Management and Cost Accounting

Chapter 1:
Management accounting (MA) (p.5)
Measures and report financial and other information intended to assist managers in fulfilling
organisational goals
 Inform strategic decisions and formulate business strategy
 Plan long, medium and short-term operations
 Determine capital structure and fund the structure
 Design reward strategies for executives and shareholders
 Inform operational decisions
 Control operations and ensure the efficient use of resources
 Measure and report financial and non-financial performance to management and other
stakeholders
 Implement corporate governance procedures, risk management and internal controls

Financial accounting (FA)

External reporting directed by authoritative guidelines
Cost accounting
Measures and reports financial and non-financial information related to the organization’s
acquisition or consumption of resources  information for financial & management accounting

Differences between financial & management accounting (p.6)

 Regulations
o MA: Internal use  No external governing regulations
o FA: External use  Directed by legal accounting guidelines & regulations
 Range and detail of information
o MA: Financial, non-financial and qualitative information detailed, highly aggregated
o FA: Broad based, lacking detail, provides an overview; focus on financial information
 Reporting interval:
o MA: Reported frequently (daily, weekly, monthly, quarterly)
o FA: Reported annually (also semi-annually or quarterly in large firms)
 Time period:
o MA: Reports may include past, present and future information
o FA: Provides information on performance & position for the past period

Cost Management and Accounting Systems (p.6f)

Cost Management is used to describe the actions managers undertake in the short and long-run
planning and control of costs that increase value for customers and lower the costs of products and
services. It is often carried out as a key part of general management strategies and their
implementation.
Strategic Decisions and Management Accounting
Many organizations seek to be more expansionist, entrepreneurial, risk taking and innovative as a
conscious move away from the inwardly focused management techniques. The successful businesses
create long-term value for shareholders and have strategies and external awareness to evolve and
change when a need arises.
The Major Purposes of Accounting Systems (p.8f)
1. Formulating overall strategies and long-range plans (product development, investments in
(tangible) equipment and (intangible) brands, patents or people)
2. Resource allocation decisions such as product and customer emphasis and pricing
(profitability of products/services, brand categories, customers, distribution channels, etc.)
3. Cost planning and cost control of operations and activities (reports on revenues, costs, assets
& liabilities of divisions, plants and other)
4. Performance measurement & evaluation of people (comparing results with planned results)
5. Meeting external regulatory and legal reporting requirements (follow accounting guidelines)

The nature of accounting information changes to match the changing/developing business

environment. There are a number of influences on changes in accounting information (p.9).

Planning and control

Planning is defined as choosing goals, predicting results under various ways of achieving those goals
and then deciding how to attain the desired goals
Budget is the quantitative expression of a plan of action and an aid to the coordination and
implementation of the plan
Control covers both the action that implements the planning decision and deciding on performance
evaluation and the related feedback that will help future decision making
Management by Exceptions is the practice of concentrating on areas not operating as expected (such
as cost overrun on a project) and placing less attention on areas operating as expected
Variance refers to the difference between the actual results and the budgeted amounts

Control = Control & Planning (in this book) because they are so strongly intertwined

Feedback: A Major Key

Examining past performances and exploring alternative ways to improve future performances
Uses of feedback include:
 Tracking growth
 Searching for alternative means of operating
 Changing methods for making decisions
 Making predictions
 Changing operations
 Changing the reward system

Accountants’ performing three important functions

 Scorekeeping refers to the accumulation of data and reporting of reliable results to all levels
of management (e.g. recording sales, payroll payments, purchases of materials, etc.)
 Attention Directing attempts to make visible both opportunities and problems on which
managers need to focus (e.g. highlighting rapidly growing markets where the company may
be underfunding its investment or products with higher-than-expected return rates)
 Problem Solving refers to comparative analysis undertaken to identify the best alternatives
in relation to the organization’s goals (e.g. comparing financial advantages of leasing vehicles
rather than owning them)
Scorekeeping function in many organisations requires processing numerous data items
 Computerised information systems are used to automate
Harrison and McKinnon
“Individuals crossing national and cultural borders to work require an understanding of the
differences in management control practices they are likely to encounter, and sensitivity to the
cultural underpinnings of those practices”.

4 Key Themes in Management Decision Making (Exhibit 1.4 p15)

1. Customer focus  Significant factor for success of an organization
2. Value-chain and supply-chain analysis
The value chain is the sequence of business functions in which utility (usefulness) is
added to the products or services of an organization (Exhibit 1.5)
Supply chain describes flow of goods services and information from cradle to grave,
regardless of whether those activities occur in the same organization or in others

3. Key success factors

Operational factors that directly affect the economic viability of the organization:
 Cost (reduce)
 Efficiency (increase)
 Quality (higher)
 Time (faster and reliable)
 Innovation (continuing flow)
4. Continuous improvement and benchmarking
“If you’re not moving forward, you’re moving backwards.”

Historically Development of Management Accounting

Stage 1: Before 1950  Cost determination and financial control
Stage 2: By 1965  Provision of management planning and control (e.g. decision analysis)
Stage 3: By 1985  Reduction of waste in resources used
Stage 4: By 1995  Creating of value through the effective use of resources and technologies that
examine the drivers of customer values and through organisational innovation

Forces of Change in Management Accounting

Over time, the previous four themes may change and new themes may arise. Management
accountants need to keep current.
Professional accountants play a role as:
 Creators of value, by taking leadership roles
 Enablers of value, by informing and guiding managerial decision making
 Preservers of value, by ensuring the protection a sustainable value creation strategy
 Reporters of value, by enabling the transparent communication of the delivery of sustainable
value to stakeholders
 Chapter 2: Cost Terms and Purposes
Cost
Resource sacrificed or forgone to achieve a specific objective
Cost object examples
 Product  Brand category
 Service  Activity
 Project  Department
 Customer  Programme
Actual cost
Costs incurred (historical costs), distinguished from budgeted or forecasted costs
Cost accumulation
Collection of cost data in some organised way through an accounting system
Cost assignment
Tracing accumulated costs to a cost object (direct costs) & allocating accumulated costs to a cost
object (indirect costs)

Direct costs are more accurate than indirect costs

Example: Tennis racket
Direct cost: Cost of the carbon fibre used to make the racket
Indirect cost: Cost of lightning needed by worker to produce the racket
Factors affecting direct/indirect cost classifications
1. Materiality of the cost
a. The higher the cost in question the more likely the economic feasibility of tracing
2. Available information-gathering technology
a. Improvements enable increasing percentage of cost to be classified as direct
3. Design of operations
a. Facility design can impact on cost classification
 Costs can be both direct and indirect

Cost driver (cost generator/determinant)

Any factor that affects cost; changes in particular cost driver do not automatically lead to changes in
overall costs
Cost management
Set of actions managers take to satisfy customers while continuously reducing & controlling costs
Cost reduction efforts focus on: 1. Value-added activities and 2. Cost drivers in them

Variable costs (amount per unit)

Cost that changes in total in proportion to changes in related level of total activity or volume
Fixed costs (lump-sum total amount)
Cost that does not change in total despite changes in related level of total activity or volume
Major assumptions underlying (the definitions of variable/fixed costs)
1. Costs are defined as variable or fixed with respect to a specific cost object
2. Time span must be specified
3. Total costs are linear
4. Only one cost driver
5. Variations in the level of the cost driver are within a relevant range

Relevant range
Range of cost driver in which a specific relationship between cost & level of activity/volume is valid

Relationships of types of costs

Unit cost/average cost

Calculated by dividing total cost by the related number of units
For decision making its best to think in terms of total costs rather than unit costs

Capitalised costs (prepaid expenses)

First recorded as an asset when they are incurred  presumed to provide future benefits
Revenue cost
Recorded as expenses of the accounting period when they are incurred (e.g. salaries paid to
marketing personnel; monthly rent paid to administrative offices)

Merchandising- and manufacturing-sector companies

Inventorial costs/Stock-related costs
Those costs associated with purchase of goods for resale or acquisition and conversion of materials
(Turn into cost of goods sold in the period the stock item is sold)
 Direct materials stock
 Work-in-progress stock
 Finished goods stock
Period cost
Not a necessary part of manufacturing process ( selling function; general administration)
Operating cost
All cost associated with generating revenues
3 widespread terms for manufacturing costs
 Direct material costs
o Acquisition costs of all materials that eventually become part of the cost object and
that can be traced to the cost object
 Direct manufacturing labour costs
o Include the compensation of all manufacturing labour that is specifically identified
with the cost object and can be trace to the cost object
 Indirect manufacturing costs
o All manufacturing costs considered being part of the cost object, but that cannot be
individually traced to that cost object (power, indirect materials, plant rent, etc.)
o Other terms are manufacturing overhead costs and factory overhead costs

Prime costs
All direct manufacturing costs  Direct material + direct labour
Conversion costs
All other but direct manufacturing costs; transforming direct materials into finished goods
 Direct labour + indirect manufacturing costs

Product cost
Sum of costs assigned to a product for a specific purpose

Classification of costs
1. Business function
a. Research & development 3. Behaviour pattern in relation to
b. Design of products, services & changes in level of a cost driver
processes a. Variable cost
c. Production b. Fixed costs
d. Marketing 4. Aggregate or average
e. Distribution a. Total costs
f. Customer service b. Unit costs
2. Assignment to cost object 5. Assets or expenses
a. Direct cost a. Inventoriable (product) costs
b. Indirect cost b. Period costs
 Chapter 3: Job-costing Systems
Cost pool
Grouping of individual cost items; can vary from the very broad to the very narrow
Cost-allocation base
Factor that is common denominator for systematically linking indirect costs to a cost object
( Generally direct labour hour/machine hour/km covered or travelled)

Job-costing system
Costs are assigned to a distinct unit, batch or lot of a product or service
Process-costing system
Cost object is masses of identical/similar units (average the cost  a per unit cost)

Most companies combine elements of both systems

General approach to job costing

1. Identify the job that is the chosen cost object
2. Identify the direct costs for the job
3. Identify the indirect cost pools associated with the job
4. Select the cost-allocation base to use in allocating each indirect-cost pool to the job
5. Develop the rate per unit of the cost-allocation base used to allocate indirect costs to the job
6. Assign the costs to the cost object by adding all direct and indirect costs

Source documents
Original documents that support journal entries
Key source documents:
 Job cost record
 Materials requisition record
 Labour time record

Normal costing (soon after the job is completed)

Traces direct costs to a cost object by using the actual direct-cost rate times the actual quantity of
the direct-cost input and allocates indirect costs based on the budgeted indirect-cost rate
Actual costing (at the end of the year/period)
Same method as normal costing, but to allocate indirect costs the actual indirect-cost rate is used

Normal costing can lead to

- Underallocated indirect costs (underapplied; underabsorbed)
- Overallocated indirect costs (overapplied; overabsorbed)
It can have
- Numerator reason (budgeted indirect costs)
- Denominator reason (budgeted quantity of allocation base)
 End of period adjustments
Adjusted allocation rate approach (most accurate)
Restates all entries in the general ledger by using actual cost rates rather than budgeted cost rates
 Actual indirect-cost rate is calculated; then every job to which indirect-cost were allocated has its
amount recalculated using the actual rate

Proration approach (p. 82)

Proration is the term we use to refer to spreading of under- or overallocated overhead among
closing stocks and cost of goods sold
Method 1:
 Prorating underallocated overhead over pertinent accounts in proportion to their total
amount of indirect cost allocated
Method 2:
 Prorating underallocated overhead over pertinent accounts in proportion to their total
closing balances
Method 3:
 Prorating underallocated overhead only to cost of goods sold account
 Chapter 4: Process-costing Systems
Conversion costs
All other but direct manufacturing costs; transforming direct materials into finished goods
 Direct labour + indirect manufacturing costs

Equivalent Units
Expresses fully and partially completed units as fully completed units
Indication of the amount of work done by manufacturers who have partially completed units on
hand at the end of the accounting period
 Calculated separately for each input (cost category)

Process Costing Cases

1. No opening or closing work-in-progress stock
 Unit costs can be averaged by dividing total costs by total units produced
2. No opening but closing work-in-progress stock
 Apply equivalent production units concept for calculating costs
3. Opening and closing work-in-progress stock
 Use stock cost-flow method to calculate cost of units completed and
transferred out and cost of closing work in progress

5 step procedure
1. Summarise the flow of physical units of output
2. Compute output in terms of equivalent units
3. Compute equivalent unit cost
4. Summarise total costs to account for
5. Assign total costs to units completed and to units in closing work in progress

Stock cost-flow methods (actual)

 Weighted-average process-costing method (WA) [simple]
o Calculates equivalent-unit cost of the work done to date (regardless of in whether it
was done in the last or current period) and assigns this cost to equivalent units
completed and transferred and to equivalent units in closing work-in-progress stock

o Stage of completion of opening work in progress stock is irrelevant

 First-in, first-out method (FIFO) [more accurate and difficult]
o Assigns cost of the previous period’s equivalent unit in opening work-in-progress
stock to the first units completed and transferred out of the process
o Assigns cost of equivalent units worked on during the period first to complete
beginning stock, then to start & complete new units and finally to units in closing-
work-in-progress stock
o Assumes that earliest equivalent units in work in progress are completed first
o Work done in opening stock before current period is kept separate from work done
in current period
Comparison between weighted-average and FIFO methods
Cost of units completed and operating income can differ materially between the weighted-average
and FIFO methods when (1) the direct materials or conversion costs per unit very significantly form
period to period and (2) the physical stock levels of work in progress are large in relation to the
total number of units transferred out of the process.

The major advantage of FIFO is that it provides managers with information about changes in the
cost per unit from one period to the next.

The weighted-average method merges unit costs from different periods and so obscures period to
period comparisons. The major advantage of the weighted-average method, are its computational
simplicity and its reporting of a more representative average unit cost when input price fluctuating
markedly from month to month.

Standard-costing method of process costing

Determining separate standard or equivalent-unit costs on the basis of different technical processing
specifications for each product

Transferred-in costs (previous department costs)

Costs incurred in previous department that are carried forward/transferred as the product’s cost
when it moves from one department to the next
Transferred-in costs are treated as if they are a separate type of direct material added at the opening
Remember:
- Include transferred-in costs from previous departments in calculations
- On a FIFO basis, do not overlook opening costs that became included in transferred-in costs
- Although unit costs may fluctuate between periods, after transferring them they are costed
at one average unit cost
- Units may be measure in different units  converse transferred-in cost into the correct unit

Hybrid-costing systems
Characteristics from both job-costing and process-costing systems
 Chapter 5: Cost allocation
Purpose of allocating indirect cost
 Provide information for economic decisions
 Motivate managers and employees
 Justify costs or calculate reimbursement
 Measure income and assets for reporting to external parties

Homogenous cost pool (p.143)

All activities whose costs are included have same or similar cause-and-effect relationship or benefits-
received relationship between cost allocator and costs of the activity
 Combined rate per unit of allocation base is the same as the sum of the rates if individual
cost pools were allocated separately

Single-rate cost-allocation method

Pools all costs in one cost pool and allocates to cost objects the same rate per unit
 Low cost of implementation; may lead to decisions favourable for the division but NOT in the
best interest for the whole organisation
Dual-rate cost-allocation method
Classifies costs in one cost pool into two subpools (typically into fixed and variable costs) with
different allocation rates or allocation bases
 Signals to division managers how variable costs and fixed costs behave differently

Operating department (production department)

Adds value to product or service that is observable by a customer
Support department (service department)
Provides services that maintain other internal departments

Support department cost-allocation methods

Direct allocation method (p.149)
Allocates each support department’s costs directly to the operating departments
- Ignores supporting hours/costs among support departments
- Benefit: Simplicity

Step-down allocation method (step/sequential allocation method, p.150)

Allows for partial recognition of the services rendered by support departments to other support
departments  requires support departments to be ranked (sequenced)
 Costs in the first-ranked support department are allocated to the others and operating dep.
 Costs of second-ranked are allocated to not yet allocated support dep. And operating dep.
 Procedure is followed until costs in the last ranked support department are allocated
Two approaches to rank support departments:
 1. Approach A: Rank support departments on percentage of total support to support provided
to other support departments; highest percentage goes first
2. Approach B: Rank support departments on total euros of service provided to other support
departments

Reciprocal allocation method (p.151)

Allocates costs b explicitly including mutual service provided among all support departments
- Most accurate, if support departments provide support to each other
Implementing requires three steps:
1. Express support department costs and reciprocal relationships in linear equation form
2. Solve equations to obtain complete reciprocal costs of each support department
3. Allocate complete reciprocal costs of each support department to all other departments on
basis of usage proportions

Complete reciprocal cost

Actual costs incurred by a support department plus a part of the costs of the other support
departments that provide service to it  Artificial costs of the support department
Reciprocal method is conceptually preferred, but not widely used. Others are relative simple to
calculate and understand.

Two methods for allocating common cost

Common cost
Cost of operating a facility, operation, activity or other cost object that is shared by two/more users

Stand-alone cost-allocation method (p.155)

Uses information pertaining/belonging to each cost object as a separate operating entity to
determine the cost-allocation weights
 Fairness rationale, because users bear proportionate share of total costs in relation to their
individual stand-alone costs

Incremental cost-allocation method

Ranks individual cost objects to allocate costs among them
- First-ranked object is the primary party and is allocated up to its cost as a stand-alone entity
- Second-ranked object is the incremental party and is allocated the additional cost
- If there are more than two parties, the non-primary parties need to be ranked

Labour-paced operations
Worker dexterity/skill and productivity determine the speed of production
 Direct labour-hours as allocation base
Machine-paced operations
Machines conduct most phases of production; workers focus on supervising or troubleshooting
instead of operating the machines
 Machine-hours allocation base
 Chapter 7: Variable Costing and Absorption Costing

Variable Costing (p.199ff)

Method of stock costing in which all variable manufacturing costs are included as inventoriable
costs; all fixed manufacturing costs are excluded  costs of the period in which they incurred
- Classifying costs by business function (manufacturing, marketing)
Contribution margin (variable costing)
Sales less variable costs  to pay fixed/period costs

Absorption Costing
Method of stock costing in which all variable manufacturing costs and all fixed manufacturing costs
are included as inventoriable costs (stock ‘absorbs’ all manufacturing costs)  fixed costs for closing
stock is transferred to costs of next period
- Classified costs by cost behaviour (variable, fixed)
- Preferred by managers; Production > Sales lead to higher operating benefit
 Each additional unit produced absorbs fixed manufacturing costs that would have been
written off as cost of the period
- May induce managers to make decisions ‘against the long-run interests’
- Generally accepted for external reporting
Gross margin (absorption costing)
Sales less cost of goods sold  to pay non-manufacturing cost

Difference between variable costing and absorption costing centres is the accounting for fixed
manufacturing costs/overhead  operating profit will differ

Explaining differences in operating profit (p.206f)

If stock level increases, variable costing will generally report less operating profit than absorption
If stock level decreases, variable costing will generally report more operating profit than absorption
3 Formulas to calculate the difference between operating profit under both methods

Denominator-level concepts and absorption costing (p.213ff)

Theoretical capacity
Denominator-level concept that is based on the production output a full efficiency for all of the time
Practical capacity
Denominator-level concept that reduces theoretical capacity for unavoidable operating interruptions
(e.g. scheduled maintenance time, shutdown for holidays)
Normal utilisation
Denominator-level concept based on the level of capacity utilisation that satisfies average customer
demand over a period (includes seasonal, cyclical or other trend factors)
Master-budget utilisation
Denominator-level concept based on the anticipated level of capacity utilisation for the next period

Chapter 8: Cost-volume-profit relationships

Cost-volume-profit (CVP)
Analyses the behaviour of total revenues, total costs and operating profit as changes occur in output
level, selling price, variable costs or fixed costs (single revenue & single cost driver)
 Six CVP assumptions (p.242)

Revenue driver
Factor that affects revenues (output sold, selling prices, levels of marketing costs)

Breakeven point (p.243)

That quantity of output where total revenues and total costs are equal  operating profit is zero
Three methods of determining the breakeven point:
1. Equation method

 Setting OP equal to zero

2. Contribution margin method

Contribution income statement

Highlights contribution margin by lining items by cost behaviour pattern

3. Graph method
Plot total cost and total revenue line  intersection is the breakeven point

Target operating profit

To calculate the unit number required to gain a specific target operating profit, replace the OP in the
first two methods with that number
Profit-volume (PV) graph
Shows the impact on operating profit of changes in the output level
Impact of income taxes
Sensitivity analysis
What-if technique that examines how results change if original predicted data are not achieved or if
an underlying assumption changes
Margin of safety (p.249)
Excess of budgeted revenues over the breakeven revenues

Operating leverage (p.252)

Describes the effects that fixed costs have no changes in operating profit as changes occur in units
sold and hence in contribution margin (high proportion of fixed costs  high operating leverage)
At any given level of sales, the degree of operating leverage equals contribution margin divided by
operating profit.

Revenue mix (sales mix, p.253f)

Relative combination of quantities of products or services that constitutes total revenues

Contribution margin and gross margin

Can be expressed as totals, as an amount per unit, or as percentages
Calculations for a) Merchandising sector, b) Manufacturing sector on page 255f

Contribution margin percentage  Total contribution margin divided by revenues

Variable-cost percentage  Total variable costs (w.r.t. units of output) divided by revenues
Gross margin percentage  Gross margin divided by revenues

Chapter 9: Determining how costs behave

Two assumptions - Estimating cost functions
1. Variations in the total costs of a cost-object are explained by variations in a single cost driver
2. Cost behaviour is adequately approximated by a linear cost function of the cost driver within
the relevant range (straight line)
Slope coefficient
Amount by which total costs change for a unit change in the cost driver within the relevant range
Constant / Intercept
Component of total costs that does not vary with changes in the level of the cost driver within the
relevant range

Mixed / Semivariable cost

Cost that has both fixed and variable elements

Cost estimation
Attempt to measure past cost relationships between total costs and the drivers of those costs

Cost estimation approaches

1. Industrial engineering method (Frank & Lillian Gilbreth)
(Also called work-measurement method)
 Estimates cost functions by analysing relationship between inputs and outputs in physical
terms
- Can be very time-consuming, therefore often too costly
- Used for direct-cost categories rather than indirect costs

2. Conference method (p.275)

 Estimates cost functions on the basis of analysis and opinions about costs and their drivers
gathered from various departments of an organisation
- Allows quickly development of cost functions and credibility through expert knowledge

3. Account analysis method (p.276)

 Estimates cost functions by classifying cost accounts in the ledger as variable, fixed or mixed
with respect to the identified cost driver
- Managers prefer qualitative over quantitative analysis
- Reliability of cost classifications increases when conference method is supplemented

4. Quantitative analysis
 High-low method and regression analysis

High-low method (p.179)

Simple method to estimate cost functions by using only the highest and lowest observed values of
the cost driver within the relevant range; the line connecting these two points is the cost function

y 2− y 1
x 2−x 1

Then, to
calculate the constant a of the cost function:

Regression analysis (p.280f) NOT RELEVANT

Statistical method that measures the average amount of change in the dependent variable that is
associated with a unit change in one or more independent variables
 Use least-square technique from computer software programs to derive cost function

6 Steps in estimating a cost function

  Choose the dependent variable
 Variable to be predicted
 Identify the independent variable(s) or cost driver(s)
 Level of activity or cost driver used to predict the dependent variable
 Collect data on the dependent variable and the cost driver(s)
 Time-series and cross-sectional data
 Plot the data
 Estimate the cost function
 High-low method and regression analysis
 Evaluate the estimated cost function

Residual term
Difference between actual and predicted costs

Criteria to choose a cost driver

 Economic plausibility
- Context (highly automated production  machine hours rather than labour-hours)
 Goodness of fit
- Differences between actual and predicted costs
 Slope of regression line
- Flat (small) slope indicates weak or not relationship
- Steep (big) slope indicates stronger relationship

Non-linear cost function (p.285)

Cost function where, within the relevant range, the graph of total costs versus the level of a single
activity is not a straight line
Step cost function (p.286)
Cost function in which the cost is constant over various ranges of the cost driver, but the cost
increases by discrete amounts (in steps) as the cost driver moves from one range to the next
Step fixed-cost function (p.286)
Cost is constant over large ranges of the cost driver in each relevant range

Learning curve
Shows how labour-hours per unit decline as units of production increase
Unit costs decrease as productivity increases
Experience curve
Shows how full product costs per unit (including manufacturing, marketing, distribution, etc.) decline
as units of output increase

Cumulative average-time learning model (p.287)

The cumulative average time per unit declines by a constant percentage each time the cumulative
quantity of units produced doubles
Incremental unit-time learning model
Declines by a constant percentage each time (time needed to produce the last unit) the cumulative
quantity of units produced doubles
 Chapter 10: Relevant information for decision making
Decision model
Formal method for making a choice, frequently involving quantitative and qualitative analyses

Accounting information and the decision process

Five-step sequence (p.311)
1. Gathering information
2. Making predictions
3. Choosing an alternative
4. Implementing decision
5. Evaluating performance

Relevant costs
Those expected future costs that differ among alternative courses of action
Relevant revenues
Those expected future revenues that differ among alternative courses of action
Differential cost
Difference in total cost between two alternatives

Quantitative factors
Outcomes that are measured in numerical terms (financial and non-financial)
Qualitative factors
Outcomes that cannot be measured in numerical terms (e.g. employee morale)

Incremental costs
Additional costs to obtain an additional quantity, over and above existing or planned quantities, of a
cost object

Potential problems in relevant-cost analysis (p.315)

 Assuming that all variable costs are relevant, which is not always the case
  Assuming that all fixed costs are irrelevant, also not always the case
 Unit costs mislead, so rather use total costs

Make-or-buy decisions
Decisions about whether producers of goods or services will insource or outsource

Book value (p.327)

Original cost minus total depreciation

Chapter 11: Activity-based costing

Cost smoothing
Describes a costing approach that uses broad averages to uniformly assign cost of resources to cost
objects when the objects in fact use resources in a non-uniform way
Product undercosting
Product consumes relatively high level of resources but is reported to have relatively low total cost
Product overcosting
Product consumes relatively low level of resources but is reported to have relatively high total cost

Product-cost cross-subsidisation (p.342)

Means that at least one miscosted product is resulting in the miscasting of other products

Refined costing system (p.346)

Reduces use of broad averages for assigning cost of resources to cost objects and provides better
measurement of the costs of indirect resources used by different cost objects

Reasons to refine costing systems

 Increase in product diversity
 Increase in indirect costs
 Advances in information technology
 Competition in product markets
Three guidelines for refining a costing system
 Direct-cost tracing  reduce costs classified as indirect
 Indirect-cost pools  make cost pools more homogenous
 Cost-allocation bases  cause-and-effect criterion, to identify cost-allocation base (cause)
for each indirect-cost pool (effect)

Activity-based costing (ABC) (p.347)

ABC systems refine costing systems by focusing on individual activities as the fundamental cost
objects; activity is an event, task or unit of work with a specified purpose
ABC systems calculate costs of individual activities and assign costs to cost objects such as products
and services on the basis of the activities undertaken to produce each product or service
Cost hierarchy (p.350 with Plastim examples)
Categorisation of costs into different cost pools on the basis of either different types of cost driver
(or allocation base) or different degrees of difficulty in determining cause-and-effect (or benefits
received) relationships
Output-unit-level cost
Resources sacrificed on activities performed on each individual unit of a product/service
Batch-level costs
Resources sacrificed on activities that are related to a group of units of products/services
Product/service-sustaining costs
Resources sacrificed on activities undertaken to support individual products/services
Facility-sustaining costs
Resources sacrificed on activities that cannot be traced to individual products/services but which
support the organisation as a whole

Activity-based management (ABM)

Describes management decisions that use activity-based costing information to satisfy customers
and manage profitability
 Pricing and product-mix decisions
 Cost reduction and process improvement decisions
 Design decisions
 Planning and managing activities
 Chapter 12: Pricing, target costing and customer profitability
(Relevant pages 376-382)
Three major influences on pricing
1. Customers
- Understanding customer’s price and product preferences
- Technology-driven customer knowledge
2. Competitors
- Reactions influence pricing decisions
 Competitor analysis
3. Costs
- Price products to exceed costs of making them

Product-cost categories and time horizon

The relevant time horizon is critical for a pricing decision
 Short-run decisions (e.g. pricing for a one-off special order with not long-term implications;
adjusting product mix and output volume)
 Long-run decisions  Time horizon of a year or longer (e.g. pricing a product in a major
market where price setting has considerable leeway; computing relevant costs for long-run)

Chapter 14: Motivation, budgets and responsibility accounting

Master budget
Single organisation-wide set of budgets for a given time period (embraces operating and financing)

Rolling budget
A budget or plan that is always available for a specified future period by adding a month, quarter or
year in the future as the month, quarter or year just ended is dropped

Operating budget (p.475)

The budgeted profit statement and its supporting budget schedules
Financial budget
Part of the master budget that comprises the capital budget, cash budget, budgeted balance sheet,
and budgeted statement of flows

Different terminology among organisations; financial statements = pro forma statements;

budgeting = targeting = profit plan

Supporting budget schedules (p.477)

Different categories that form the master budget (e.g. revenue budget, production budget, direct
materials usage/purchases budget, manufacturing overhead budget, closing stock budget, etc.)

Padding the budget or introducing budgetary slack

Practice of underestimating revenues or overestimating budgeted costs in order to make budgeted
targets more easily achievable

Production budget (p.478)

Direct
materials purchases budget

Costs of goods sold budget

Financial planning models

Mathematical representations of the relationships across operating activities, financial activities and
financial statements

Kaizen budgeting
Budgetary approach that explicitly incorporates continuous improvement during the budget period
into the resultant budget numbers

Activity-based budgeting
Focuses on the cost of activities necessary to produce and sell products and services; separates
indirect costs into separate homogenous activity cost pools
4 Key steps:
1. Determine budgeted costs of performing each unit of activity at each activity area
2. Determine demand for each individual activity based on budgeted, production, new product
development and so on
3. Calculate costs of performing each activity
 4. Describe the budget as costs of performing various activities

Responsible centre
Part, segment or subunit of an organisation whose manager is accountable for a specified set of
activities; the higher manager’s level the broader the responsibility centre to manage
Responsibility accounting
System that measures the plans (by budgets) and actions (by actual results) of each responsibility
centre
4 Major types of responsibility centre:
1. Cost centre  manager accountable for costs only
2. Revenue centre  manager accountable for revenues only
3. Profit centre  manager accountable for revenues and costs
4. Investment centre  manager accountable for investments, revenues and costs

Variances between budgeted and actual results – Helpful for managers (p.488)
1. Early warning. Variances alert managers early to events not easily or immediately evident.
Manager can then take corrective actions or exploit available opportunities
2. Performance valuation. Variances inform managers about how well the company has
performed in implementing its strategies
3. Evaluating strategy. Variances sometimes signal to managers that their strategies are
ineffective
4. Communicating the goals of the organisation. The budget-making exercise and budgeting
information are useful in conveying to managers across the organisation the goals of
subunits and the wider corporate goals

Controllability
Degree of influence that a specific manager has over costs, revenues or other items in question
Controllable cost
Any cost that is primarily subject to the influence of a given manager of a given responsibility centre
for a given time span
 Chapter 15: Flexible budgets, variances and management control
Variance
Difference between an actual result and a budgeted amount (benchmark)

Static budget (p.509)

Budget that is based on one level of output; it is not adjusted or altered after it is set, regardless of
ensuing changes in actual output (or actual revenue and cost drivers); developed at the start of the
budget period
Static budget variance = Actual results – Static budget amount of operating profit

Favourable variance (denoted F)

Variance that increases operating income relative to the budgeted amount
Unfavourable variance (denoted U)
Variance that decreases operating income relative to the budgeted amount
Flexible budget
Adjusted in accordance with ensuing changes in actual output; calculated at the end of the period
when the actual output is known
Five steps in developing a flexible budget
1. Determine the budgeted selling price per unit, the budgeted variable costs per unit and the
budgeted fixed costs
2. Determine the actual quantity of the revenue driver
3. Determine the flexible budget for revenue based on the budgeted unit revenue and the
actual quantity of the revenue driver
4. Determine the actual quantity of the cost driver(s)
5. Determine the flexible budget for costs based on the budgeted unit variable cost and fixed
costs and actual quantity of the cost driver(s)

Flexible-budget variance
Difference between the actual results and the flexible-budget amount for the actual levels of
revenue and cost drivers
Flexible budget variance = Actual results – Flexible budget amount
Sales-volume variance
Difference between the flexible-budget amount and the static-budget amount
Sales volume variance = Flexible budget amount – Static budget amount

Selling price variance

Flexible budget variance pertaining to revenues
Selling price variance = (Actual selling price – Budgeted selling price) x Actual units sold

Price variance
Difference between the actual price and the budgeted price multiplied by the actual quantity of
input in question (such as direct materials purchased or used); also called input-price variance or
rate variance (especially for direct labour)
Price variance = (Actual price of input – Budgeted price of input) x Actual quantity of input
Efficiency variance (p.517f)
Difference between the actual quantity of input used (such as metres of cloth of direct materials)
and the budgeted quantity of input that should have been used, multiplied by the budgeted price;
sometimes called input-efficiency variances or usage variances
Efficiency variance = (Actual quantity of input used – Budgeted quantity of input allowed for actual
output units achieved) x Budgeted price of input
The higher the level, the more detailed information analysis report to managers
Sum of price variance and efficiency variance equals flexible budget variance

Standard input (p.515)

Carefully predetermined quantity of input required (kg for materials or hours of labour time) for one
unit of output
Standard cost
Carefully predetermined cost; can relate to units of inputs or units of outputs

Performance evaluation
 Effectiveness – Degree to which a predetermined objective or target is met
 Efficiency – Relative amount of inputs used to achieve a given level of output

Continuous improvement budgeted cost (p.523)

Budgeted cost that is successively reduced over succeeding time periods

Relating batch costs to product output

Calculating the flexible budget variance for batches instead of units of output: p. 525f