Ma
youeef
s4.zipQ Management Accounting.doc
SECTION A -
1. Tiger Co operates an activity-based costing system and has forecast the following information for next year.
Cost Pool Cost Cost Driver Number of Drivers
Production set-ups £105,000 Set-ups 300
Product testing £300,000 Tests 1,500
Component supply and storage £25,000 Component orders 500
Customer orders and delivery £112,500 Customer orders 1,000
General fixed overheads such as lighting and heating, which cannot be linked to any specific activity, are expected to be £900,000 and these overheads are absorbed on a direct labour hour basis. Total direct labour hours for next year are expected to be 300,000 hours.
Tiger Co expects orders for Product AB1 next year to be 100 orders of 60 units per order and 60 orders of 50 units per order. The company holds no inventories of Product AB1 and will need to produce the order requirement in production runs of 900 units. One order for components is placed prior to each production run. Four tests are made during each production run to ensure that quality standards are maintained. The following additional cost and profit information relates to product AB!
Component cost: £1.00 per unit
Direct labour: 10 minutes per unit at £7.80 per hour
Profit mark up: 40% of total unit cost
Required:
(a) Calculate the activity-based recovery rates for each cost pool.
(b) Calculate the total unit cost and selling price of Product ZT3.
(c) Discuss the reasons why activity-based costing may be preferred to traditional absorption costing in the modern manufacturing environment.
(d) Explain the approach Tiger Co has chosen for it’s method of pricing and the reasons
why it may have done so
(e) Identify two other methods of deciding upon a selling price and explain what their
their advantages and disadvantages are.
Section B -
2. Many firms still focus on profitability as their main measure of performance, despite increasing evidence that non-financial measures are often more important.
Required:
(a) Explain the arguments for using the profit measure as the all-encompassing measure of the performance of a business.
(b) Explain the limitations of this profit-measurement approach and of undue dependence on the profit measure.
(c) Explain the problems of using a broad range of non-financial measures for the short- and long-term control of a business.
3. Holden plc is a large multinational organisation.
a. Explain the term ‘decentralised structure’ and the advantages and disadvantages that Holden plc might experience if it adopts a decentralised structure
b. Explain the term ‘transfer price’. What are the different methods that Holden could use to determine the price it uses to transfer goods or services from one division to another
c. Discuss the problems that arise specifically when determining transfer prices where divisions are located in different countries
4. Much of our management accounting theory in the UK was developed in the
1800’s and many of these techniques are still used in the UK today.
Other countries have developed other techniques and principles, which have also been proven to work, although they are very different to those used in this country.
The Japanese company Toyota developed a new theory, the Toyota Production System (TPS), which has been widely used not only in Japan but also in organisations worldwide.
(a) Explain what you understand by Kaizen costing and contrast it to Business Process Re-engineering (BPR)
(b) Discuss how the TPS systems is implemented
(c) There are four principles necessary for a system of TPS. Identify and explain them.
S1/ASB 4420MSc Accounting and Finance 2014-15.doc
ASB 4420 MSc Accounting and Finance 2014 - 15
Session
1 Introduction – what is management accounting?
2 Overhead absorption – traditional v ABC
3 Budget theory
4 Control – standard costing, variance analysis
5 Control – standard costing , variance analysis
6 Pricing – methods, learning curve
7 Divisional performance – short termism, ROI, RI, EVA
8 Divisionalism – transfer pricing
9 Performance measurement – non financial measurement
10 Modern developments – Kaizen v BPR
S1/introduction 2014-15.pptx
MSc Accounting and Finance
Management Accounting
Introduction
Course: ASB 4420 Management Accounting
Tutor: Wendy Ashurst
Email: [email protected]
Office: Hen Coleg room 0.15
Introduction
Assessment
Assignment 25 % of marks
Exam 75 % of marks
Introduction
Recommended Texts
Colin Drury: Management Cost Accounting
Anthony Atkinson: Management Accounting
Will Seal: Management Accounting
Kaplan Publishing – ACCA F5 Performance Management – study text
S1/session 1.pptm
MSc Accounting and Finance
Management Accounting
Session One
Costs - Revision
Costs – for stock valuation
Period and product costs
The measurement of these costs is important in Financial Accounting, to determine the profit figure and for valuing assets. This is because the Standards require that only manufacture costs are included in the product cost.
1. Product costs – the cost of goods purchased or produced for resale.
2. Period costs – those costs not included in the stock valuation, which are therefore treated as expenses in the period incurred.
Costs – for stock valuation
Elements of Manufacturing costs
The costs of manufacturing a product can be broken down into the following elements:
1. Direct materials – the cost of all materials which can be physically identified with a specific product,
2. Direct labour – the cost of any wages paid, which can be specifically traced to a particular product
3. Direct overheads – any overheads incurred, which can be traced to a specific product
4. Prime cost – the total of the direct costs
5. Manufacturing overheads – all other manufacturing costs, plus indirect expenses eg rent and depreciation
6. Total manufacturing cost – all the above costs added together
eg table, wood, metal etc
(labourers and not supervisors)
eg royalties, hire of plant
Supervisors’ wages
Costs – for decision making and planning
These costs provide management with information on which they can base decisions for future events.
a) Cost behaviour – companies need to know how costs will vary with different levels of activity.
Costs – for decision making and planning Cost behaviour
1. Fixed costs – those costs which remain constant for a specified time, eg depreciation or rates. In the short term, the TOTAL fixed costs remain constant over the level of activity, whereas the unit fixed cost will decrease proportionally.
Unit Fixed Costs
Total Fixed Costs
£s
Output
£s
Output
1. Eg supervisors’ salaries
2. Variable costs – those costs which vary in direct proportion to the volume of activity. In the short term, the TOTAL variable costs are linear, and the UNIT variable costs are constant.
Costs – for decision making and planning Cost behaviour
Total Variable Costs
£s
Output
£s
Output
Unit Variable Costs
3. Semi-fixed – these costs can also be known as Step-Costs. They remain fixed for a given level of activity, but then increase by a constant amount at some critical points. Eg, salary of supervisor
Costs – for decision making and planning Cost behaviour
Step-Costs
£s
Output
Costs – for decision making and planning Cost behaviour
4. Semi-variable – these costs include both fixed and variable costs. Eg, cost of maintenance can be fixed or variable.
Fixed would be when, say, every October or March, plant requires overhaul. Variable would be when overhaul was required after every 10,000 units.
Introduction
Introduction
Relevance Lost?
“...the issue of inappropriateness of current management accounting which offered ... little capacity for providing useful & timely information for better decisions & control in the areas of product costing & managerial performance. Moreover they pointed to the contemporary environment of rapid technological change, vigorous global & domestic competition, & enormously expanding information processing capabilities. Conventional management accounting which developed from a stable & monopolistic environment had been ‘subservient to financial reporting’ rather than facilitating internal processes for better management resources.” (Wickramasinghe et al 2007:1)
Time Line
1825 ~ 1925 – development of the cost management practices of MA
1925 onwards – almost no developments
Techniques used in the 1980’s – were the same as techniques developed a century beforehand
Problem
MA = Static
Business = Evolving
MA systems no longer met the requirements of a meaningful managerial device
1980’s ~ 2000’s – MA has responded by
Cost Management
Strategic Management Accounting
Management Accounting in New Organisations
All three known as ‘Management Accounting Change’
Learning in Management Accounting so far:
Variety of numerical techniques
Impression that MA is a pool of techniques whereby you choose according to requirement
This is NOT how MA should be viewed
Should not be seen as ‘add on’ option, but as a stand alone function
Hence MA change, as we are in a period of realignment and redefining
We need to go back a stage and understand how MA has evolved
To do this we first need to define MA
What is Management Accounting?
Management Accounting Defined
Defined....
“management accounting is a unitary and universal practice, independent of the time and space in which it operates. For this, management accounting has a specific set of functions based on perfectly defined techniques which have been developed from both theory and practice. It is hoped that wherever and whenever these techniques are used, the same outcomes are expected, and their fullest original forms are adopted.” (Wickramasinghe et al 2007:4)
Wickramasinghe et al (2007) considered MA should be viewed, not in a confined definition, but in the concept of how and where it functions. Hence they consider it from 3 perspectives:
Technical – managerial view
Pragmatic – interpretive view
Critical – socio-economic view
Technical – Managerial View
MA = calculations done for the purpose of DM & control, via
Product costing
Budgeting & standard costing
Variance analysis
CVP analysis
MA supports organisational functions i.e. operations / HR
Pragmatic – Interpretive View
Considers organisational practice (application) & consequences of the same
Focus is on the research and researchers who act independently of each other
Therefore their outcomes tend to be fragmented, failing to result in a single directional change for MA, examples:
Birkett and Poullaos
“Management accounting is an outcome of historical evolution: in the 1950’s it was conventional ‘management accounting’; from the mid-1960’s, it was a support or staff role; from the mid-1980’s, it was about ‘resource management’; from the 1990’s, the ‘resource management’ perspective became more focused on risk management and value creation” (Wickramasinghe et al 2007:7)
Scapens
“Robert Scapens pointed to a ‘gap’ between theory and ‘practices’. He has recently said that ‘practices’ must be studied and interpreted rather than being much concerned about the ‘gap’. When looking at practices, management accounting is a set of ‘rules’ that could be ‘routinised’ and ‘institutionalised’: an institutional theory view. Scapens’ followers study ‘practices’ and identify numerous factors that enable or constrain the process of institutionalisation.” (Wickramasinghe et al 2007:8)
Critical – Socio-economic View
“Taking the functions of management accounting beyond the organisational boundaries, and argue that management accounting practices play certain roles in the reproduction of wider socio-political systems of dominations and exploitation.” (Wickramasinghe et al 2007:9)
Features:
Debatable
Arguable
Divergent
Sceptical
We are witnessing management accounting change in the form of a move from the Mechanistic Approach to the Post-Mechanistic Approach
Mechanistic Approach
Approach to MA up to the 1980’s
Features mechanisation in facilitation borne out of:
Mechanisation in production technology
Mechanisation in production-orientation in management
Mechanisation
“the technology used for mass production, one dedicated to produce similar products on a large scale. The engineering character of this technology is semi-automatic and inflexible. Once the investments in such technology have been made, the recovery of the cost of capital has to be achieved by large-scale production over a long period of time, a production conception which leads to economies of scale. Thus, orientation is essentially centred on production rather than customer needs.” (Wickramasinghe et al 2007:12)
Post-Mechanistic Approach
Post-Mechanistic
Post 1980’s, features:
Digitalisation in technology (manufacturing flexibility)
Customer orientation in management, rather than production
New management accounting
Tend to explore ‘economies of scope’ not ‘economies of scale’
0
25
50
75
100
125
150
50100150200250300350400
Output
0
25
50
75
100
125
150
50100150200250300350400
Output
0
25
50
75
100
125
150
50100150200250300350400
Output
0
25
50
75
100
125
150
50100150200250300350400
Output
0
25
50
75
100
125
150
50100150200250300350400
Output
S2/ABC answer(1).xls
Sheet1
| ABC answer | ||||||||
| a. | A | B | C | D | ||||
| Direct Material | 40 | 50 | 30 | 60 | ||||
| Direct Labour | 28 | 21 | 14 | 21 | ||||
| ----------- | ----------- | ----------- | ----------- | |||||
| Marginal cost | 68 | 71 | 44 | 81 | ||||
| Overheads | 80 | 60 | 40 | 60 | ||||
| ----------- | ----------- | ----------- | ----------- | |||||
| 148 | 131 | 84 | 141 | |||||
| ----------- | ----------- | ----------- | ----------- | |||||
| W1 | Absorption rate = overheads / level of activity | |||||||
| = 26000 / 1300 hours | ||||||||
| = £20 per machine hour | ||||||||
| e.g. product A has 4 machine hours at £20 each = £80 | ||||||||
| b. | A | B | C | D | ||||
| Machine department | W2 | 3851 | 2407 | 1284 | 2888 | |||
| set up costs | W3 | 1500 | 1250 | 1000 | 1500 | |||
| stores receiving | W4 | 900 | 900 | 900 | 900 | |||
| inspection/quality control | W5 | 600 | 500 | 400 | 600 | |||
| materials handling | W6 | 1320 | 1100 | 880 | 1320 | |||
| ----------- | ----------- | ----------- | ----------- | |||||
| 8171 | 6157 | 4464 | 7208 | |||||
| units | 120 | 100 | 80 | 120 | ||||
| overhead per unit | 68.09 | 61.57 | 55.80 | 60.07 | ||||
| Marginal cost (from part a) | 68 | 71 | 44 | 81 | ||||
| ----------- | ----------- | ----------- | ----------- | |||||
| 136.09 | 132.57 | 99.80 | 141.07 | |||||
| ----------- | ----------- | ----------- | ----------- | |||||
| W2 | Machine department based on machine hours | |||||||
| 10430 / 1300 = £8.023 | ||||||||
| so eg A has 4 hours per unit x 120 output units x £8.023 = £3851 | ||||||||
| W3 | Set up costs based on number of productuion runs = 21 | |||||||
| 5250 / 21 = £250 | ||||||||
| eg A has 6 prodcution runs at £250 = £1500 | (120 units / 20 units per run = 6) | |||||||
| W4 | Stores receiving based on number of requisitions = 80 | (20 per product) | ||||||
| 3600 / 80 = 45 | ||||||||
| eg A has 20 requisitions at £45 each = £900 | ||||||||
| W5 | Inspection/quality control based on prodcution runs = 21 | |||||||
| 2100 / 21 = £100 | ||||||||
| eg A has 6 production runs at £100 each - £600 | ||||||||
| W6 | Materials handling based on orders executed = 42 | |||||||
| 4620 / 42 = £110 | ||||||||
| eg A has 12 at £110 each = £1320 | (120 units / 10 units in a sales batch) |
Sheet2
Sheet3
S2/ABC example.pdf
ACTIVITY BASED COSTING
Example
A company manufactures 4 products W, X, Y, and Z.
The data for the last period was:-
No. of prod'n Material cost Direct lab Machine hrs
Output units runs per unit £ hours per unit per unit
W 10 2 20 1 1
X 10 2 80 3 3
Y 100 5 20 1 1
Z 100 5 80 3 3
Direct labour costs £5.00 per hour
Overhead costs are:-
£
Short-run variable costs 3080
Set-up costs 10920
Expediting and scheduling costs 9100
Materials handling costs 7700
------------
30800
======
Required:
Calculate the product costs using
1 Traditional absorption costing
2 ABC
S2/session 2 14-15 students version.pptx
MSc Accounting and Finance
Management Accounting
Product Costing
Management Accounting Defined
“Management Accounting is concerned with the internal accounting within a business. Essentially, it is the provision of both financial and non-financial information to managers so that they can manage costs and make decisions.” (Jones 2006:378)
Activity One
Consider the following phrases, and give examples of what Jones might be referring to:
Internal Accounting
Financial and Non-Financial Information
Managing Costs
Making Decisions
Formal Definition
“Management Accounting is an integral part of management, requiring the identification, generation, presentation, interpretation and use of information relevant to:
formulating business strategy;
planning and controlling activities;
decision making
efficient resource usage;
performance improvement and value enhancement
safeguarding tangible and intangible assets
corporate governance and internal control.” (CIMA Official Terminology, 2000)
Activity Two
List three decisions that the Management Accountant might be required to either make or provide information for?
Management Accounting and Financial Accounting
FA provides information for external users, MA provides information for internal users.
FA is concerned with recording information, MA is concerned with providing information.
FA exists within a statutory context, MA does not.
FA predominantly uses the financial statements, MA predominantly uses budgets and costing data.
FA is backward looking (the past), MA looks to the future.
The context of Management Accounting
Cost Accounting
Costing
Planning, Control and Performance
Decision Making
Short Term Decisions
Capital Investment Appraisal (CIA)
Sources of Finance
Contemporary Approaches
Japanese Management Accounting
Strategic Management Accounting
Costing
“Costing involves ascertaining all the costs of a product or service so as to form the basis for pricing and for stock valuation……[to] make sure that manufactured products were priced so as to fully recover all the costs incurred in making them.” (Jones 2006:394)
Basic principle behind cost accounting and the cost accountant (the predecessor to management accounting and the management accountant)
Note: the word manufactured products ~ the definition existed at a time when manufacturing was the predominant industry, what about now?
Traditional Costing (Absorption Costing)
(Traditionally relating to costs existing within the manufacturing sector).
Splits costs into either DIRECT or INDIRECT.
Direct Cost - can be directly related to a product or service, collectively known as PRIME COSTS.
Indirect Cost - cannot be directly related to a product or service, collectively known as OVERHEADS.
Both types of cost need to be totalled and recovered in the selling price attributed to the product or service.
The process of Absorption Costing
“Record all costs
Classify all costs
Allocate all the indirect costs to the departments of the business
Reallocate costs from service support departments to production departments
Calculate an overhead recovery rate
Absorb both the direct costs and the indirect costs into individual products” (Jones, 2006:401)
Why?
Activity Three ~ Example of how to absorb overheads
2 Indirect Costs
For example DL Hrs or D m/c Hrs
Activity Three ~ Example of how to absorb overheads
2 Indirect Costs
For example DL Hrs or D m/c Hrs
Problems with Absorption Costing?
Direct costs used to outweigh indirect costs owing to the large manufacturing industry in existence in comparison to a relatively small service or knowledge-based industry.
Therefore absorption of overheads was minimal, & normally conducted on either a DL hour or machine hour basis. However, in our current climate, heavily dominated by service or knowledge based organisations, who have potentially no machine hours & very few direct labour hours, neither absorption basis would be appropriate.
A new method to allocate costs became necessary...
Activity Based Costing (ABC)
The fundamental basis for ABC is that “activities that occur within a firm cause overhead costs” (Jones 2006:407)
ABC therefore seeks to identify the costs and the activities and apportion the former to the latter on, what is potentially, a more equitable basis.
The process of ABC
“Record all the costs
Classify all the costs
Identify activities
Identify cost drivers and allocate overheads to them
Calculate activity-cost driver rates
Absorb both the direct costs and indirect costs into a product or service” (Jones 2006:p408)
Activity Four
Activity Based Costing Example
ABC - the future?
ABC is considered to be more informative and relevant than traditional product costing.
It gives greater opportunity to manage costs, which is highly relevant given the changing role of the cost accountant to the management accountant.
It is suitable for both manufacturing and service organisations.
But it is much more time consuming and requires substantial effort to integrate, particularly in the first year.
Canteen Admin Production Transportation Sales Total
Number of employees 5 10 35 30 20 100
Square metres 50 100 250 250 100 750
Rent £100,000
Staff Welfare Costs £50,000
Overhead £150,000
Canteen Costs
Overhead Burden £150,000
Direct Labour Hours 100 500 300 200 1,000hrs
Direct Machine Hours 0 600 400 0 1,000hrs
Overhead Absorption Basis
Overhead Absorption Rate
|
|
Canteen |
Admin |
Production |
Transportation |
Sales |
Total |
Number of employees |
5 |
10 |
35 |
30 |
20 |
100 |
|
Square metres |
50 |
100 |
250 |
250 |
100 |
750 |
|
Rent |
|
|
|
|
|
£100,000 |
|
Staff Welfare Costs |
|
|
|
|
|
£50,000 |
|
Overhead |
|
|
|
|
|
£150,000 |
|
Canteen Costs |
|
|
|
|
|
|
|
Overhead Burden |
|
|
|
|
|
£150,000 |
|
Direct Labour Hours |
|
100 |
500 |
300 |
200 |
1,000hrs |
|
Direct Machine Hours |
|
0 |
600 |
400 |
0 |
1,000hrs |
|
Overhead Absorption Basis |
|
|
|
|
|
|
|
Overhead Absorption Rate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Canteen Admin Production Transportation Sales Total
Number of employees 5 10 35 30 20 100
Square metres 50 100 250 250 100 750
Rent 6667 13333 33334 33333 13333 £100,000
Staff Welfare Costs 2500 5000 17500 15000 10000 £50,000
Overhead 9167 18333 50834 48333 23333 £150,000
Canteen Costs -9167 965 3377 2895 1930
Overhead Burden 19298 54211 51228 25263 £150,000
Direct Labour Hours 100 500 300 200 1,000hrs
Direct Machine Hours 0 600 400 0 1,000hrs
Overhead Absorption Basis Machine
hours
Labour
hours
Overhead Absorption Rate £90.35 £126.32
|
|
Canteen |
Admin |
Production |
Transportation |
Sales |
Total |
Number of employees |
5 |
10 |
35 |
30 |
20 |
100 |
|
Square metres |
50 |
100 |
250 |
250 |
100 |
750 |
|
Rent |
6667 |
13333 |
33334 |
33333 |
13333 |
£100,000 |
|
Staff Welfare Costs |
2500 |
5000 |
17500 |
15000 |
10000 |
£50,000 |
|
Overhead |
9167 |
18333 |
50834 |
48333 |
23333 |
£150,000 |
|
Canteen Costs |
-9167 |
965 |
3377 |
2895 |
1930 |
|
|
Overhead Burden |
|
19298 |
54211 |
51228 |
25263 |
£150,000 |
|
Direct Labour Hours |
|
100 |
500 |
300 |
200 |
1,000hrs |
|
Direct Machine Hours |
|
0 |
600 |
400 |
0 |
1,000hrs |
|
Overhead Absorption Basis |
|
|
Machine hours |
|
Labour hours |
|
|
Overhead Absorption Rate |
|
|
£90.35 |
|
£126.32 |
|
|
|
|
|
|
|
|
|
S2/session 2 2014-15.pptx
MSc Accounting and Finance
Management Accounting
Product Costing
Management Accounting Defined
“Management Accounting is concerned with the internal accounting within a business. Essentially, it is the provision of both financial and non-financial information to managers so that they can manage costs and make decisions.” (Jones 2006:378)
Activity One
Consider the following phrases, and give examples of what Jones might be referring to:
Internal Accounting
Financial and Non-Financial Information
Managing Costs
Making Decisions
Formal Definition
“Management Accounting is an integral part of management, requiring the identification, generation, presentation, interpretation and use of information relevant to:
formulating business strategy;
planning and controlling activities;
decision making
efficient resource usage;
performance improvement and value enhancement
safeguarding tangible and intangible assets
corporate governance and internal control.” (CIMA Official Terminology, 2000)
Activity Two
List three decisions that the Management Accountant might be required to either make or provide information for?
Management Accounting and Financial Accounting
FA provides information for external users, MA provides information for internal users.
FA is concerned with recording information, MA is concerned with providing information.
FA exists within a statutory context, MA does not.
FA predominantly uses the financial statements, MA predominantly uses budgets and costing data.
FA is backward looking (the past), MA looks to the future.
The context of Management Accounting
Cost Accounting
Costing
Planning, Control and Performance
Decision Making
Short Term Decisions
Capital Investment Appraisal (CIA)
Sources of Finance
Contemporary Approaches
Japanese Management Accounting
Strategic Management Accounting
Costing
“Costing involves ascertaining all the costs of a product or service so as to form the basis for pricing and for stock valuation……[to] make sure that manufactured products were priced so as to fully recover all the costs incurred in making them.” (Jones 2006:394)
Basic principle behind cost accounting and the cost accountant (the predecessor to management accounting and the management accountant)
Note: the word manufactured products ~ the definition existed at a time when manufacturing was the predominant industry, what about now?
Traditional Costing (Absorption Costing)
(Traditionally relating to costs existing within the manufacturing sector).
Splits costs into either DIRECT or INDIRECT.
Direct Cost - can be directly related to a product or service, collectively known as PRIME COSTS.
Indirect Cost - cannot be directly related to a product or service, collectively known as OVERHEADS.
Both types of cost need to be totalled and recovered in the selling price attributed to the product or service.
The process of Absorption Costing
“Record all costs
Classify all costs
Allocate all the indirect costs to the departments of the business
Reallocate costs from service support departments to production departments
Calculate an overhead recovery rate
Absorb both the direct costs and the indirect costs into individual products” (Jones, 2006:401)
Why?
Activity Three ~ Example of how to absorb overheads
2 Indirect Costs
For example DL Hrs or D m/c Hrs
Activity Three ~ Example of how to absorb overheads
2 Indirect Costs
For example DL Hrs or D m/c Hrs
Problems with Absorption Costing?
Direct costs used to outweigh indirect costs owing to the large manufacturing industry in existence in comparison to a relatively small service or knowledge-based industry.
Therefore absorption of overheads was minimal, & normally conducted on either a DL hour or machine hour basis. However, in our current climate, heavily dominated by service or knowledge based organisations, who have potentially no machine hours & very few direct labour hours, neither absorption basis would be appropriate.
A new method to allocate costs became necessary...
Activity Based Costing (ABC)
The fundamental basis for ABC is that “activities that occur within a firm cause overhead costs” (Jones 2006:407)
ABC therefore seeks to identify the costs and the activities and apportion the former to the latter on, what is potentially, a more equitable basis.
The process of ABC
“Record all the costs
Classify all the costs
Identify activities
Identify cost drivers and allocate overheads to them
Calculate activity-cost driver rates
Absorb both the direct costs and indirect costs into a product or service” (Jones 2006:p408)
Activity Four
Activity Based Costing Example
Activity Based Costing - example
Using traditional overhead absorption costing
Total costs
Overheads
95
25
95
25
Variable cost
15
5
15
5
Labour
80
20
80
20
Materials
Z
Y
X
W
W1
Activity Based Costing – (W1)
Using traditional overhead absorption costing
Overhead absorption
Budgeted costs
Budgeted level of activity
30800
440
=
=
£70/hr
Budgeted level of activity = machine or labour hours
W 10 X 1 hour 10
X 10 X 3 hours 30
Y 100 X 1 hour 100
Z 100 X 3 hours 300
440
Overhead absorption
W 1 hour @ £70 = £70
X 3 hours @ £70 = £210
Y 1 hour @ £70 = £70
Z 3 hours @ £70 = £210
Activity Based Costing - example
Using traditional overhead absorption costing
305
95
305
95
Total costs
210
70
210
70
Overheads
95
25
95
25
Variable cost
15
5
15
5
Labour
80
20
80
20
Materials
Z
Y
X
W
W1
Activity Based Costing - example
Using ABC
Total costs
Overheads
95
25
95
25
Variable cost
15
5
15
5
Labour
80
20
80
20
Materials
Z
Y
X
W
W2
Activity Based Costing – W2
Using ABC
403
10
4030
1100
1300
1560
70
W
120
106
417
Cost per unit
100
100
10
Output
12000
10600
4170
Overheads
2750
2750
1100
£550
Materials handling
3250
3250
1300
£650
Expediting + scheduling
3900
3900
1560
£780
Set-ups
2100
700
210
£7
Short run variable costs
Z
Y
X
Cost driver
Activity Based Costing - example
Using ABC
215
131
512
428
Total costs
120
106
417
403
Overheads
95
25
95
25
Variable cost
15
5
15
5
Labour
80
20
80
20
Materials
Z
Y
X
W
W2
Activity Based Costing - example
Comparison of traditional overhead absorption costing
and ABC costing
| W | X | Y | Z | |
| Traditional | 95 | 305 | 95 | 305 |
| ABC | 428 | 512 | 131 | 215 |
| Difference | 333 | 207 | 36 | (90) |
ABC - the future?
ABC is considered to be more informative and relevant than traditional product costing.
It gives greater opportunity to manage costs, which is highly relevant given the changing role of the cost accountant to the management accountant.
It is suitable for both manufacturing and service organisations.
But it is much more time consuming and requires substantial effort to integrate, particularly in the first year.
Canteen Admin Production Transportation Sales Total
Number of employees 5 10 35 30 20 100
Square metres 50 100 250 250 100 750
Rent £100,000
Staff Welfare Costs £50,000
Overhead £150,000
Canteen Costs
Overhead Burden £150,000
Direct Labour Hours 100 500 300 200 1,000hrs
Direct Machine Hours 0 600 400 0 1,000hrs
Overhead Absorption Basis
Overhead Absorption Rate
|
|
Canteen |
Admin |
Production |
Transportation |
Sales |
Total |
Number of employees |
5 |
10 |
35 |
30 |
20 |
100 |
|
Square metres |
50 |
100 |
250 |
250 |
100 |
750 |
|
Rent |
|
|
|
|
|
£100,000 |
|
Staff Welfare Costs |
|
|
|
|
|
£50,000 |
|
Overhead |
|
|
|
|
|
£150,000 |
|
Canteen Costs |
|
|
|
|
|
|
|
Overhead Burden |
|
|
|
|
|
£150,000 |
|
Direct Labour Hours |
|
100 |
500 |
300 |
200 |
1,000hrs |
|
Direct Machine Hours |
|
0 |
600 |
400 |
0 |
1,000hrs |
|
Overhead Absorption Basis |
|
|
|
|
|
|
|
Overhead Absorption Rate |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Canteen Admin Production Transportation Sales Total
Number of employees 5 10 35 30 20 100
Square metres 50 100 250 250 100 750
Rent 6667 13333 33334 33333 13333 £100,000
Staff Welfare Costs 2500 5000 17500 15000 10000 £50,000
Overhead 9167 18333 50834 48333 23333 £150,000
Canteen Costs -9167 965 3377 2895 1930
Overhead Burden 19298 54211 51228 25263 £150,000
Direct Labour Hours 100 500 300 200 1,000hrs
Direct Machine Hours 0 600 400 0 1,000hrs
Overhead Absorption Basis Machine
hours
Labour
hours
Overhead Absorption Rate £90.35 £126.32
|
|
Canteen |
Admin |
Production |
Transportation |
Sales |
Total |
Number of employees |
5 |
10 |
35 |
30 |
20 |
100 |
|
Square metres |
50 |
100 |
250 |
250 |
100 |
750 |
|
Rent |
6667 |
13333 |
33334 |
33333 |
13333 |
£100,000 |
|
Staff Welfare Costs |
2500 |
5000 |
17500 |
15000 |
10000 |
£50,000 |
|
Overhead |
9167 |
18333 |
50834 |
48333 |
23333 |
£150,000 |
|
Canteen Costs |
-9167 |
965 |
3377 |
2895 |
1930 |
|
|
Overhead Burden |
|
19298 |
54211 |
51228 |
25263 |
£150,000 |
|
Direct Labour Hours |
|
100 |
500 |
300 |
200 |
1,000hrs |
|
Direct Machine Hours |
|
0 |
600 |
400 |
0 |
1,000hrs |
|
Overhead Absorption Basis |
|
|
Machine hours |
|
Labour hours |
|
|
Overhead Absorption Rate |
|
|
£90.35 |
|
£126.32 |
|
|
|
|
|
|
|
|
|
S3/Flexed budget with variances.pdf
Flexible budgeting
Example
The World History Museum has an Education Department which specialises in running courses in
various subjects. The courses are run on premises which the museum rents for the purpose and
they are presented by freelance expert speakers. The courses are of a standard type and format
and can therefore be treated alike for budgetary control purposes.
The museum currently uses fixed budgets to control expenditure. The following data shows the
actual costs of the Education Department for the month of April compared with budgeted figures.
Actual Budget Variance
Number of courses run 5 6 -1
£ £ £
Expenditure
Speakers fees 2500 3180 680
Hire of premises 1500 1500 0
Depreciation of equipment 200 180 -20
Stationery 530 600 70
Catering 1500 1750 250
Insurance 700 820 120
Administration 1650 1620 -30
---------- ---------- ----------
8580 9650 1070
----------- ----------- -----------
Other information
1. Depreciation of equipment is a fixed cost
2. Administration is a fixed cost
3. The budget figures for catering costs and insurance costs include a fixed element as follows:
Catering £250
Insurance £100
The remaining elements of those two costs are variable
4. All other costs are variable
Required:
1. Use the information above to produce a budgetary control statement for April, based on a
flexible budget for the actual number of course run
2. Calculate the revised variances based on your flexed budget.
S3/session 3(1).pptx
MSc Accounting and Finance
Management Accounting
Session Three
Planning, Control & Performance
Budgeting & Standard Costing
Cost Accounting
‘Costing’ and ‘Planning, Control & Performance’
Budgeting
Standard Costing & Variance Analysis
Budget Theory
Budget Theory
The Use of Budgets
Budgets are used in almost every business organisation of any size and so it can be deduced that budgeting plays a fundamental role in the functioning of human activity, of which economic enterprise is an important part
A tradition accounting-orientated approach sees a budget as “as plan showing how resources are to be acquired and used over a specific time interval.” This means that budgetary systems are one of the major means available to an organisation, in achieving organisational control.
Budget Theory
Human Behaviour
It must be remembered that an organisation can only act through the actions of the individuals who make it up, and so the achievement of an organisation’s objectives will only occur if sufficient individuals are aware of what constitutes appropriate behaviour and even then, only if they are motivated to implement those actions which are organisationally desirable
Therefore the acid test for any accounting system is whether it produces desirable behaviour from those who receive the information it provides
Budget Theory
Perfect Accounting System
It is tempting to assume that waiting to be discovered is a form of budget that will serve the purpose of organisational control in an optimum fashion
This is unlikely, as what constitutes as appropriate budget system is influenced by the characteristics of individual managers, by the type of organisation in which it is implemented, and by the nature of the environment in which it operates
Therefore the task is to discover the type of system which fits the particular circumstances
Budget Theory
The purpose/role of budgets
Budgets have many purposes and it is unlikely that any one system will serve all the functions
Budget Theory
The purpose/role of budgets
Authorisation
Forecasting
Communication
Co-ordination
Framework for responsibility accounting
System of control
Motivation
Budget Theory
Participative / Non-participative Budgeting
Budget theory
Non-participative budgeting…. The budget is set without the person responsible for carrying it out, having an input. (top down budget)
Participative budgeting … budget holders have the opportunity to have input. (Bottom up budget)
Budget Theory
Participation should:
Increase motivation
Contain more relevant information
Free up senior managers to concentrate on strategy
Budget Theory
However it may
Be subject to bias
Not be in line with organisational objectives
Prepared by inexperienced managers
Senior managers may resent the loss of control
Budget Theory
Incremental Budgeting
Budget Theory
Incremental Budgets
……. Start with the previous periods budget and add (or subtract) an incremental amount.
Advantages include:
It’s quick and easy
Budget Theory
But ……
It can build in any previous problems
Allow managers to overspend
Makes no attempt to justify the spending
Zero-based Budgeting
(ZBB)
ZBB
A problem in budgeting is trying to motivate managers and employees at all levels to agree to changes in work practices and to actively look for ways of improving performance and results
Budgetary slack is defined as the “difference between the minimum necessary costs and the costs which are built into the budget or which are actually incurred.”
ZBB
When preparing the budget, a manager may overstate his costs so that he will not be blamed in the future for over-spending
When controlling actual operations, managers will then try to ensure that their spending rises to meet their budget, otherwise they will be blamed for careless budgeting
A manager may waste money to use up his allowance in case it is cut back in the future
ZBB
Zero-based budgeting is one way of removing slack from the budget.
ZBB is a cost-benefit approach where it is assumed that a cost allowance for an item is zero will remain so until the manager responsible for it both justifies the cost’s existence and identifies the benefits it brings
This means a questioning attitude is developed whereby every cost item and its level has to be justified in relation to the way it helps meet objectives
ZBB
ZBB was pioneered in the United States and it gained wide acceptance as it is a simple idea based on common sense. It is concerned with the evaluation of costs and benefits of alternatives and so is based on a concept of opportunity costing
ZBB
It can be applied in both profit-seeking and non-profit-seeking organisations alike.
It can be applied in any organisation where alternative levels of provision for each activity are possible and where the costs and benefits can be separately identfied
ZBB
There are three stages for the implementation
1. the definition of decision packages
2. the packages are evaluated and ranked
3. the resources are allocated
ZBB
Advantages of ZBB:
If properly carried out, it should result in a more efficient allocation of resources to activities and departments
It focuses attention on value for money and makes explicit the relationship between the input of resources and the output of benefits
It develops a questioning attitude which makes it easier to identify inefficient or obsolete operations
It leads to greater staff and management knowledge of operations and activities and so can increase motivation
It is a systematic way of challenging the status quo
ZBB
Disadvantages of ZBB:
It is a time consuming process which can generate volumes of documents
There is considerable management skill required for both drawing up the decision packages and also for the ranking process. These skills may not exist in the organisation
It may encourage the wrong impression which is that all decisions have to be made in light of the budget. Organisations need to be flexible enough to deal with circumstances when they change
It is not always acceptable to staff or management who may prefer the “cosy” status quo, and so see it as a threat and not as challenge
ZBB
Disadvantages of ZBB:
5. There will need to be many subjective judgements when ranking the packages, and political pressures within an organisation will also contribute to the problem
6. It tends to emphasise short-term benefits which may be to the detriment of the longer term ones
Budgets and Performance Evaluation
Budgets and Performance Evaluation
Budgets are used to assess management performance.
Hopwood (1973) identified 3 styles of using budgetary information to evaluate management performance
Budget constrained style
Profit conscious style
Non – accounting Style
Budgets and performance evaluation
Hopwood’s research showed:
Budget constrained style – attention was focused on costs. There was a high degree of pressure often leading to manipulation of data
Profit-conscious style – high involvement with costs, but less pressure. Less manipulation, better relationships
Non-accounting style – similar to profit-conscious but less concern with costs.
Budgets and Performance Evaluation
Therefore evidence that better managerial performance achieved using profit conscious or non-accounting.
However a later study by Otley (1978) gave contradictory findings.
It found a closer link between good performance and the budget constrained style.
Budgets and Performance Evaluation
Explanation of the two different findings:
They took place in different organisational environments.
Hopwood – US manufacturing steelworks
Otley – UK coal mining
Flexible Budgeting
Flexible Budgeting
Responsibility Accounting
Is based on the recognition of individual areas of responsibility in the organisation, which are known as responsibility centres, with a single person being in charge.
The objective is to accumulate costs and revenue for each individual responsibility centres so that any deviations can be reported to the person in charge
It is implemented by issuing Performance Reports at frequent intervals informing of the deviations from the budget for expenses
Flexible Budgeting
As some costs vary with the level of activity, this should be taken into consideration. When preparing performance reports it is misleading to compare actual costs at one level of activity with the budget costs at a different level of activity. So we should adjust the original budget to actual level of activity.
The cost behaviour of the individual costs should be considered. i.e. are they fixed costs, variable costs, or a mixture of the two
Flexed Budget Control Statement
Analysis of costs : fixed costs
1. Depreciation 180
2. Administration 1620
Flexed Budget Control Statement
3. Semi variable costs
Catering total 1750 for 6 courses
Fixed element 250 variable element 1500 for 6
250 each
Total for 5 course 5 x 250 = 1250 + 250 = 1500
Insurance total 820 for 6 courses
Fixed element 100 variable element 720 for 6
120 each
Total for 5 courses 5 x 120 = 600 + 100 = 700
Flexed Budget Control Statement
Analysis of costs - variable costs
Variable Per course
for 6
Speakers fees 3180 530
Hire of premises 1500 250
Stationery 600 100
I
Flexed Budget Control Statement
| Expenditure | Fixed cost | Variable cost | Total cost | Actual cost | Variance |
| £ | £ | £ | £ | £ | |
| Speakers’ fees | - | 2650 | 2650 | 2500 | 150 |
| Hire of premises | - | 1250 | 1250 | 1500 | (250) |
| Depreciation of equipment | 180 | - | 180 | 200 | (20) |
| Stationery | - | 500 | 500 | 530 | (30) |
| Catering | 250 | 1250 | 1500 | 1500 | - |
| Insurance | 100 | 600 | 700 | 700 | - |
| Administration | 1620 | - | 1620 | 1650 | (30) |
| 2150 | 6250 | 8400 | 8580 | (180) |
S3/session 3(2).pptx
MSc Accounting and Finance
Management Accounting
Session Three
Planning, Control & Performance
Budgeting & Standard Costing
Cost Accounting
‘Costing’ and ‘Planning, Control & Performance’
Budgeting
Standard Costing & Variance Analysis
Budget Theory
Budget Theory
The Use of Budgets
Budgets are used in almost every business organisation of any size and so it can be deduced that budgeting plays a fundamental role in the functioning of human activity, of which economic enterprise is an important part
A tradition accounting-orientated approach sees a budget as “as plan showing how resources are to be acquired and used over a specific time interval.” This means that budgetary systems are one of the major means available to an organisation, in achieving organisational control.
Budget Theory
Human Behaviour
It must be remembered that an organisation can only act through the actions of the individuals who make it up, and so the achievement of an organisation’s objectives will only occur if sufficient individuals are aware of what constitutes appropriate behaviour and even then, only if they are motivated to implement those actions which are organisationally desirable
Therefore the acid test for any accounting system is whether it produces desirable behaviour from those who receive the information it provides
Budget Theory
Perfect Accounting System
It is tempting to assume that waiting to be discovered is a form of budget that will serve the purpose of organisational control in an optimum fashion
This is unlikely, as what constitutes as appropriate budget system is influenced by the characteristics of individual managers, by the type of organisation in which it is implemented, and by the nature of the environment in which it operates
Therefore the task is to discover the type of system which fits the particular circumstances
Budget Theory
The purpose/role of budgets
Budgets have many purposes and it is unlikely that any one system will serve all the functions
Budget Theory
The purpose/role of budgets
Authorisation
Forecasting
Communication
Co-ordination
Framework for responsibility accounting
System of control
Motivation
Budget Theory
Participative / Non-participative Budgeting
Budget theory
Non-participative budgeting…. The budget is set without the person responsible for carrying it out, having an input. (top down budget)
Participative budgeting … budget holders have the opportunity to have input. (Bottom up budget)
Budget Theory
Participation should:
Increase motivation
Contain more relevant information
Free up senior managers to concentrate on strategy
Budget Theory
However it may
Be subject to bias
Not be in line with organisational objectives
Prepared by inexperienced managers
Senior managers may resent the loss of control
Budget Theory
Incremental Budgeting
Budget Theory
Incremental Budgets
……. Start with the previous periods budget and add (or subtract) an incremental amount.
Advantages include:
It’s quick and easy
Budget Theory
But ……
It can build in any previous problems
Allow managers to overspend
Makes no attempt to justify the spending
Zero-based Budgeting
(ZBB)
ZBB
A problem in budgeting is trying to motivate managers and employees at all levels to agree to changes in work practices and to actively look for ways of improving performance and results
Budgetary slack is defined as the “difference between the minimum necessary costs and the costs which are built into the budget or which are actually incurred.”
ZBB
When preparing the budget, a manager may overstate his costs so that he will not be blamed in the future for over-spending
When controlling actual operations, managers will then try to ensure that their spending rises to meet their budget, otherwise they will be blamed for careless budgeting
A manager may waste money to use up his allowance in case it is cut back in the future
ZBB
Zero-based budgeting is one way of removing slack from the budget.
ZBB is a cost-benefit approach where it is assumed that a cost allowance for an item is zero will remain so until the manager responsible for it both justifies the cost’s existence and identifies the benefits it brings
This means a questioning attitude is developed whereby every cost item and its level has to be justified in relation to the way it helps meet objectives
ZBB
ZBB was pioneered in the United States and it gained wide acceptance as it is a simple idea based on common sense. It is concerned with the evaluation of costs and benefits of alternatives and so is based on a concept of opportunity costing
ZBB
It can be applied in both profit-seeking and non-profit-seeking organisations alike.
It can be applied in any organisation where alternative levels of provision for each activity are possible and where the costs and benefits can be separately identfied
ZBB
There are three stages for the implementation
1. the definition of decision packages
2. the packages are evaluated and ranked
3. the resources are allocated
ZBB
Advantages of ZBB:
If properly carried out, it should result in a more efficient allocation of resources to activities and departments
It focuses attention on value for money and makes explicit the relationship between the input of resources and the output of benefits
It develops a questioning attitude which makes it easier to identify inefficient or obsolete operations
It leads to greater staff and management knowledge of operations and activities and so can increase motivation
It is a systematic way of challenging the status quo
ZBB
Disadvantages of ZBB:
It is a time consuming process which can generate volumes of documents
There is considerable management skill required for both drawing up the decision packages and also for the ranking process. These skills may not exist in the organisation
It may encourage the wrong impression which is that all decisions have to be made in light of the budget. Organisations need to be flexible enough to deal with circumstances when they change
It is not always acceptable to staff or management who may prefer the “cosy” status quo, and so see it as a threat and not as challenge
ZBB
Disadvantages of ZBB:
5. There will need to be many subjective judgements when ranking the packages, and political pressures within an organisation will also contribute to the problem
6. It tends to emphasise short-term benefits which may be to the detriment of the longer term ones
Budgets and Performance Evaluation
Budgets and Performance Evaluation
Budgets are used to assess management performance.
Hopwood (1973) identified 3 styles of using budgetary information to evaluate management performance
Budget constrained style
Profit conscious style
Non – accounting Style
Budgets and performance evaluation
Hopwood’s research showed:
Budget constrained style – attention was focused on costs. There was a high degree of pressure often leading to manipulation of data
Profit-conscious style – high involvement with costs, but less pressure. Less manipulation, better relationships
Non-accounting style – similar to profit-conscious but less concern with costs.
Budgets and Performance Evaluation
Therefore evidence that better managerial performance achieved using profit conscious or non-accounting.
However a later study by Otley (1978) gave contradictory findings.
It found a closer link between good performance and the budget constrained style.
Budgets and Performance Evaluation
Explanation of the two different findings:
They took place in different organisational environments.
Hopwood – US manufacturing steelworks
Otley – UK coal mining
Flexible Budgeting
Flexible Budgeting
Responsibility Accounting
Is based on the recognition of individual areas of responsibility in the organisation, which are known as responsibility centres, with a single person being in charge.
The objective is to accumulate costs and revenue for each individual responsibility centres so that any deviations can be reported to the person in charge
It is implemented by issuing Performance Reports at frequent intervals informing of the deviations from the budget for expenses
Flexible Budgeting
As some costs vary with the level of activity, this should be taken into consideration. When preparing performance reports it is misleading to compare actual costs at one level of activity with the budget costs at a different level of activity. So we should adjust the original budget to actual level of activity.
The cost behaviour of the individual costs should be considered. i.e. are they fixed costs, variable costs, or a mixture of the two
Flexed Budget Control Statement
Analysis of costs : fixed costs
1. Depreciation 180
2. Administration 1620
Flexed Budget Control Statement
3. Semi variable costs
Catering total 1750 for 6 courses
Fixed element 250 variable element 1500 for 6
250 each
Total for 5 course 5 x 250 = 1250 + 250 = 1500
Insurance total 820 for 6 courses
Fixed element 100 variable element 720 for 6
120 each
Total for 5 courses 5 x 120 = 600 + 100 = 700
Flexed Budget Control Statement
Analysis of costs - variable costs
Variable Per course
for 6
Speakers fees 3180 530
Hire of premises 1500 250
Stationery 600 100
I
Flexed Budget Control Statement
| Expenditure | Fixed cost | Variable cost | Total cost | Actual cost | Variance |
| £ | £ | £ | £ | £ | |
| Speakers’ fees | - | 2650 | 2650 | 2500 | 150 |
| Hire of premises | - | 1250 | 1250 | 1500 | (250) |
| Depreciation of equipment | 180 | - | 180 | 200 | (20) |
| Stationery | - | 500 | 500 | 530 | (30) |
| Catering | 250 | 1250 | 1500 | 1500 | - |
| Insurance | 100 | 600 | 700 | 700 | - |
| Administration | 1620 | - | 1620 | 1650 | (30) |
| 2150 | 6250 | 8400 | 8580 | (180) |
S4/Learning Curve example.pdf
Learning Curve Cumulative Average Time Model Example The cost estimate for a new product is: £ Materials 5000 Labour (at £5 per hour) 4000 Overheads ( 150% of labour) 6000 --------- 15000 Profit ( 20% on cost) 3000 --------- Selling price 18000 --------- An 80% learning curve applies. There is only one customer interested but they may be interested in buying a number of units in the near future, if a selling price can be agreed. Required:
1. Quote the lowest price possible for unit number 2. 2. Quote a price for a. 4 units b. 8 units - if they are ordered together.
S4/Selling price examples.pdf
Pricing 1. A company is launching a new product which has a variable cost of:
£ Direct Materials 12
Direct Labour 10 Variable production overhead 3
25
The direct labour rate is £5 per hour. The variable overheads are absorbed on a machine hour basis, with the absorption rate being set at £6 per machine hour. The fixed production overheads are £144,000 per month, and are to be absorbed on a labour hour basis. The budgeted labour hours are 24,000 per month. Management require a profit of 30 % on cost. Required Calculate the selling price using
a) Marginal cost plus pricing b) Full cost plus pricing
2. A company is budgeted to produce 50,000 units, which have a variable cost of £5 per unit and fixed costs of £150,000 per year. The finance director wants a profit of 25 %. The managing director has produced the following:
£ Demand
9 42,000
10 38,000
11 35,000
12 32,000
13 27,000
The normal level of activity is 50,000 units. Required
a. What would the profit be if the full cost plus price is charged with a 25 % profit?
b. What is the profit-maximising price?
S4/session 4 students version.pptx
MSc Accounting and Finance
Management Accounting
Session four
Pricing
Pricing
The selling price of a product must be greater than its average unit cost of goods sold, in order to make a profit
Pricing
Marginal cost-plus pricing
Marginal cost-plus pricing or mark-up pricing involves adding a profit margin to the marginal cost of production/sales
Pricing
Marginal cost-plus pricing example
Selling price
Profit 30 %
Marginal Cost
Variable production o/h
Direct labour
Direct materials
Pricing
Advantages of Marginal cost-plus pricing
It is a simple and easy method to use
The mark-up percentage can be varied, so mark-up pricing can be adjusted to reflect market conditions
It draws management attention to contribution, and the effects of higher or lower sales volume on profit
In practice, mark-up pricing is used in businesses where there is a readily-identifiable basic variable cost. Eg retail industries
Pricing
Disadvantages of Marginal cost-plus pricing
Although mark-up can be varied, it does not ensure sufficient attention is paid to demand conditions, competitors’ prices and profit maximisation
It ignores fixed overheads in the pricing decision, but the sales price must be sufficiently high to ensure that a profit is made after covering fixed costs
Pricing
Full cost-plus pricing
Full cost-plus pricing is a method of determining the sales price by calculating the full cost of the product and adding a percentage mark-up for profit
Pricing
Full cost-plus pricing example
Selling price
Profit @ 30 %
Full production cost
Fixed production o/h
Variable o/h
Direct Labour (2 hours)
Direct Materials
Pricing
Budgeted overheads
Absorption rate = ------------------------------------
Budgeted level of activity
= ------------------------------
=
Pricing
Absorption rate =
Product takes
Fixed overheads =
=
Pricing
Full cost-plus pricing example
Selling price
Profit @ 30 %
Full production cost
Fixed production o/h
Variable o/h
Direct Labour (2 hours)
Direct Materials
Pricing
Advantages of full cost-plus pricing
It is a quick, simple and cheap method of pricing which can be delegated to junior managers
Since the size of the profit margin can be varied, a decision based on a price in excess of full cost should ensure a company working at normal capacity will cover all of its fixed costs and make a profit
Pricing
Disadvantages of full cost-plus pricing
It fails to recognise that since demand may be determining price, there will be profit-maximising combination of price and demand
There may be a need to adjust prices to market and demand conditions
Budgeted output volume needs to be established. Output volume is a key factor in the overhead absorption rate
A suitable basis for overhead absorption must be selected, especially where a business produces more than one product
Pricing
Profit maximising price
Possibly the most important problem of cost-plus pricing is that it fails to recognise that since sales demand may be determined by the sales price, there will be a profit maximising combination of price and demand
Pricing
Example – Full cost profit maximising
Selling price
Profit @ 25 %
Fixed overheads
Variable cost
Pricing
Example – profit maximising
Total contribution
Demand
Unit contribution (S.P – 5)
Selling Price
Learning Curve Theory
Learning Curve Theory
…….. Was first developed in the 1920’s and 30’s in the US, in the aircraft industry.
It can be used in any industry where;
A job is fairly repetitive
The speed isn’t dictated by the speed of machinery.
The worker is likely to become more efficient and quicker over time.
Eventually there will be nothing left to learn and the learning process will stop
Learning Curve Theory
The workforce must ‘learn’ as whole for it to apply
If there is a regular turnover of staff, the the learning effect will be disrupted.
Learning Curve Theory
……. The direct labour time should be expected to get shorter with the learning as so will apply to products which are:
a) relatively short lived with a high rate of obsolescence for the learning effect to be a permanent feature
b) complex products made in small quantities
Learning Curve Theory
The Cumulative Average Time Model
The cumulative average time per unit falls by a constant % every times the total output doubles.
The cumulative average time is the average time per unit, for all units produced so far back to and including the first unit made
Learning Curve Theory
The 80% learning curve is commonly applied.
This means that the cumulative average time required per unit of output is reduced to 80% of the previous amount, each time the output doubles.
Learning Curve Theory
Example: The first unit requires 100 hours. An 80% learning curve is to be applied.
Learning Curve Theory
Units cum av time total time
1 100 100
2 80 160
4 64 256
8 51.2 409.6
Learning Curve Theory
Units cum av time total time extra time
1 100 100 100
2 80 160 60
4 64 256 96
8 51.2 409.6 153.6
Learning Curve Theory
Uses:
To calculate the marginal cost of making extra units of a product
To quote selling prices for a contract
To prepare realistic production budgets
To compare budget and actual costs
Learning Curve Theory
Limitations:
It can only be applied in labour intensive organisations, which are repetitive and reasonably skilled
Employees must be motivated to learn
It assumes a stable labour mix
Breaks between production runs must be short or learning will be forgotten
Difficult to determine accurately
Learning Curve Theory
Cumulative average time model example
1 Quote the lowest price possible for unit number 2
Learning Curve Theory
Units cum av time total time extra time
Learning Curve Theory
1. Quote the lowest price possible for unit number 2
Materials
Labour
Overheads 150% of labour
-------
Profit 20% on cost
--------
Selling Price
=====
Learning Curve Theory
2. Quote a price for
a. 4 units
b. 8 units
if they are ordered together
S4/session 4.pptx
MSc Accounting and Finance
Management Accounting
Session four
Pricing
Pricing
The selling price of a product must be greater than its average unit cost of goods sold, in order to make a profit
Pricing
Marginal cost-plus pricing
Marginal cost-plus pricing or mark-up pricing involves adding a profit margin to the marginal cost of production/sales
Pricing
Marginal cost-plus pricing example
32.50
Selling price
7.50
Profit 30 %
25.00
Marginal Cost
3.00
Variable production o/h
10.00
Direct labour
12.00
Direct materials
Pricing
Advantages of Marginal cost-plus pricing
It is a simple and easy method to use
The mark-up percentage can be varied, so mark-up pricing can be adjusted to reflect market conditions
It draws management attention to contribution, and the effects of higher or lower sales volume on profit
In practice, mark-up pricing is used in businesses where there is a readily-identifiable basic variable cost. Eg retail industries
Pricing
Disadvantages of Marginal cost-plus pricing
Although mark-up can be varied, it does not ensure sufficient attention is paid to demand conditions, competitors’ prices and profit maximisation
It ignores fixed overheads in the pricing decision, but the sales price must be sufficiently high to ensure that a profit is made after covering fixed costs
Pricing
Full cost-plus pricing
Full cost-plus pricing is a method of determining the sales price by calculating the full cost of the product and adding a percentage mark-up for profit
Pricing
Full cost-plus pricing example
Selling price
Profit @ 30 %
Full production cost
Fixed production o/h
3.00
Variable o/h
10.00
Direct Labour (2 hours)
12.00
Direct Materials
Pricing
Budgeted overheads
Absorption rate = ------------------------------------
Budgeted level of activity
£144000
= ------------------------------
24000 labour hours
=£6.00 per labour hour
Pricing
Absorption rate = £6.00 per labour hour
Product takes 2 labour hours to produce
(£10 per unit / £5 per hour)
Fixed overheads = 2 hours at £6.00 per hour
= £12.00
Pricing
Full cost-plus pricing example
48.10
Selling price
11.10
Profit @ 30 %
37.00
Full production cost
12.00
Fixed production o/h
3.00
Variable o/h
10.00
Direct Labour (2 hours)
12.00
Direct Materials
Pricing
Advantages of full cost-plus pricing
It is a quick, simple and cheap method of pricing which can be delegated to junior managers
Since the size of the profit margin can be varied, a decision based on a price in excess of full cost should ensure a company working at normal capacity will cover all of its fixed costs and make a profit
Pricing
Disadvantages of full cost-plus pricing
It fails to recognise that since demand may be determining price, there will be profit-maximising combination of price and demand
There may be a need to adjust prices to market and demand conditions
Budgeted output volume needs to be established. Output volume is a key factor in the overhead absorption rate
A suitable basis for overhead absorption must be selected, especially where a business produces more than one product
Pricing
Profit maximising price
Possibly the most important problem of cost-plus pricing is that it fails to recognise that since sales demand may be determined by the sales price, there will be a profit maximising combination of price and demand
Pricing
Example – Full cost profit maximising
£10
Selling price
2
Profit @ 25 %
8
3
Fixed overheads
5
Variable cost
Therefore, at a selling price of £10 and demand at 38,000, contribution is (10-5), 38,000 X 5 = £190,000
Pricing
Example – profit maximising
216000
224000
210000
190000
168000
Total contribution
27000
32000
35000
38000
42000
Demand
Selling price £12 with demand at 32,000
gives best contribution £224,000
8
13
7
12
6
11
5
10
4
9
Unit contribution (S.P – 5)
Selling Price
Learning Curve Theory
Learning Curve Theory
…….. Was first developed in the 1920’s and 30’s in the US, in the aircraft industry.
It can be used in any industry where;
A job is fairly repetitive
The speed isn’t dictated by the speed of machinery.
The worker is likely to become more efficient and quicker over time.
Eventually there will be nothing left to learn and the learning process will stop