct from cost of process Deduct from cost

of abnormal loss

Deduct from value of abnormal gain

Dr Scrap a/c

Cr Process a/cDr Scrap a/c

Cr Abnormal loss a/c

Dr Abnormal gain a/c Cr Scrap a/c

LOSS GAIN


3. Dealing with scrap value

107

Example:

JJ has a factory which operates two production processes, cutting and pasting. Normal loss in each process is 10%. Scrapped units out of the cutting process sell for $3 per unit whereas scrapped units out of the pasting process sell for $5. Output from the cutting process is transferred to the pasting process: output from the pasting process is finished output ready for sale.

Relevant information about costs for control period 7 are as follows:

Pls prepare accounts for the cutting/pasting process, abnormal loss, abnormal gain and scrap.

Cutting process Pasting process

Units $ Units $

Input materials 18,000 54,000

Transferred to pasting process

16,000

Material from cutting process 16,000

Added materials 14,000 70,000

Labor and overheads 32,400 135,000

Output to FGs 28,000


4. Losses with a disposal cost

108

Disposal cost

Normal loss Abnormal loss/gain

Add to cost of process

Add to cost of abnormal loss

Add to value of abnormal gain

Dr Process a/c

Cr Disposal cost a/c

Dr Abnormal loss a/c

Cr Disposal cost a/c

Dr Disposal cost a/c

Cr Abnormal gain a/c

LOSS GAIN


5. Valuing WIP

109

Equivalent units are partially complete and are part of work in process inventory. Partially completed products are expressed in terms of a smaller number of fully completed units- as a proportion of completed units.

Calculating and Using Equivalent Units of Production

Different degree of completion for each cost element:MaterialsConversion costs = labor + overheads

Cost perequivalent

unit

= Costs for the period

Equivalent units of production for the period


5. Valuing WIP

110

Example 1:

For process 1 in ABC Co, the following is relevant for the latest period:

Period cost: $4440

Input: 800 units

Output: 600 fully-worked units and 200 units only 70% complete.

There were no process losses

Prepare statement of Eus and Process 1 account.


5. Valuing WIP

111

Example 1:Statements of EUs

Output % Eus

FGs 600 100% 600

Closing WIP 200 70% 140

Total 800 740

Costs $4440

Cost per EU $6

Process 1 A/c

Units $ Units $

Input 800 4440

Transferred to next process

600 3600 (600*6)

WIP 200 840 (140*6)

Total 800 4440

800 4440


5. Valuing WIP

112

How to value WIP if there is WIP at the beginning of the period?

Valuing Opening WIP

FIFO method Weighted Average method

Cost during period

Work done during period

Cost till date

Work done till date


5. Valuing WIP

113

Assumption in FIFO Assumption in WAC

WIP at the beginning of the period must be completed, and transferred out first.

Makes no distinction between work done in prior and current period

Closing WIP includes the most recently incurred costs

Blends together units and costs from prior period and current period.


5. Valuing WIP

114

Work in process, May 1: 200 units Materials: 55% complete. $ 9,600Conversion: 30% complete. $ 5,575

Production started during May: 5,000 unitsProduction completed during May: 4,800 unitsCosts added to production in May

Materials cost $ 368,600Conversion cost $ 350,900

Work in process, May 31: 400 unitsMaterials 40% complete.Conversion 25% complete.


5. Valuing WIP

115

Prepare the process account for May 2008- FIFO

Beginning WIP200 Units

55% Complete

Ending WIP400 Units

40% Complete

5,000 Units Started

4,600 Units Startedand Completed

MaterialsMaterials

90 Equivalent Units4,600 Units Completed160 Equivalent Units

400 × 40%

4,850 Equivalent units of Materials

200 x 45%


5. Valuing WIP

116

Prepare the process account for May 2008- FIFO

5,000 Units Started


400 × 25%

4,840 Equivalent units of Conversion


30% Complete

Ending WIP400 Units

25% Complete

ConversionConversion

140 Equivalent Units 4600 Units completed 100 Equivalent Units

200 x 70%


5. Valuing WIP

117

Prepare the process account for May 2008- WAC


55% Complete

Ending WIP400 Units

40% Complete

5,000 Units Started


MaterialsMaterials

4800 Units Completed160 Equivalent Units

400 × 40%

4,960 Equivalent units of Materials


5. Valuing WIP

118

Prepare the process account for May 2008- WAC

5,000 Units Started


400 × 25%

4,900 Equivalent units of Conversions


30% Complete

Ending WIP400 Units

25% Complete

ConversionConversion

4800 Units completed 100 Equivalent Units


6. Joint and by products

119

6.1. Joint products Joint products are two or more products produced

simultaneously by the same process up to a “split-off” point. Each is important and can have a significant sales

value. Each should therefore be valued separately. e.g..,

seafood processing, oil refining,... Cost incurred up to this point are called common costs

or joint costs. The split-off point is the point at which the joint

products become separate and identifiable. Should be treated as normal output from the process



120

6.1. Joint products Joint Cost Apportionment Methods

Physical units: production units Sales value at split-off point: the sales value of the total

output from the particular processes concerned. Net realizable value: final sales value – further processing

cost



121

6.2. By products What are the differences between a joint and a

by- product?

•The distinction between joint and by-products rests solely on the relative importance of their sales value.

•A by-product is a secondary product recovered in the course of manufacturing a primary product.

Characteristics of By-products:Relatively low in sales value Small in quantity produced Sold in bulks



122

6.2. By products Accounting for by-products: Similar to Normal

LossCost of By-product: Generally NO cost is

apportioned to the by-products.Income of By-product: 4 methods

added to sales of main products. treated as a separate, incidental source of income. deducted from the cost of production of the main

product. Net realizable value (NRV) of the by-product is

deducted from the cost of production in the period. ***** the most common method.


Part B-7- Alternative costing

123

1. Activity based costing2. Calculation of ABC3. Absorption costing vs. ABC4. Advantages and disadvantages of ABC5. Total Quality Management6. Life cycle costing7. Target costing


1. Activity base costing (ABC)

124

Costs are firstly assigned to the activities which are the real causes of the overheadThen costs of those activities are assigned to the products which are actually demanding those activities

Overheads

Activity 1

Activity 2

Activity 3

Product 1

Product 2


1. Activity base costing (ABC)

125

Activities cause costs: the special engineering, special testing, machine setups, etc—(they cause the company to consume resources).The reasons for the development of ABC:

(1) manufacturing overhead costs have increased significantly,

(2) the manufacturing overhead costs no longer correlate with the productive machine hours or direct labor hours,

(3) the diversity of products and the diversity in customers' demands have grown, and

(4) some products are produced in large batches, while others are produced in small batches.

2. Calculation of ABC


Step1

•Identify an organization's major activities

Step 2

•Identify the cost drivers- factors which determine the size of the costs of an activity (cause the costs of an activity)

Step 3

•Collect the costs of each activity into cost pools (equivalent to cost centers under the traditional costing methods) (each activity)

Step 4

•Charge support overheads to products on the basis of their usage of the activity- number of the activity’s cost driver it generates


1. Activity base costing (ACB)

127

Activity Cost drivers

Ordering Number of orders

Materials handling Number of production runs

Production scheduling Number of production runs

Dispatching Number of dispatches


2. Calculation of ACB- Example

128

We will assume that a company has annual manufacturing overhead costs of $2,000,000—of which $200,000 is directly involved in setting up the production machines. During the year the company expects to perform 400 machine setups. Let’s also assume that the batch sizes vary considerably, but the setup efforts for each machine are similar.

For simplicity, let’s assume that the remaining $1,800,000 of

manufacturing overhead is caused by the production activities that correlate with the company’s 100,000 machine hours.

Assume that a company manufactures a batch of 5,000 units and it

produces 50 units per machine hour, calculate the cost assigned to the units with activity based costing and without activity based costing compares.

If a company manufactures a batch of 50,000 units and produces 50 units

per machine hour, show how the cost assigned to the units with ABC and without ABC compares.

http://www.accountingcoach.com/terms/B/batch-size.html



129

With ABC Without ABC

Mfg overhead costs assigned to setups

$200,000 $–0–

Number of setups 400 Not applicable

Mfg overhead cost per setup

$500 $–0–



130


Total manufacturing overhead costs

$2,000,000 $2,000,000

Less: Cost traced to machine setups

200,000 –0–

Mfg O/H costs allocated on machine hours

$1,800,000 $2,000,000

Machine hours (MH) 100,000 100,000

Mfg overhead costs per MH

$18 $20

Mfg Overhead Cost Allocations

$500 setup cost per batch + $18

per MH$20 per MH



131


Mfg overhead for setting up machine

$500 $–0–

No. of units in batch

5,000 Not applicable

Mfg O/H caused by Setup – Per Unit

$0.10 Not applicable

If the company manufactures a batch of 5,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:



132


Mfg overhead costs per machine hour

$18 $20

No. of units produced per machine hour

50 50

Mfg O/H caused by Production – Per Unit

$0.36 $0.40

Total Mfg O/H Allocated – Per Unit

$0.46 $0.40



133


Mfg overhead for setting up machine

$500 $–0–

No. of units in batch

50,000 Not applicable

Mfg O/H caused by Setup – Per Unit

$0.01 Not applicable

If the company manufactures a batch of 50,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:



134


Mfg overhead costs per machine hour

$18 $20

No. of units produced per machine hour

50 50

Mfg O/H caused by Production – Per Unit

$0.36 $0.40

Total Mfg O/H Allocated – Per Unit

$0.37 $0.40



135

As the tables above illustrate: with activity based costing the cost per unit decreases from $0.46 to

$0.37 because the cost of the setup activity is spread over 50,000 units instead of 5,000 units.

Without ABC, the cost per unit is $0.40 regardless of the number of units in each batch.

If companies base their selling prices on costs, a company not using an ABC approach might lose the large batch work to a competitor who bids a lower price based on the lower, more accurate overhead cost of $0.37.

It’s also possible that a company not using ABC may find itself being the low bidder for manufacturing small batches of product, since its $0.40 is lower than the ABC model of $0.46 for a batch size of 5,000 units. With its bid price based on manufacturing overhead of $0.40—but a true cost of $0.46—the company may end up doing lots of production for little or no profit.


3. Absorption costing vs. ACB

136

ACB Absorption costing

ABC ascertains the purpose of each activity or service and assigns the cost of such activity or service to the product or service unit that demands such activity.

Cost of a product unit under absorption costing = cost of direct materials + direct labor + variable manufacturing overheads + (fixed manufacturing overhead costs/units produced).

Traces the costs of product units. (define activity >>> allocate COST)

Allocates costs to product units. (allocate all production cost)

ABC presumes that products or services consume activities, and activities consume resources. It thus, works to convert indirect costs into direct costs.

It works under the simple approach of assigning resources to products or services directly.


3. Absorption costing vs. ABC

137

ABC Absorption costing

Identifies the actual proportion of fixed overheads costs incurred by the product unit.

Divides equally the fixed overhead costs with the number of product units

Price fixation in ABC bases calculations to derive the actual overheads incurred on a unit, and does not vary with change in inventory levels.

Price fixation in absorption costing depends on the inventory. The higher the inventory, the lower the product cost and lower the inventory; or the higher per-product cost

Not allowed by GAAP. Allowed by GAAP

Improves the quality of management accounting information, especially in large and multi-product operations

Remains more suitable for small firms and enterprises with homogeneous products or services.


4. Advantages and disadvantages of ABC

138

Advantages Disadvantages

Estimate cost precisely The method is complex, time consuming and costly

Provide quantifiable figure for planning and estimates

Not accept by GAAP

Facilitate the determination of selling price

Difficult to identify/analyze/quantify cost in the activity

Help to identify inefficient/ non-profitable products/activities

Help to allocate resources to profitable items

Etc Etc


5. Total quality management

139

TQM is a process of applying a zero defect philosophy to the management of all resources and relationships within an organization as a means of developing and sustaining a culture of continuous improvement which focuses on meeting customer expectation. Quality combines the criteria:

How well made a product is/ how well performed if it is a serviceHow well it serves its purposeHow it measures up against its rival


5. Total quality management

140

Basic principles of TQM:Get it right, first time: basic principal of TQM- the cost of

preventing mistakes is less than the cost of correcting them.Continuous improvement: always possible to improvePerformance measures for TQM must embrace every activity

of the organizationThe requirement of quality: 8 requirements of quality

according to Mark Lee Inman

Customer Customer-supplier relationship

Preventing the cause of the defect in the 1st place

Employees must be personally responsible for defect free production

Any level of defects is unacceptable

All departments are involved

Quality certification Emphasize cost of poor quality


6. Life cycle costing

141


5. Life Cycle costing

142

Market introduction

Growth Maturity Decline

Demand/sales

-Demand needs to be created-Sales is slow to start

- Public awareness increases- Sales volumes increase significantly

Sales peaks - Decline

Price Targeted price Begin to decrease due to competition

Tends to drop

Diminish

Cost Very high Reduced due to economics of scale

Lower Counter-optimal

Competition Little or no Begin to increase with a few players

Increase Increase/ Peaks

Profitability Make no money Begin to rise Go down Diminish


7. Target costing

143

Target cost is an estimate of a product cost which is determined by subtracting a desired profit margin from a competitive market price.

This target cost may be less than the planned initial product cost but it is expected to be achieved by the time the product reaches the maturity stage of the product life cycle


7. Target costing

144

Step 1

•Determine a product specification of which an adequate sales volume is estimated

Step 2

•Set a selling price at which the organization will be able to achieve a desired market share

Step 3

•Estimate the required profit based on return on sales or return on investment

Step 4

•Calculate the target cost = target selling price- target profit

Step 5

•Compile an estimated cost for the product based on the anticipated design specification an d current cost level

Step 6

•Calculate cost gap = estimated cost - target cost

Step 7

•Make efforts to close the gap (at design phase)

Step 8

•Negotiate with the customer before making the decision about whether to go ahead with the project

F2- Management Accounting Part B Class

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