Management Accounting: Data, Information, Cost Classification, Cost Behaviors

OPERATIONAL LEVEL P1 Management Accounting Chapter 2: Accounting for Management, Sources of Data and Presenting Information. (C) Personal Use only. Any un-authorized use, copying or reproducing full or partial content is contravention of intellectual property act and unlawful. Failure to comply will be subjected to legal recourse.

Contents 10 3 Cost Centres Introduction to Cost accounting for Decision and Control 11-20 4 Types of Costing Purpose of Costing 21 Reconciliation between Absorption and Marginal Costing 5 Cost Classification Nature and Elements 22-23 Joint Product Costing 6-9 24-28 Cost behaviors Module Question and Keys

Introduction Welcome to Students who have enrolled to pursue ACCA- Applied Knowledge level course that leads to RQF Level -4 (Diploma in Accounting and Business). This subject Management Accounting, is one tri-part courses of Applied Knowledge level along with Financial Accounting and Business and Technology. Under this subject, this chapter covers the nuances of management accounting to begin with. This chapter includes good information, planning, decision making and control, strategic, tactical and operational planning. This chapter also introduces the concept of cost center, revenue and investments centers. This is followed by deep understanding of sources of data, external and internal, sampling and some insights into Big Data. This chapter culminates in explaining how to present the information derived from data collected, through reports, graphs and tables.

Data and Information DATA: Data can be anything. From text, numbers, video files, audio files, symbols. It could be simply anything. Data and information is loosely used inter- changeably, but they are not one. Data precedes information. DATA: Data is processed meaning unwanted data are eliminated and only relevant ones are used for providing suitable information. INFORMATION: Information is derived from data after processing the latter. This should be meaningful for the users. INFORMATION: Care should be taken in providing information which are adequate, relevant to the consumers of those information.

Cost Classification - Nature and Elements Cost elements are those which has direct or no relevance to production. Material, Labor and Overheads Elements OVERHEADS All indirect expenses necessary to produce the product Indirect Classification Nature PRIME COST: Direct Materials Direct Labor Direct Production Expenses Direct

Cost Behaviors Cost behaviors are fluctuations of cost based on the level of activity of a company. Eg. Units produced; capacity used etc. It is imperative to understand the fundamentals of basic cost behavior patterns. Common costs and their behaviors are dealt below: Semi Variable Cost This has both fixed and variable components.They stay fixed up to certain level and moves after they cross the threshold. Electricity deposit paid to obtain connection is fixed and monthly bill payment based on units of electricity consumed is variable. Present Variable Cost This cost varies proportionately with the activity.This cost has the tendencies to be linear or non-linear in nature. Due to economies of scale each additional unit of production adds lesser to its total costs. Any additional labor will add up more to the total cost thereby making it non-linear. Fixed Cost This is a Period cost. The cost is constant till certain level of activity or period but will become higher once the level of activity moves to a equally higher level. However, we need to understand that fixed cost / unit will decrease if the level of activity gets higher as per unit fixed costs gets distributed to higher number of units.

Flat Fixed Cost Fixed Cost Total Fixed Cost CIMA Terminology on Fixed Cost: A cost which is incurred for an accounting period that, within certain output or turnover limits tends to be unaffected by fluctuations in the levels of activity (output or turnover) Units Produced Stepped Fixed Cost Flat fixed cost: This cost is incurred notwithstanding if a revenue is earned or not. For example, factory premises leasehold rent needs to be paid irrespective if the company has commenced its production or not. Total Fixed Cost Stepped Fixed Cost: Again, these costs are fixed but keeps increasing due to increase in level of operation. As seen in the previous slide, example of lease rent for certain years will remain flat and then moves to next level for some period. It remain constant till the end of second time before it gets increased again. Units Produced Fixed Cost / Unit Cost per unit However, fixed cost per unit will start to curve at every additional unit of production and looks concave as mentioned in the third graph. Units Produced

Linear Variable costs: Variable Cost Total Variable Cost ($) CIMA Terminology on Variable Cost: A cost that varies with a measure of activity . Total Units Produced Most of the times these costs are linear. Total variable costs gets reduced upon every additional unit. No production then there is no variable cost. This cost increase proportionately to the number of units produced Non-Linear Variable Costs: Total Variable Cost ($) Eg: If per unit Direct Material cost is $5, Direct Labor is $3 and Direct Expenses is $2 and total variable cost amounts to $10 per unit and if a company does not produce even 1 unit, then the cost will be $0 and if one unit is produced then it is $10 and if 100 units are produced then the total variable cost will be $1000. Variable cost will remain linear i.e. per unit variable cost will remain $10 per unit irrespective 1 unit or 100,000 units are produced. This Is called LINEAR variable cost because of its trajectory. Total Units Produced Variable Costs increases as production increases Total Variable Cost ($) Non Linear Variable Cost: Variable cost per unit will decrease whenever there is an increase in production due to certain benefits are factored into the cost. E.g. Bulk purchase discount will reduce per unit cost of material and this reduces direct material costs. Total Units Produced

Semi Variable Cost CIMA Terminology defines Semi Variable Cost: Semi Variable Cost: Total Costs A cost containing both fixed and variable components and thus partly affected by a change in the level of activity Total Costs Also known as hybrid, semi-fixed or mixed cost as this cost has the mix of both fixed element as well as variable element of a cost. This cost will remain fixed up to certain level of activity and after that, like variable cost, will start increasing proportionate to unit of production. Variable Cost Fixed Cost An example for this cost is electricity charges A fixed amount of deposit is taken for installation of connection, activating the connection and a free units up to certain level after which a rate/ unit is charged for those units that were used by the consumer beyond free units. Units Produced One should also remember that Variable cost need not always begin at the start line at zero, it may travel along fixed cost line and then spike out after certain level in production level.

Cost Centres Every activity in an organization related to a department or a process are accounted under one category called Cost Centres. Operation cost, staff cost, Capital Expenditure, Project cost and many such costs are accounted under each of these cost centres for ease of arriving at profitability or making a budget. It is also easier to compare performance of each cost centres and measure the efficiency of them to pay bonus or other sops. Product Geography Cost Centre based on location is easier for measuring performance and profitability. Cost Centre based on products is set up to track product wise performance, allocation of costs esp. promotions and measuring its profitability. Department Staff costs, equipment, rent based on floor space used are all accounted under this category of cost centre. Department level profitability can be calculated. Asset Asset based cost centre is another type of cost centres. Purchase, Disposal, Revaluation and Depreciation can be easily identified and accounted.

Types of Costing There are different types of calculating to costs to be realized from sales. Some of them are calculated per unit cost basis and some of them traditionally in total. They are discussed in detail in following slides Traditional Absorption Cost Joint Product Costing Marginal Costing Digital Costing Activity Based Costing Refer Chapter 3

Traditional Absorption Costing This is a traditional costing technique of finding the total cost per unit. Absorption cost focuses on all production related costs only. Under Absorption cost, the total production cost consists of - Direct Material Cost per unit + Direct Labor Cost per unit + Production Overheads per unit, (Production Overheads is absorbed based on units produced, machine hours or labor hours). Absorption Costing Non-Production Cost Production Cost Overhead is directly connected to the number of units produced. It is calculated as: Total Overhead cost (allocated and apportioned) Budgeted Volume Admin. Cost Prime Cost Selling & Dist Cost Indirect Cost

Allocation, Apportionment and Absorption of Overheads Accounting overhead costs in an Absorption costing are first allocated, then apportioned and are then absorbed into the direct production overheads. Allocation In this step, costs are all identified and allocated to various cost centers or codes. This is a process in which production costs are identified and allocated to cost centres or cost codes either in full or in part based on the expenditure incurred. Apportionment This is step 2 in this Absorption costing method. Finding the correct basis for apportionment of the overheads. All production costs should have been apportioned to direct production units within that department. Absorption An absorption rate is calculated for each unit within the department as standard measure. Based on this rate the overheads are absorbed to the overall cost of each unit within the department. Absorption cost is based on absorption rate per unit.

Allocation, Apportionment and Absorption of Overheads Whenever there are several produced or a nonstandard jobs are done for the customer then production volume is measured by three ways. The absorption rate would be the number of machine hour used for production. 03 Machine Hour Worked Direct labor hour used to measure production volume, in such case percentage of labor hour is used as absorption rate. 02 Percentage of labor hour Direct Labor Hour 01 Direct labor worked in the department therefore the absorption rate is a rate per direct labor worked.

Absorption Rate Budgeted rate of absorption, Over and Under absorption Cost Absorption is quick Most of the time, absorption rates are budgeted rates which are pre-determined. It is a cumbersome exercise to arrive at the absorption rate after completion of production. Costs are absorbed as the production of goods moves in line. Budgeted Rates Absorption of costs using budgeted rates can lead to over absorption or under absorption situations. Over Absorption Over and under absorption is calculated: (Budgeted Overhead rate per unit x Actual Units) Actual Overhead incurred Under Absorption

Absorption Costing Merits and Disadvantages There are merits in this traditional costing technique, however one cannot overlook the inherent disadvantages in continuing this method. Through absorption rate over or under absorption of production overhead is identified and therefore inefficiency of under utilization of resources. The allocation, apportionment and absorption is all done in arbitrarily, and is not efficient way to identify the right overhead. It is subjective. Fixed Costs: Fixed cost is part of total cost and therefore cannot be avoided in recognising overall cost structure. Inefficiency Identified Arbitrary method of apportionment and absorption Fixed Cost Accrual basis Inventory Cost Activity Based Costing (ABC) Inconsistency in financial information Inventory costs carries a part of fixed cost element in its value. Warehouse rent, store maintenance staff cost are all part of inventory cost. Since inventory cost based on the absorption costs will be fluctuating, there will be changes in the profit information and thereby frequent inconsistency in the financial information. This is one type of absorption costing which treats all costs as variable. It identifies overhead costs with a product or service which had created this expenditure. ABC is discussed in due course in detail.

Marginal Costing Marginal costing is one other costing methods wherein a product cost is based on variable costs alone. Fixed costs are absorbed within the contribution of that unit of production. Cost increases or Decreases based on unit addition or reduction. Per unit variable cost Marginal cost arises at every unit of additional production. Marginal cost comprised of Direct material, Direct Labor and Variable costs. Dis - Advantages a)Simple and easy to calculate b) No absorption techniques c) Cost increase based on additional unit a) Grey area in classifying fixed and variable costs. b)Absorbing FC in contribution is not rational approach as FC is usually higher. advantages

Templates of Absorption Costing & Marginal Costing Marginal Cost Template Sales Less Opening Inventory + Variable Cost of Production - Closing Inventory Less Variable Selling, Admin & Distribution cost Contribution Less: Fixed Costs Fixed Cost of Production Fixed Selling, Admin & Dist.Cost Net Profit/ (Loss) $ $ X Absorption Costing Template Sales Less: Opening Inventory + Purchases - Closing Inventory Over / (Under) absorption Gross Profit - Sellinf=g, Admin, Distritbution Variable Fixed Net Profit or (Loss) $ $ X X X X X (X) (X) (X) (X) X/(X) X (X) X X X X X (X) (X) X/(X) X / (X)

Example -1 Petersons makers of Men s Tee shirts has the following information to provide: Selling Price $/Unit Direct Material $/Unit Direct Labour $ / Unit Variable Overhead $/Unit 30 12 8 5 Fixed Overheads are $ 6000, Budgeted production and sales are 1500 Units. Using the above information calculate under Absorption costing a) Profit for the period and b) profit per unit. Calculate under marginal costing a) Calculate contribution per unit, b) total contribution and c) profit for the period.

Solution Marginal Costing: Profit per unit is $1. a) Contribution = Sales - DM Lab - Variable cost = $30 ($ 12+ $ 8 + $5) = $ 5. Absorption Costing Sales (1500 units x $30) Less: Opening Inventory + Purchases (1500units x 12) +Labour (1500 units x 8) Gross Profit - Selling, Admin, Distritbution +varaiable cost(1500 units x5) Fixed $ $ 45,000 b) Total contribution = $5 x1500 units = $ 7500 c) Profit per unit - calculation: (18,000) (12,000) $ (30,000) 15,000 Total Contribution 1500 x $5 7,500 Less: Fixed Cost (6,000) Profit 1,500 (7,500) (6,000) Profit per unit - $ 1,500 / 1,500 units 1.00 (13,500) Net Profit or (Loss) 1,500

Reconciliation between Absorption and Marginal Costing Due to different valuation techniques in evaluating inventory, the profits that are arrived are different and can be reconciled. Profits in Absorption costing will be higher if there is higher inventory cost. Because some Fixed overheads are still carried in Inventory. Absorption Cost Profit + / - Increase / (Decrease) in Inventory x Fixed Overheads = Marginal Cost Profits. An element of Fixed overheads is carried in inventory cost to be recovered from sales in future. There is no need to reconcile profits between Marginal Costing and Absorption Costing if there are no movements in inventory cost. Profits in Marginal Costing is higher if the inventory cost is lower due to fixed overhead being realized as and when sales takes place.

Joint Product Costing This cost is incurred for products produced at the same time in the same process but segregated at some point in time either for different processing after some stage or sent for sale. 1 2 3 4 5 Methods By-Product Split off Joint Product Joint Cost

Joint Product Costs Apportionment There are three types of apportionment of joint product costs Actual measurement of joint products, Net Realizable value and market value. Market Value Before apportioning the cost, need to find the market value of each joint product at the point of split up. Market value of each such joint products are arrived to ascertain if they are profitable if sold in the market on a given day. Measurement of Joint Products Joint costs are apportioned to the units of production of each product. Where joint costs are NOT equally incurred, they can be separated and apportioned using weighting factors. Net Realizable Value If one of the product from the joint products is carried further processing, cost incurred for that stage is ascertained. Such additional cost is then reduced from the total joint cost which is the realizable cost of each product within the joint products group.

Module Test Questions (Multiple Choice Questions) Q. No 1: Jamieson & Co manufactures track suit for athletes the selling price of which is $ 75. The other information are as follows: Direct Material $ 27 Direct Labour $ 17 and Variable Overhead is $11. Budgeted Fixed overhead is $ 17,500 per annum charged across equally in all months. Budgeted production is 7500 pieces per month. In the given month actual production was 2500 pieces and exceeded sales by 250 pieces, what would be the profit reported under absorption costing. a) $29,083.33 b) $ 27,083.33 c) $ 28,553.33 d) 28,083.33 Q. No 2: There is not much of a movement in inventory value and has remained the same for the past 6 months, how do we valuation the inventory between absorption costing and marginal costing? a) There is no need to reconcile inventory under both absorption and marginal costing. b) The inventory cost will be higher in absorption costing since an element of fixed cost portion is included in the inventory and therefore needs to be reduced. c) The inventory cost will be lower in absorption costing since an element of fixed cost is includedin the inventory and therefore needs to be increased. d) None of the above.

Module Test Questions (Multiple Choice Questions) Q. No 3: Exe Limited makes a single product whose total cost per unit is budgeted to be $ 45. This includes fixed cost of $ 8 per unit based on the volume of 10,000 units per period. In a period, sales volume was 9,000 units and the production volume was 11,500 units. The actual profit for the same period calculated using absorption costing was $42,000. If the profit statement were prepared using marginal costing, identify the profit for the period. a) $ 10,000 b) $22,000 c) $ 50,000 d) $ 62,000 Source: Kaplan CIMA Study Text Q. No 4: Fixed production overhead is always over absorbed when: a)Actual overheads incurred are higher than budgeted overhead b)Actual fixed production overheads incurred are lower than the ones absorbed c)Actual fixed production overheads incurred are higher than the ones absorbed d)Actual output is higher than the budgeted output

Module Test Questions (Multiple Choice Questions) Q. No 5: There are two products K & L and are joint products. The joint production costs for the products are $ 1500. Following information is provided for you to find the profit at the point of separation. Product K Product L Kgs produced 250 150 Kgs Sold 220 100 Selling price / Unit $ 12 $ 8. Apply correct joint costs between Product K & L. a) K - $ 1598, L $ 414 b) K - $ 1798, L - $ 614, c) K - $ 1698 L - $514 d) K - $ 2,000 L- $1000

Module Questions - Keys Q. No 1: d) Since these types of questions in MCQ are frequent, it is time saving to approach through marginal costing and then work back to absorption costing. therefore the profit is low. To find out Profit under absoption cost, we need to increase the profit. Q. No 2: a) Q. No 3: Difference in Profit = Contribution per unit x Difference in volume Profit as per absorption Costing = $ 42,000 Profit as per Marginal Costing = $ 42,000- $20,000 = $ 22,000 $ Sales DM, DL,VOH Contribution Contribution for the month Less Fixed Cost Profit 75 -55 20 27, 17,11 $ 8 x 2500 units = $20,000 2250 45,000 (17,500) 27,500 Profit shown is calculated based on Marginal costing, Q. No 4: b) 17500 / 7500 units Fixed cost per unit Add back Fixed cost of over production Profit under Absorption Cost 2.33 583.33 28,083.33

Module Questions - Keys K $ 3,000 L $ Q. No 5: c) Sales value of the production Proportion Jont cost apportionment Per unit joint cost 30/42 12/42 1,200 1,071 4.28 429 2.86 Trading Result Sales Cost of Sales Profit Closing Inventory 2,640 (942) 1,698 128 800 (286) 514 143

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