CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
CAP1 MANAGEMENT ACCOUNTING SESSION 1 – INTRODUCTION NOTES
By the end of this session, you should:
Be able to explain the role of the Management Accountant in an organisation.
Be able to explain the different ways of categorising costs
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Contents
Syllabus .................................................................................................................................... 3
Organisational objectives and the role of the management accountant ........................ 3
Role of management accounting - Chapter Reference 1.1 and 1.2 (Pages 1 to 8) ..... 3
Ethical Issues - Chapter Reference 1.5 (pages 16 to 20) ................................................. 5
Management Accounting Today - Chapter Reference 1.3 and 1.6 (Pages 8 to 11 and 20 to 21) .................................................................................................................................... 6
Cost Classification - Chapter Reference 2.2 (pages 30 to 40) ....................................... 8
Analysing Costs between fixed and variable .................................................................... 10
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Syllabus Organisational Context
Budgetary Control
Standard Costing & Variances
Cost and Management Accounting
Decision making
Key Points to Note : • Continuous assessment - 15% • Final Exam – 85% • Move from knowledge based to competency based exams
Organisational objectives and the role of the management accountant
Outline the role of management accounting in the achievement of organisational objectives
Distinguish profit making businesses and other types of organisations
Describe the operating environment of the management accountant; internal and external
Describe the management accounting system
Outline the role of management accounting in running the business
Outline possible ethical issues facing the management accountant
Cost Classification
Explain basic cost classifications, revenue classifications and typical terms used by management for planning
Analyse cost by cost function and type
Explain cost behaviour patterns, to include fixed, variable and semi-variable costs
Explain how cost behaviour patterns vary on an activity basis and per unit basis
Distinguish between contribution and gross margin
Role of management accounting - Chapter Reference 1.1 and 1.2 (Pages 1 to 8)
Planner e.g. budgeting
Information provider e.g. operating statements
Controller e.g. budgetary control
Motivator e.g. providing budgets
Decision maker e.g. relevant costing
Planning 1. Establishing Objectives 2. Short or long Term 3. Levels of Planning, for example, Strategic, Tactical and Operational
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Types of Organisations
Manufacturing
Service Companies
Not for Profit organisations
Decision Making Stages in Decision Making Planning Phase
1. Set Objective 2. Identify ways to achieve objective 3. Make a decision about best way to achieve objectives
Implement Decision Control Phase
1. Gather information about actual results 2. Compare actual to plan results 3. Revise original objectives if necessary
Types of Decisions 1. Product Mix 2. Sales Price 3. Credit Terms to offer to customers 4. Sources of Finance to use 5. Capital Expenditure 6. Setting Budgets for marketing spend
Responsibility Accounting & Responsibility Centres
Cost Centre – A production, service or location, function, activity or item of equipment whose costs can be identified and recorded.
Profit Centre – Part of Business for which both costs and revenues are identified.
Investment Centre – Managers responsible for investment decisions as well as costs and revenues.
Revenue Centre – Only accountable for revenue
Financial Accounting is recording of transactions and summarising them in periodic financial statements for external users. Duties of Financial Accountant:
Maintaining bookkeeping system of nominal ledger,
Accounts payable control,
Accounts receivable control,
Preparation of Statutory accounts
Information prepared by financial accountant is at too high a level for individual managers. Cost and management Accountant provides this more detailed information
Cost Accounting
Careful evaluation of resources used within the company,
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Techniques employed are designed to provide financial information about the future performance.
Historical cost of product or service
Management Accounting
Forward Looking – Budgets and Forecasts
Provision of non financial information to managers
Provide advice based on information to management
Include involvement in planning, decision making and control
Ethical Issues - Chapter Reference 1.5 (pages 16 to 20) Ethical issues facing the management accountant
Corporate Social Responsibility Vs maximising shareholder wealth
Ethical investment
Short term opportunism Vs Long term sustainability
Decisions impacting adversely on stakeholder groups e.g. suppliers, employees etc.
Examples of Unethical Behaviour by Management Accountant
Not accruing for unpaid expenses,
Delaying maintenance expenditure in an effort to reduce costs,
Inflating closing inventory valuations in order to increase reported profits. Why motivates this unethical behaviour?
Financial Incentives offered to management,
Promotion Opportunities and
Avoid Scrutiny Code of Conduct Principles underlying the code of conduct are:
Integrity,
Objectivity,
Professional Competence and
Confidentiality.
Resolution of Ethical Conflict 1. Discuss with Superior 2. Confidential Discussion with Independent Advisor 3. Withdraw / Resign from assignment 4. Inform Organisation / Regulatory Authorities
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Management Accounting Today - Chapter Reference 1.3 and 1.6 (Pages 8 to 11 and 20 to 21)
Users of Management Information
Internal Users External Users
Employees
Management
Investors
Customers / Suppliers
Competitors
Government
General Public
Lenders
Internal Activities of a Company
• Production • Research & Development • Product Design • Marketing • Sales and Delivery • Customer Service • Human Resources
Changing Competitive Environment
• Customers Expectations Excellent Service High quality products at low price, Variety and range of products.
• Shorter Product Life Cycles • Increased International Competition • Technological Advances and Improvements
Difference between Management and Financial Accountant
Management Accountant Financial Accountant
What Parts of organisation Whole Organisation
When Monthly (prospective) Annual (Retrospective)
Who Internal Managers External Users
Why Planning & Control Financial Decisions
How Free Format Prescribed Format (GAAP)
Key Attributes Relevance & Timeliness Verification and Precision
Management Accounting is concerned with the provision of information to internal management to hep direct and control the organisations operations. Primarily concerned with Planning, Decision Making and Control.
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Financial Accounting is concerned with the provision of information to shareholders, creditors and other users outside of the organisation to assist them in making financial decisions. Primarily concerned with stewardship. Computers in Management Accounting
Speed of information availability
Checks can be incorporated to validate input for reasonableness
Electronic Storage
Maintenance required to prevent corruption of data from virus attack
Adaptability of information e.g. coding structures and report writers
Computers in Management Accounting
Capture of information e.g. bar coding
Immediate update / amendment of data
Can handle a large of volume of data quickly
Output can be presented in a variety of formats
Ability to model/analyse information e.g. spreadsheet modelling
Ability to present and transfer information e.g. graphs, e-mail attachments etc. Characteristics of Financial Information
Accurate
Complete
Cost Effective
Understandable
Reliable
Available to Users via appropriate delivery channels
Timely Factors affecting Quality of Information
Source of Information
Type of Information – Financial or non-financial
Methods of recording and processing data – Manual or computerised
Presentation of Information
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Cost Classification - Chapter Reference 2.2 (pages 30 to 40) Classification of Costs
Element – Material, Labour and Expense
Separating costs into fixed and variable elements
Nature – Direct or Indirect
Behaviour – Variable, Fixed, Semi Variable or Stepped Fixed
Function – production or non-production costs, for example, Selling, distribution or administration costs
Fixed Costs
Activity (units)
Total
fixed
costs (£)
£5k
Fixed
costs
per unit
(£)
Activity (units)Activity (units)
Total
fixed
costs (£)
£5k
Fixed
costs
per unit
(£)
Activity (units)
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Variable Costs
Changes in Fixed and Variable costs in total and on a per unit basis
Total Cost Cost Per Unit
Variable Cost Total Cost changes as the activity level changes
Cost per unit remains the same as activity changes
Fixed Cost Total fixed costs remain the same as activity levels change
Cost per unit decreases as activity level increases
Semi Fixed / Stepped Costs
• Costs are fixed until certain trigger points are breached e.g. number of supervisors
• If one supervisor is required for 10 staff then the supervisor’s salary costs will remain fixed until more than 10 staff are employed when a second supervisor will be required
Activity (units)
Total
variable cost
(£)
30
Variable costs
per unit (£)
Activity (units)
1
10
10
20
2 3 1 2 3
Activity (units)
Total
variable cost
(£)
30
Variable costs
per unit (£)
Activity (units)
1
10
10
20
2 3 1 2 3
Activity (no of staff)
Total semi-
fixed costs
(£k)
60
20
20
40
3010
Activity (no of staff)
Total semi-
fixed costs
(£k)
60
20
20
40
3010
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Semi Variable Costs
Cost separation is the process of separating the fixed and variable elements of a semi-variable cost : Methods
• High – Low Method • Scatter graph method
Analysing Costs between fixed and variable
Example 1 You have been provided with the following information regarding costs incurred over the past two months: June 3,000 units 7,500 July 2,000 units 6,000 Expected output in August is 4,000 units. Requirement What will the variable and fixed costs be? Solution Use the High / Low Method: Step 1 Calculate the variable cost per unit Cost at high Volume - Cost at low volume High activity level – Low activity Level 7,500 – 6,000 = 1,500 3,000 – 2,000 1,000 = 1.50 Variable Cost per unit
Activity
Total semi-
variable costs
(£)
Variable element
Fixed element
Activity
Total semi-
variable costs
(£)
Variable element
Fixed element
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Step 2 Calculate the fixed costs Once you know the variable cost per unit you can calculate the fixed costs. You can select either activity level given in the question to calculate the fixed cost.
Activity Level of 3,000 units Total Cost 7,500 Variable Cost (3,000 X 1.50) (4,500) Fixed Cost 3,000 Activity Level of 2,000 units Total Cost 6,000 Variable Cost (2,000 X 1.50) (3,000) Fixed Cost 3,000 Step 3 Calculate the Cost at 4,000 units of output Fixed Cost 3,000 Variable Cost (4,000 X 1.50) 6,000 Total Cost 9,000 Question 1 Over the last two months the following production costs were incurred by Department XZ: Level of activity Production cost May 3,180 units €15,405 June 4,200 units €18,873 In July budgeted production was 5,000 units. What is the budgeted production cost for July? Example A company manufacturing a single product has the following costs at two different activity levels: Activity level (units) 30,000 50,000 Total costs (€) 189,000 303,000 Variable costs are constant at all activity levels, but fixed costs increase by €4,000 every 20,000 units. Requirement What is the total costs at an activity level of 35,000 units? Solution We need to make an adjustment to the total costs before we put them into the formula. The reason for this is because each activity level has a different amount of fixed costs. Total Costs at 50,000 units 303,000 Additional Fixed Costs ( 4,000) 299,000 Variable Cost per unit……. 299,000 – 189,000 = 110,000 = 5.50
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
50,000 – 30,000 20,000
Activity Level of 30,000 units Total Cost 189,000 Variable Cost (30,000 X 5.50) (165,000) Fixed Cost 24,000
Activity Level of 50,000 units Total Cost 303,000 Variable Cost (50,000 X 5.50) (275,000) Fixed Cost 28,000
Costs at 35,000 units of output Fixed Cost 24,000 Variable Cost (35,000 X 5.50) 192,500 Total Cost 216,500 Alternative Method Only difference between costs at 30,000 and 35,000 units is the additional variable costs. The fixed costs are the same. Total Costs at 30,000 units 189,000 (35,000 – 30,000) X 5.50 27,500 216,500 Question 2 A company manufacturing a single product has the following costs at two different activity levels: Activity level (units) 25,000 35,000 Total costs (€) 185,000 255,000 Variable costs are constant at all activity levels, but fixed costs increase by € 5,000 every 10,000 units. Requirement What are the fixed costs at an activity level of 28,000 units?
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Scatter Graph Approach • Plot all previous activity levels & costs on a graph • Draw a line of best fit, using your judgement • Use line to determine cost for other activity levels • The intercept of the line on the vertical axis should be the fixed cost, i.e. cost
when activity level is zero • We can then calculate the approximate variable cost by substitution into one
of our existing data points Cost Behaviour Summary
Total Cost Cost per Unit
Variable Total cost changes as activity level changes
Cost per unit remains the same even when the activity level
changes
Fixed Total cost remains the same even when the activity level
changes
Cost per unit goes down as activity level goes up
Semi-Variable
Includes a fixed element and a variable element
Includes a fixed element and a variable element
Stepped Total cost remains the same but only for a set time period or level
of activity
Cost per unit goes down as activity level goes up (within each time period or level of
activity)
-
50,000
100,000
150,000
200,000
250,000
300,000
350,000
400,000
450,000
- 100 200 300 400 500 600 700 800
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Example 3 Classify the following costs according to their behaviour:
Cost Behaviour
Petrol
Quarterly Rent for Factory
Telephone Bill
Raw Materials
Depreciation of one and two machines
Electricity Bill
Petrol
Example 4 Classify the following costs as one of the following:
Production
Selling
Distribution
Administration
Finance Costs to be classified:
Cost Function
Print Cartridges for General Office
Salary of Factory Supervisor
Salary of Payroll Supervisor
Interest Charge on Overdraft
Sales staff commissions
Road Tax for delivery vans
Direct Cost
• A Direct Cost is incurred on a specific product, service, job or batch • Direct Cost include:
• Direct Materials, for example, Flour for Bread, • Direct Labour, for example, Production Workers Wages, • Direct Expense, for example, Plant hire • Total of Direct Costs = Prime Cost
Indirect Costs
• Indirect Costs cannot be traced to a specific product, service, job or contract. • Indirect costs can be either manufacturing or non manufacturing. Indirect
costs are also referred to as overhead. • Manufacturing Overhead is apportioned to product and services.
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
• Non Manufacturing overhead is charged to the SOCI in the period it is incurred. Non manufacturing overhead is made up of administration, selling, distribution and finance costs.
• Examples of Manufacturing Overhead are: Indirect Materials, for example, glue, oil, Indirect Labour, for example, factory supervisor, Indirect Expense, for example, factory rent, machine depreciation
Example 5 Classify the following costs by element and by nature
Cost Material / Labour / Expense ( by Element)
Direct / Indirect (by Nature)
Hire of Plant – Specific Job
Factory Supervisors Salary
Depreciation on Equipment
Factory Workers Salary
Packing Materials for Finished Goods
Oil for Machines
Example of Cost Card
Direct Material Direct Labour Direct Expense PRIME COST Variable Production Overhead MARGINAL PRODUCTION COST Fixed Production Overhead TOTAL PRODUCTION COST Non Production Overhead Administration cost Selling Cost Distribution Cost TOTAL COST Profit Sales Price
X X X X X X X X
X X X X X X
Companies set their selling price to achieve a particular mark up or margin:
Mark Up on cost – Selling price is set to achieve a particular mark up on cost of producing the product.
Margin of Selling Price – Price is set to achieve a percentage of profit on the selling price
Example 6 A Ltd has estimated the cost of producing its latest product as €7.50 per unit. What is the selling price if the company wants to achieve :
(a) A mark up of 20%, or (b) A margin of 25%.
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
Solution (a) To calculate the selling price per unit :
Cost X 100 + Mark Up 100 7.50 X 100 + 20 = 7.50 X 120 = 9.00 100 100 (b) To calculate the selling price per unit:
Cost / (1 – Margin) where the margin is expressed as a percentage 7.50 / (1 – 0.25) = 10.00 Product Costs and Period Costs Product costs
• Costs associate with a particular product/service • Include direct & indirect costs (manufact. overheads) • Initially recorded as part of the value of inventory • Treated as expenses (cost of sales) when inventory is sold
Period costs (non-manufacturing costs) • Don’t relate specifically to a particular product/service • Treated as expenses in period in which incurred • Never included in the value of inventory
Relevant and Non Relevant Costs
• Used in the process of decision making. • A relevant cost will impact on the decision being made, whereas an irrelevant cost
will not.
Sunk Cost
• A Sunk cost is a cost that has already been incurred or committed to and cannot be changed by any future action to be taken.
• Example : A company carried out market research to assess customer interest in a new product. The market research findings were favourable and the company is now assessing whether to begin manufacturing and selling the new product.
• In assessing whether the product should be produced the money spent on the market research is a sunk cost and not relevant to the decision to produce the product. The market research costs were already committed to and irrespective of whether the product is produced or not these costs have been committed to.
Opportunity Cost
• The opportunity cost is relevant is evaluating the consequences of one course of action over another.
• In decision making a company must include all relevant costs as well as benefits foregone if the resources were committed to the next best alternative.
• This approach ensures that profits are maximised.
CAP1 Management Accounting, Academic Year 2011 / 2012 © Chartered Accountants Ireland
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