Acca Fia Ma2 PDF

Notes
FIA MA2
Management Accounting 2
For exams in 2014
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ExPress Notes
FIA MA2 Management Accounting
Contents
Page | 2
About ExPress Notes
1.
Management Information
2.
Cost Recording
14
3.
Costing Techniques
20
4.
Decision making
33
5.
Cash management
47
6.
Spreadsheets
50
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ExPress Notes
Chapter 1
Management Information
KEY KNOWLEDGE
Management Information Requirements
Purpose of Management Information

Planning: has to do with the formulation of objectives within the organization, both in the
short- and long-term (see below).
Decision-making: refers to conclusions drawn once all relevant information has been
analysed. Implementation of decisions taken (.e. the decision to take action) follows.
Control: Post-implementation, actual results are analysed in order to determine whether
planning and decisions taken need to be revised or to implement corrective actions.
The control step acts as a feedback loop into the previous processes. Remember, look at
theses systems dynamically: we learn from experience and need to take corrective steps and
to improve processes continuously!
The Features of useful management information
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ExPress Notes
The qualities of good information can be summarized in the word ACCURATE:
Accurate,
Complete,
Cost-beneficial,
User-targeted,
Relevant,
Authoritative,
Timely and
Easy to use
Financial and Non-financial information for managers

In addition to financial information which can be extracted from the financial accounting
records, managers rely for their decision-making on a host of information that is derived
from non-financial sources. These can range from industry data (overall size, market shares
of different competitors) to customer opinions about the products and services offered.
Internally, non-financial information can embrace a host of operational statistics which are
relevant to managerial decision-making: examples include the rate of staff turnover; the
time it takes to cook a hamburger (in a restaurant business); the rate of defects in a
production process; the set-up time necessary between different production batch runs; or
measurements of service/product quality.
Planning at different levels of the organisation
Strategic: Covers the big view of the organization and its

objectives. Long-term in nature.
Tactical: Planning over the short-term (usually one year), and

typically in connection with budgeting processes.
Operational: Day-to-day decisions, implemented on-the-spot

and directly involving all levels of the organization.
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ExPress Notes
Management responsibilities
Responsibilities correspond to specific areas and functions within an organisation. They are
best understood in relation to the following diagram:
Responsibility centres
Cost Centres
Revenue Centres
Profit Centres
Investment Centres
Cost centres: Responsible for current expenses only

Revenue centres: Responsible for revenues, but not current expenses other than marketing
expenses
Profit centres: Responsible for revenues and current expenses
Investment centres: Responsible for revenues, current expenses and capital expenditure
In order to competently manage his/her area of responsibility, a manager needs to have
relevant information (and authority) pertaining to their job function.
Relevant information not only supports decision-making, but also allows the performance of
the respective responsibility centre to be monitored, both by the (direct) managers in charge
as well as by the levels (above) to which they report.
The Role of Information technology

Information technology has had a dramatic and far-reaching impact on the structure and
conduct of business. IT has also been frequently poorly employed at great cost to
companies.
When implemented well, IT has made it possible for companies to exploit the benefits of
increased accuracy of information and faster decision-making.
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ExPress Notes
Suitable formats for the presentation of management information according to purpose

Managerial accounting is a free-style form of accounting in which format and structure of
information are not prescribed externally, but conform to the requirements of the users
(management and staff).
KEY KNOWLEDGE
Cost Accounting Systems
In order to understand the relationship between Management accounting and Financial

Accounting systems, it is useful to summarize the differences between the two. Management
accounting is:
Aimed at internal users (as opposed to financial accounting, which is aimed at
external stakeholders)
Focused on present and future performance (as opposed to financial accounting,
which reports past performance)
Not required by law and not regulated by accounting frameworks (as opposed to
financial accounting, which is a legal requirement and is regulated by accounting
frameworks)
Focused on specific areas or activities (as opposed to financial accounting, which
provides a holistic view of companys performance)
Employs non-financial indicators as well financial, while financial accounting uses
only financial measures.
Since the management accounting system is based on (or derived from) a companys
financial accounting system, the two are usually combined (or integrated) for reasons of
cost and efficiency, i.e. to avoid duplications.
Coding transactions
Transactions in a business are more easily processed by use of a coding system. This
involves assigning to a particular transation a code, i.e. a kind of symbolic label, which
identifies the nature of the transaction in a systematic and unambiguous way. In doing so,
this allows transactions to be grouped together in information systems, processed, added up
and analyzed in a manner that permits checking and reconciliation (against original records).
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ExPress Notes
The characteristics of a coding system shares some of the features of good information: it
must be standardized, logical, objective, brief (i.e. capable of being summarized), verifiable,
comprehensive and yet flexible (allowing development to cover all relevant situations in a
relevant manner).
Cost units: The units are the discreet items to be measured, such as packs of nails (batches)
or a student.
KEY KNOWLEDGE
Cost Classification
There are a variety of ways in which one can classify costs:
Production vs. Non-Production

Production costs: These are costs (both direct and indirect, also variable and fixed) which
relate to the production of goods; this is also referred to as manufacturing or factory cost. It
is these costs, accumulated, which provide the value at which goods are placed in inventory
(prior to sale) and form the cost of goods value when sold.
Non-production costs: These are expenses that are incurred independent of production and
include administrative, selling, distribution and finance costs. These costs can have the
character of period costs, as they relate to the period of time in which they occur.
Direct vs. Indirect
Direct costs: are costs that can be directly attributable to a product.
Indirect costs: these are costs that cannot be directly attributable to a product.
Fixed vs. variable
Page | 11
ExPress Notes
Fixed costs: are costs that remain constant regardless of the volume of production. A variety
of indirect costs are fixed.
Variable costs: vary in proportion with the volume produced. Direct costs are by their nature
variable in behaviour.
Other types of costs

Mixed costs: these are costs that contain a fixed and a variable element.
Step costs: costs that remain fixed within a defined range of production, but at a certain
level of output increase in a significant way to a new (fixed) level.
High/Low Method
Analyze the following operating costs as a function of output:
Output
(units)
Costs
($)
1,000
1,200
1,400
1,600
250,000
295,000
325,000
370,000
Take the maximum and minimum levels of output (the independent variable) and the
associated costs (dependent variable) and calculate the differences:
Max
Min
Diff.
Output
1,600
1,000
600
Costs
370,000
250,000
120,000
The variable cost per unit is: 200 (120,000/600)

Given the formula:
Total cost = Fixed cost + (Variable cost per unit x No. of units)
We can calculate the fixed cost
Fixed cost = 50,000
Page | 12
ExPress Notes
The high-low method can also be applied to the following situations:
Page | 13
When fixed costs change (step) along the output range; and
When the variable cost per unit changes
ExPress Notes
Chapter 2
Cost Recording
KEY KNOWLEDGE
Accounting for materials
Every company which buys, processes and sells materials will have established procedures
for ordering, receiving and issuing (such materials) which are generically similar. Some may
have highly automated systems in place, while others record the steps manually.
The key documents one should be familiar with are:
Purchase requisition form: This is an internal form that provides the authorization for
materials to be ordered from a supplier (external).
Purchase order (PO): The buyer issues a PO to the seller, indicating the
Description
Quantity
Price
of the product ordered.

The PO is a legal offer. Its acceptance by the seller creates a contractual commercial
relationship for the intended transaction.
Page | 14
ExPress Notes
Goods Received Note (GRN): This is completed by the buyer upon delivery to verify whether
the order has been properly fulfilled. It will contain:
Order No.
Description
Quantity ordered
Quantity delivered
Materials issuance (or requisition) form: This is the form necessary to authorize the release
of materials from inventory into the production process at the company.
Materials
The ordering, receiving and issuing of materials from inventory must be controlled according
to procedures and documented at all stages with forms appropriate to the purpose.
The controls and procedures are designed to monitor inventory movements so as to
minimise discrepancies and losses and theft.
Accounting entries
Materials
Debit (Dr) entries
=
Inventory
Credit (Cr) entries
=
Increase in
inventory
Decrease in
inventory
Economic Order Quantity

Within a company, there is a natural temptation to accumulate buffer stocks (raw materials
and semi-finished goods) so that production is never interrupted.
Similarly, in order to avoid stock-outs, sales managers will insist on maintaining a plentiful
level of finished goods. All of this costs money.
The EOQ is a method which seeks to minimize the costs associated with holding inventory.
To determine the total costs, the following data is required:
Q = order quantity
Page | 15
ExPress Notes
D = quantity of product demanded annually

P = purchase cost for one unit
C = fixed cost per order (not incl. the purchase price)
H = cost of holding one unit for one year
The total cost function is:
Total cost = Purchase cost + Ordering cost + Holding cost
which can be expressed algebraically as follows:
TC
= PxD
+ C x D/Q
+ H x Q/2
It is this total cost function which must be minimized.

Recognizing that:
PD does not vary;
Ordering costs rise the more frequently one places (during the year); and
Holding costs rise the fewer times one places orders (due to larger quantities being
ordered each time),
It follows that there is a trade-off between the Ordering and the Holding costs.
The optimal order quantity (Q*) is found where the Ordering and Holding costs equal each
other, i.e.
C x D/Q = H x Q/2
Rearranging the above and solving for Q results in
EXAMPLE
A trucking company uses disposable carburettor units with the following details:
Page | 16
ExPress Notes
Weekly demand
500 units
Purchase price
USD 15 / unit
Ordering cost
USD 40 / order
Holding cost
7% of the purchase price
Assume a 50 week year. What is the optimal order quantity?

The EOQ = 1,380 units
KEY KNOWLEDGE
Accounting for labour
Direct and Indirect Labour

Direct labour refers to work which is directly involved in the manufacture of a product.
Indirect labour (e.g. the supervisors salary, or that of a security guard) forms part of
overhead costs.
It is important to note that the basic pay portion of direct labour costs is included in the
prime cost of a product.
Overtime premiums, bonuses, employers contributions, sick pay and idle time costs relating
to direct workers are all accounted for as overheads (indirect costs). One exception:
Overtime performed as a result of a client request is recorded as a direct labour cost.
Accounting for labour costs
Labour account
Debit (Dr) entries Credit (Cr) entries
=
=
Labour costs
incurred
Transfer to P&L
Note: The transfer to the P&L takes place via the Work-In-Progress (WIP) account for direct
labour costs and the production overheads account in the case of indirect labour costs.
Page | 17
ExPress Notes
Remuneration methods
There are two basic forms of remuneration:
Time-based, and
Outputbased (e.g. piecework)
Effective incentive schemes are designed to ensure that the interests and behaviour of
individual employees and groups of employees are in-line (i.e. consistent) with the
companys objectives.
Managerial metrics relating to labour
The key ratios to learn are:
Labour turnover
=
No. of departing employees requiring replacement

Average no. of employees
Labour efficiency
=
Standard hours of output

Actual hours worked
Labour capacity
=
Actual hours worked

Total budgeted hours
Labour production volume

=
Standard hours of output

Total budgeted hours
This last ratio is the result of multiplying the labour efficiency with the labour capacity ratio.
Page | 18
ExPress Notes
KEY KNOWLEDGE
Accounting for other expenses
Direct and Indirect costs

Traditionally, accountants maintain that costs have to be charged to whatever is being
costed the goal is ultimately to link costs to the units of product themselves:
Direct costs are not a problem as they are directly attributable to the product.
Indirect costs in this context referred to as overheads -- are more difficult to link to
products (e.g. a supervisors salary or a security guard).
Page | 19
ExPress Notes
Chapter 3
Costing Techniques
KEY KNOWLEDGE
Absorption costing
This is one method which seeks to make the link between overheads and (product) cost
units. The diagram below provides a useful roadmap.
Total Production Costs
Direct Costs
Indirect costs (overheads)
2. Allocate/Apportion to Cost Centres
Production A
Production B
Service C
1. Allocate
3. Reapportion from
Service to Production
Production A
Production B
4. Absorb
Cost Unit
Page | 20
ExPress Notes
The focus (above) is production. Overhead costs that are not incurred at the time of
production do not find their way into inventory.
It is useful to think of production costs as being those that end up as part of the inventory
(valuation) while other (non-production) costs are incurred outside, and normally after the
product leaves inventory.
Allocation and Apportionment
Allocate, Apportion and Re-apportion indirect production costs (shown on the right side of
the diagram) to cost units.
Our focus is on the first category (production); the other overhead costs are not incurred at
the time of production and do not find their way into inventory. Always think of the costs
going into inventory and those that occur after the product leaves inventory!
EXERCISE
A company producing refrigerators and toasters has identified the following overhead costs
relating to production:
$
8,000
1,500
3,000
2,500
15,000
Rent
Indirect materials
Power
Equipment insurance
The company has 3 cost centres, 2 production workshops (A & B) and 1 warehouse (C,
service centre).
1. Suggest the basis on which the costs shown above might be charged to the various cost
centres.
Rent
Indirect materials
Power
Equipment
Page | 21
8,000
1,500
3,000
2,500
Basis
sq.m.
Specific
kWh
Book
A
4000
600
1500
1000
B
2500
700
1000
1400
C
1500
200
500
100
ExPress Notes
insurance
value
15,000 sq.m.
7100
5600
2300
As a manager with cost centre responsibility, what could be your concerns with respect
to the bases selected above?
2. Re-apportion the service centre costs to the production workshops.
Assumption: C is used by A (65%) and B (35%):
A
Costs apportioned to A, B, C:
7,100
5,600
Costs re-apportioned from C:
1,500
800
Total overheads:
8,600
6,400
C
2,300
(2,300)
3. Absorb the overheads into the units produced.

Assumption: The company absorbs overhead costs on the basis of direct labour hours
Total labour
Hrs
Workshop A
Workshop B
1,400
950
Overheads
$
Overhead Absorption
Rate (OAR) $
8,600
6,400
6.14
6.74
Each workshop uses its OAR to keep track of overhead costs as it produces.
Alternatively, the company can use a blanket or company-wide OAR, calculated as:
Total overhead costs
Total labour hours
15,000 =
2,350
6.38
A companys cost cards for two products (toasters and refrigerators) could look as follows:
Refrigerator (cost per unit)
Direct materials (15kg @ $2/kg)
Direct labour (1.75hrs @ $15/hr)
Variable OHs
Fixed OHs (1.75hrs @ $6.38/hr)
Total
Page | 22
$
30.00
26.25
5.00
11.17
72.42
ExPress Notes
Toaster (cost per unit)

Direct materials (1kg @ $3/kg)
Direct labour (0.30hrs @ $15/hr)
Variable OHs
Fixed OHs (0.30hrs @ $6.38/hr)
Total
$
3.00
4.50
2.00
1.91
11.41
Summary Absorption costing
Method of measuring the cost of products or services by including a fixed overhead fair
share into the product manufacturing/service provision cost
Results in reporting higher ending inventories and higher operating profits (as fixed
factory overheads are taken to inventory cost instead of being expensed as incurred)
It addresses the problem of allocating factory overheads per product lines
Step 1: Identify total factory overheads to be absorbed
Step 2: Take the total quantity recorded for the absorption base
o
The absorption base should be highly correlated with incurrence of overhead
Most common absorption bases selected: direct labour hours, machine hours,
units of output
Step 3: Compute overhead absorption rate (OAR) as Step 1 / Step 2 ($/unit of

absorption base)
Step 4: Obtain unit overhead cost per product line, by multiplying the OAR with the
absorption base quantity recorded per unit
Step 5: For each product, multiply Step 4 by total output to determine factory
overhead to absorb in the production cost.
Over- and under-absorbed factory overheads

o
Page | 23
In practice, OARs are pre-determined on an annual basis, making

assumptions on total activity levels for selected absorption bases. Such
assumptions can be based on manufacturing technical capacity, normal
capacity, or expected capacity.
ExPress Notes
When actual activity levels differ from those used in pre-determining absorption
rates, this results in over- or under-absorption.
KEY KNOWLEDGE
Marginal costing
Features of Marginal Costing

A marginal approach to costing focuses on the variable (marginal) costs generated in a
business and considers fixed costs as period costs. This allows the company to be able to
quantify the amount by which its costs rise, if it produces/sells an additional unit of output.
Marginal costing:
Is an alternative costing method, with variable costs only being charged as a cost of
sale (excludes fixed factory overheads from manufacturing costs)
Results in reporting lower ending inventories and lower operating profits (as fixed
factory overheads are fully expensed as incurred instead of being absorbed in
inventory cost)
Recognizes that fixed costs become irrelevant for short term production decision
making based on product profitability (sunk costs)
Avoids arbitrary bases for fixed overhead absorption into the production cost
Contribution
Contribution is defined as the difference between Sales revenue and the marginal cost of
sales, or
Contribution = Sales Variable costs (both production and non-production)
Example
Below is data on a manufacturing company.
Selling price (per unit):
Cost card (per unit):
Direct materials
Direct labour
Page | 24
120
45
18
ExPress Notes
Variable production O/Hs

Total variable costs
9
72
There is a variable selling cost of $2 per unit

Year 1
(units)
Year 2
(units)
Budget (normal) production
1,100
1,100
Actual Production
Actual Sales
1,000
950
1,100
1,150
Actual fixed production O/Hs

$16,500
$16,500
Actual SGA costs
$ 7,000
$ 7,000
Based on the above data, a profit and loss statement for the Years 1 and 2 is prepared.
Assume that the beginning inventory is zero.
Profit/Loss (Marginal costing)

Year 1
$
Sales (950/1,150 units)
Year 2
$
114,000
138,000
Less: Variable cost of sales

Opening inventory
3,600
Production costs:
o
Variable
(1,000 x $72)
(1,100 X $72)
Less: closing inventory

(50 x $72)
Page | 25
72,000
79,200
(3,600)
(68,400)
(82,800)
Less: Variable selling costs

(950 x $2)
(1,150 x $2)
(1,900)
Contribution
43,700
52,900
Less: Fixed production O/Hs
(16,500)
(16,500)
(2,300)
ExPress Notes
Less: SGA costs
(7,000)
Profit
(7,000)
20,200
29,400
Inventory is valued at variable production costs.
Absorption Costing
This method argues that focusing on marginal costs is potentially misleading in the longer
run because fixed production costs have also to be covered. Accounting conventions require
that fixed production costs be reflected in each unit produced.
Revised cost card (Absorption costing)
Cost card (per unit):
Direct materials
Direct labour
Fixed production O/Hs
Total production costs
45
18
9
15
87
Year 1
$
Profit/Loss (Absorption costing)

Sales (950/1,150 units)
Year 2
$
114,000
138,000
Less: Variable cost of sales

Opening inventory
4,350
Production costs:
o
Page | 26
Variable
(1,000 x $72)
(1,100 X $72)
72,000
Fixed
(1,000 x $15)
(1,100 X $15)
15,000
Less: closing inventory

(50 x $87)
(4,350)
Over/(under) absorption
1,500
79,200
16,500
0
(84,150)
(100,050)
ExPress Notes
Gross Profit
29,850
Less: Variable selling costs

(950 x $2)
(1,150 x $2)
37,950
1,900
2,300
Less: SGA costs

7,000
(8,900)
Profit
20,950
Inventory is valued at the full production costs.
7,000
(9,300)
28,650
Summary of Absorption costing and Marginal costing formats
Absorption Costing
Marginal Costing
Variable/Fixed
production costs
Variable production/
non-production costs
Revenue
Less: Cost of Sales
Gross profit
Contribution
Less: Expenses
Variable/Fixed
Fixed production/
Net Profit
Reconciliation of the two methods
The different profit figures calculated under Absorption costing and Marginal costing can be
reconciled thus:
The difference in profit = Net change in inventory (no. of units) X the fixed cost per unit
It follows that:
Page | 27
If the level of inventory increases in a given period, then profits (for that period)
under the Absorption costing system will be greater than under Marginal costing; and
ExPress Notes
If the level of inventory decreases, then profits under the Absorption costing system
will be smaller than under Marginal costing
If the inventory level does not change, then the profit calculated under both methods
will be equal.
KEY KNOWLEDGE
Job costing / Batch costing
This refers to the calculation of costs associated with a specific job or customer order. This
is appropriate in situations where each product or service is distinct, and possibly unique, in
its delivery.
Batch costing is similar to job costing; the distinction lies in the identification of costs with
specific batches, which are numbered (separately identified) for this purpose.
KEY KNOWLEDGE
Process costing
Process costing is a technique that applies to the mass production of a large number of
identical products, moving through a series of processing stages. The accumulated costs of
production can be averaged over the number of items produced.
Illustration 1
units
Input units
from Process A
Additional:
Materials
Labour
Overheads
1,000
1,000
Avg.cost/unit:
Page | 28
Process B
$
20,000
5,000
3,000
2,000
30,000
Output to
Process C
units
1,000
30,000
1,000
30
30,000
ExPress Notes
The average cost is determined by the following formula:

Average cost per unit =
Total cost of inputs Scrap value of rejected units

No. of units of input Normal loss
The total cost of inputs refers to labour, materials and overhead costs of production. If
losses occur along the way that necessitate the scrapping of defective units, then to the
extent that these items fetch a scrap value, then that (scrap) value will reduce the total
costs.
Similarly, an accounting is made of the number of units introduced into a process with the
expectation that a normal loss will be incurred. The number of good units emerging from a
process will therefore be the number of units entering it, minus the expected number lost in
processing.
Illustration 2
Normal loss
10% of input
1,000 =
Avg. cost / unit
900 +
good
100
NL
33.3
Conclusion:
units
Input units
from Process A
Additional:
Materials
Labour
Overheads
1,000
1,000
Page | 29
Total cost of inputs

Process B
$
20,000
Output to
Process C
5,000 Normal loss

3,000
2,000
30,000
units
900
30,000
100
1,000
30,000
ExPress Notes
Illustration 3
Scrap value
scrap/unit
Avg cost/unit
5
32.78
Conclusion:
Process B
$
units
Input units
from Process A
Additional:
Materials
Labour
Overheads
1,000
Total cost of inputs Scrap value of normal loss units

20,000
1,000
Output to
Process C
5,000 Normal loss

3,000
2,000
30,000
units
900
29,500
100
500
1,000
30,000
Abnormal gains and losses are accounted for as an adjustment to the accounts using the
same value as the good output (deducted in the case of loss and added in the case of
gains).
Illustration 4
Abnormal loss
1,000 =
850 +
good
100 NL
50
AL
Conclusion:
Input units
Page | 30
units
1,000
Total cost of inputs Scrap value of normal loss units

Process B
$
Output to
units
850
ExPress Notes
20,000
from Process A
Additional:
Materials
Labour
Overheads
27,861
Process C
1,000
5,000 Normal loss

3,000 Abnormal loss
2,000
30,000
100
50
500
1,639
1,000
30,000
Joint products / By-products

Joint products are two or more products that share a common processing path until the
point of separation. Until they go their own (separate) ways, the costs of production during
the joint processing cannot be physically distinguished.
There are different methods used to apportion common costs to such products at the point
of separation:
Market value (based on expected sales price)
Number of units (litres, tons, or some other objective physical measurement)
Net realizable value = Final sales value Incremental processing costs
By-products are goods which are incidental to the production process and which generate
cash from sales, though the amount is modest in comparison to the overall revenues of the
firm. The cash received for by-products can be viewed as a bonus that reduces production
costs.
Joint processing and further processing
Decisions need to be taken as to the further processing of products after their point of
separation.
Care must be taken to focus on the incremental (relevant) values.
EXAMPLE
Page | 31
ExPress Notes
Determine which of the following products should be sold immediately (at the indicated
price) or processed further (for later sale):
A
B
C
Cost at point of
Separation
Immediate
Price
25,000
30,000
40,000
27,000
28,000
45,000
Further (variable)
processing cost
5,000
5,000
4,000
Post-processing
Price
30,000
32,000
50,000
KEY KNOWLEDGE
Service costing
Services distinguish themselves from products in the following ways:
Heterogeneity: The quality of the service is rarely exactly the same, due to the human
touch; e.g. hair cuts;
Intangibility: Services are not tangible;
Perishability: One cannot place a service in inventory;
Simultaneity: Services are produced and consumed at the same time
(Think of HIPS)
Cost units
Finding an appropriate cost unit is a challenge in service costing. In many cases, a
Composite cost unit is identified; e.g.
Student lunches, or
Man-days
The cost per service unit is found by dividing the total cost of the service by the number of
service units involved.
Page | 32
ExPress Notes
Chapter 4
Decision-making
KEY KNOWLEDGE
Cost-Volume-Profit (CVP) Analysis
The breakeven formula
Total Costs = Fixed Costs + Unit Variable Cost x Number of Units
Total Revenue = Sales Price x Number of Units
If
TC = Total Costs,
FC = Fixed Costs,
V = Unit Variable Cost,
X = Number of Units,
TR = Total Revenue,
SP = Selling Price,
C = SP V = Unit Contribution and
Page | 33
ExPress Notes
CM%= C/SP = Contribution Margin,
Then the break-even point (the output level at which TR=TC) is:
In units sold: X = FC/C

In dollar sales: TR = FC/CM%
Safety Margin = Budgeted Sales Break-even point (units/dollars)

C is an important indicator, as it shows the contribution of each unit sold towards
covering fixed costs. Therefore, in the short run, the firm may prefer to produce/sell
below break-even in order to recover some of its fixed costs.
KEY KNOWLEDGE
Break-Even Analysis
Marginal costing is useful in calculating the break-even level of sales.
The break-even point is the level where the company achieves zero profit (neither gain
nor loss). It just manages to cover its fixed costs.
Below is data on a manufacturing company.
Page | 34
ExPress Notes
Cost per unit (of product):
Direct materials
Direct labour
Total variable production costs
45
18
9
72
Distribution & selling (variable)
Additional info:
Selling price per unit
120
Fixed production costs

Fixed Selling, General, Admin
costs
16,500
7,000
EXAMPLE
Based on the data in the previous example, calculate the break-even point of the
company.
Total fixed costs:
Contribution per unit:
23,500
46
Break-even point: 23,500/46 = 511 units

Contribution per sale C/S ratio
This is understood as the amount of contribution generated by every dollar sold.

In the previous example, the companys C/S ratio is: $ 0.3833 (120/46)
The break-even level of sales can be calculated as:
Fixed costs
C/S ratio
Break-even point (sales) = $ 61,310
Page | 35
ExPress Notes
KEY KNOWLEDGE
Short-term decision-making
Limiting factors
When a single limiting factor is present in a production plan, then it is necessary to identify
it and to plan production around it.
Take the following example:
Product
Selling price
Labour cost per unit ($)
Material cost per unit ($)
X
30
10
5
Y
40
16
8
Z
50
20
10
Contribution
15
16
20
It appears that in the face of unlimited demand for all three products, Product Z would be
given priority as it maximizes the contribution per unit.
Now, assume that labour hours are limited to 500 and that labour costs $2 per hour
(demand remains unlimited for all three products).
In the above case,
Product
Labour cost per unit ($)
No. of hours per unit
Contribution per hour
X
10
5
Y
8
8
Z
20
10
Now it becomes clear that Product X is favoured for the full number of hours available (500).
100 units of X can be produced.
If demand for X were limited to, say, 80 units (requiring 400 labour hours), then the
remaining available hours (100) could be used to produce either Y or Z (in this case there is
indifference between the two).
The steps to be followed in working out the optimal production plan are:
(1) Calculate the contribution per unit of product;
(2) Calculate the contribution per unit of limited resource;
(3) Rank the products according to Step 2;
Page | 36
ExPress Notes
(4) Produce according to the priority established in Step 3, up to the demand limit of
each product or until the limited resource is exhausted
Make-Buy
A make-buy decision requires the determination of all relevant costs.
EXAMPLE
An automotive components producer can supply itself externally with car heaters for USD
210 per unit. In considering whether to make these internally, the company calculates that
an equivalent unit can be made in 2 labour hours using USD 100 worth of materials.
Labour is currently at full capacity producing carburettors which generate contribution of
USD 100. A carburettor takes 2.5 hours to produce. Labour costs USD 10 per hour. The
carburettor also absorbs fixed overhead costs at the rate of USD 20 per labour hour.
The relevant costs are ($):
Materials:
100
Contribution lost
(carburettors):
80
Labour (added-back): 20
200
It is cheaper to produce internally.
Relevant costs
One of managements responsibilities involves making decisions affecting the firm in the
short-run based on relevant costs.

What is relevance?
A relevant cost is a cash cost which is uniquely incurred (or avoided) as a consequence of
taking a decision; cash, because it is the main determinant of value (unlike accounting
profit); and unique in the sense that is not common to the alternative choices that are under
consideration.
Page | 37
ExPress Notes
EXAMPLE
A company seeking to determine whether to continue to transport its products by truck or to
switch to the railroad discovers that insurance costs are identical in both choices; in that
case, insurance costs are not relevant to the decision.
If, however, there is a difference in the two insurance costs, then one can speak as the
difference between the two choices as being incremental; this difference (referred to in
some places as the differential) is relevant to the decision under consideration.
Future
Relevant costs refer to the future, i.e. they can be influenced prospectively by choice. It
follows that:
Sunk costs are not relevant: They have already taken place and cannot be reversed.
Committed costs, if they cannot be avoided, are likewise not relevant, even if the timing of
their occurrence is in the future. Their unavoidability has already been established in the
past (making them effectively the equivalent of sunk costs).
In keeping with the above logic, relevant costs therefore involve cash, are incremental and
relate to the future.
Costing projects
It is a standard management accounting practice to determine the relevant costs of a new
project in order to come up with a price quotation. Setting a price without having an
accurate understanding of costs can put a company at a competitive disadvantage,
particularly if there is intense competition.
EXAMPLE
A proposed project lasting 6 months requires the following inputs:
1) Labour
Page | 38
ExPress Notes
The following resources are needed:
A specialist specifically qualified for this work needs to be hired at a cost of USD
10,000 per month;
The specialist will be assisted by two subordinates who are existing employees, each
paid USD 40,000 p.a. One is not working on anything else for the foreseeable future,
while the other is fully involved on another project and would need to be replaced for
the duration of the proposed one at a cost of USD 5,000 per month;
A division manager has agreed to supervise the project and estimates that 5% of his
time (equivalent to USD 6,500) be allocated for this purpose.
2) Materials
The project calls for the use of 200 litres of Agent Q and 50 kg. of Compound P.
Additional data:
Agent Q
In stock
Historical price
Current price
Scrap value
150 litres
USD 7
USD 5
USD 1
USD 12
USD 15
USD 2
Compound P 100 kg.

Agent Q is no longer in use.
Compound P is in regular use at the company.
3) R&D
The project manager notices that R&D relevant to this project had been performed for
another contract (later abandoned) at a cost of USD 15,000. He sees an opportunity to
recover that cost now.
4) Equipment
The company needs equipment for the project which would cost USD 15,000 to buy.
Alternatively, it has some existing unused equipment that could be deployed. The used
equipment is in good condition and could have been scrapped for USD 8,000 now or for USD
5,000 in 6 months. (Note: Ignore time adjustments of monetary values)
Prepare the costs for the proposed project.
Page | 39
ExPress Notes
Relevant costs need to be identified with care, as they may include opportunity costs.
EXAMPLE
A company considers building a storage facility on the site of a parking lot. If the parking lot
had been generating parking fees which will now be lost, then this foregone revenue is an
opportunity cost.
Shut Down decisions
Whether to close a plant making (accounting) losses depends on relevant costs:
Revenues (m)
40
Costs (m)
(44)
Profits (m)
(4)
If 25% of the costs are fixed costs allocated by H.O., then it appears that closing the plant
will leave the company worse off, as 40m in revenues and only 33m in costs will be
disappear. A careful examination of all costs needs to be made before arriving at a final
decision.
KEY KNOWLEDGE
Principles of discounted cash flow
Simple vs. Compound interest
Simple interest is the calculation of interest applied to the principal amount only. If $100 are
lent at a simple interest of 5% p.a. then interest payments will be based only on the
principal, as for example, an annual interest payment of 5% of $100, or $5 p.a.
If interest is payble semi-annually on a compunded basis, then at the end of the first year,
the interest will be $5.0625, calculated as:
Page | 40
ExPress Notes
5% on $100 for the 1st half of the year, plus 5% on $102.50 for the 2nd half (i.e. the interest
of $2.50 from the 1st half of the year is added to the principal amount and forms the basis
for the interest calculation in the 2nd half).
Nominal vs. Effective interest
In the example above, 5% serves as the nominal interest rate, while the effective interest
rate is 5.0625%; this is the total interest achieved on a compounded basis ($2.50 plus
$2.5625).
The preeminence of cash
Cash, both its receipt and possession, lies at the basis of economic value. Cash is used to
pay the bills and bonuses. It is a better indicator of wealth when compared with measures
defined by accounting conventions, such as accounting profit.
The relevance of cash flow to capital investment appraisal
The appraisal process is predicated on the fact that capital expenditures are investments
which will (hopefully) confer future benefits referred to as the payback. The payback may be
a lengthy (and risky) one.
Timing and value
Tracking and measuring cash flows on a time-adjusted basis is critical: cash received quickly
can be used to repay debt (avoiding interest costs) or invested (earning interest). Cash paid
with a delay can reduce costs (as long as penalties are not incurred).
It follows that the longer one waits for a receipt of cash, the less that cash is worth in
todays terms. Among other factors, its purchasing value may diminish due to the effects of
inflation.
Compounding
Instead of receiving USD 100 today, assume it will be received after one year. To
compensate for the delay, what should the value be after one year?
Present Value (PV)

100
Page | 41
Future Value (FV)

100 x (1+r)
ExPress Notes
In the above example, if r = 5% p.a. then the FV after one year will be USD 105.
This process can be repeated year after year.
Discounting
The above relationship between PV and FV:
PV x (1+r) = FV
can be re-arranged to:
PV = FV
(1+r)
with r representing the discount rate.

The above refers to one-period discounting, with r corresponding to the period.
If discounting is done over more than one period, then the discounting effect will be:
PV = FV
(1+r)n
where n refers to the number of periods.
Thus, 100 received after two years, discounted at 10% p.a. will be
PV = 100 = 82.6
(1.10)2
This reflects that the uncertainty of getting money back increases with time.
This allows one to discount future values into present values and can be applied to a series
of cash flows:
Year:
Future Values:
100
100
125
105
140
If discounted at r = 10%, then the above cash flows can be restated at their present values:
Page | 42
FV discounted:
100
1.10
100
(1.10)2
125
(1.10)3
105
(1.10)4
140
(1.10)5
PV:
90.9
82.6
93.9
71.7
86.9
ExPress Notes
Added together results in total PV = 426.

Reducing future cash flows of different timings and amounts to one PV is a powerful
tool.
Note: If all the cash flows had been equal say 100 then the PV calculation would have
been simplified:
FV discounted:
100
1.10
100
(1.10)2
100
(1.10)3
100
(1.10)4
100
(1.10)5
PV:
90.9
82.6
75.1
68.3
62.1
The addition of the above is = 379

Net Present Value (NPV)
To add meaning to the future cash flows, we can include the amount invested (which gives
rise to the FVs):
Year:
100
100
125
105
140
Investment: (200)
FV:
PV:
(200)
90.9
82.6
93.9
71.7
86.9
Year 0 amounts denote the present and are automatically = PV.

The NPV of the above cash flows is therefore = 226.
Internal rate of Return (IRR)

The internal rate of return (IRR) is defined as the discount rate (r) at which the net present
value (NPV) of a stream of cash flows will be equal to zero. In other words,
If, at a discount rate r, NPV = 0, then IRR = r
Page | 43
ExPress Notes
The IRR includes among its assumptions the following: any cash flows generated in the
course of a project being evaluated are calculated as being reinvested at the IRR rate. This
is illustrated thus:
Time
Cash flows
0
1
2
(20,000)
5,000
30,000
The IRR of the above cash flows (using interpolation or calculator) is 35.61%.
The above cash flows is equivalent to re-investing the 5,000 (Year 1) at the IRR rate
(35.61%) to maturity (Year 2).
Time
Cash flows (A)
0
1
2
(20,000)
5,000
30,000
Cash flows (B)

(20,000)
0
36,780.5 (30,000 + 6,780.5*)
* 5,000 x 1.3561 = 6,780.5

The IRR of the cash flows shown in Column (B) is 35.61% -- exactly the same as in Column
(A).
Note: Column (B) cash flows resemble that of a zero-coupon bond, with investment at time
0 and no cash returns until the final year.
This calculation confirms that interim cash flows are re-invested at the IRR rate. This
assumption has been criticized for being unrealistic, since cash paid out of a project
(returned to the investors, for example) is unlikely to obtain the same rate if invested
elsewhere: they may be higher (i.e. interest rates may have risen in the meantime), or
lower (placed in the bank to earn deposit interest).
Comparison of NPV and IRR methods

The following decision rules apply to appraisal methods:
NPV: Positive NPV projects are acceptable; the higher the better.
IRR: An IRR in excess of a hurdle rate (set by the company) indicates acceptability; the
higher (the IRR) the better.
Page | 44
ExPress Notes
EXAMPLE
Year
-5,000
6,000
-7,500
8,850
IRR
NPV:
10%
14%
20%
454
263
172
18%
545
263
129
Intuitively, IRR should be preferable, as it relates return to amount invested.

Equal investment amounts do not necessarily remove the ambiguity.
EXAMPLE
Year
IRR
-500
-500
NPV (9%)
100
600
20%
97
500
155
25%
89
Payback method
Initial Investment:
40,000
Cash flows
(A)
Year 1
Year 2
Year 3
Year 4
Year 5
Total
Payback
Page | 45
5,000
6,000
12,000
13,000
15,000
51,000
Year 5
Cashflows
(B)
15,000
13,000
12,000
6,000
5,000
51,000
Year 3
16%
ExPress Notes
What are the advantages and disadvantages of this method?
Advantages
It is easy to understand and to use. It focuses on the time needed to cover the investment
(in money terms) and no more; it can be considered a minimalists approach
(psychologically).
If you invest in a Central American country where you expect a coup in the next 2 years, the
payback method may be for you! But remember, the net (money) returns start only after
that point!
Disadvantages
It is a crude measure. It does not take opportunity costs or expected returns on money
invested into account.
Discounted Payback
We can apply the concept of discounting to the Payback method in order to capture the time
value of money element.
Year:
100
100
125
105
140
Investment: (200)
FV:
PV:
(200)
90.9
82.6
93.9
In the table above, the (simple) payback period is in Year 2;

The Discounted Payback period is longer (Year 3).
Page | 46
71.7
86.9
ExPress Notes
Chapter 5
Cash Management
KEY KNOWLEDGE
Cash and Cash Flow
Cash comprises both cash and bank deposits payable on demand and also cash equivalents
which are defined as short-term, highly liquid investments that are readily convertible to
known amounts of cash and which are subject to an insignificant risk of changes in value.
The amount of cash held by a business at a point in time is found in the balance sheet
under current assets.
Cash flow refers to the movement of cash in and out of a business over a period of time.
This information is found in a statement of cash flows, which is a primary financial
statement. Such a statement is useful in that it is structured to show the extent to which a
company is able to generate net cash from its operating activities and how such net cash is
used in investing and/or financing activities.
Page | 47
ExPress Notes
Examples of cash receipts and payments include:
Operating: cash flow from trading activities, e.g. cash received from customers, cash
paid to suppliers and to employees;
Financing: Cash paid on interest;
Taxation: Actual cash paid during the year;
Investing: Cash flows on purchase or sale of non-current assets;
Financing: Cash flows on raising or redeeming long-term finance, such as shares or
Debentures; dividends can also be included here.
Cash flow accounting

The relationship between cash flow accounting and accounting for income and expenditure
lies in the use of accruals and decisions as to the capitalisation of expenditures. Cash flow
accounting dispenses with the matching principle in financial accounting.
As the cash flow statement is derived from the income statement and the balance sheet,
adjustments need to be made to remove the effects of accrual accounting so that the cash
movements can be made more transparent.
Importance of cash flow management
Planning, tracking and collecting cash are all important because cash PAYS THE BILLS.
The failure to pay bills puts a company in danger of bankruptcy.

What begins as a condition of illiquidity can evolve into insolvency.
Cash flow is vital to going concern and commercial success, regardless of profitability.
Having enough cash on hand is therefore critical in being able to settle obligations when
they fall due (both planned and unforeseen); however, holding too much cash in a business
is costly. There is a trade-off between liquidity and profitability.
Determining the optimal amount of cash to hold becomes the challenge facing managers.
Cash management functions are typically handled by treasury, and include:
Page | 48
Collecting cash from customers (as soon as possible);

Disbursing cash to suppliers (as late as practically possible);
Investing short-term cash surpluses in low-risk interest-bearing investments (such as
Treasury bills) in order to generate additional income for the company;
ExPress Notes
KEY KNOWLEDGE
Cash budgets
A cash budget is an estimate of the receipt and payments of cash in and out of the business
for a defined future period based on existing conditions and operating assumptions.
By understanding the nature and timing of cash receipts and expenditures, management is
better able to influence them and plan/budget for the future. The purpose is to ensure that
the company has sufficient cash on-hand to avoid missing disbursements when they fall
due.
There are statistical techniques which assist management in planning cash levels.
Cash budget/forecast
Businesses should develop their cash budget/forecast formats in a way which best reflects
the type of business conducted and transactions generated. Such tools serve as a
mechanism for monitoring and control.
Investing and Financing
Cash surpluses and deficits occur as a result in timing differences between the receipt of
cash and the necessity to settle obligations punctually. If a deficit results, then the company
should have overdraft faciltities in place with a bank.
If deficits prove to be longer-term in nature, then the company should consider short-term
borrowing, or possibly, longer-term forms of finance if the deficit is expected to persist.
In the event of surpluses, these can be invested (e.g. T-bills mentioned earlier); other types
of investments include:
Bank deposits
Money- market deposits
Certificates of deposit
Government bonds
Local authority stock
Page | 49
ExPress Notes
Chapter 6
Spreadsheets
KEY KNOWLEDGE
Use of spreadsheets
The use of spreadsheets is a basic skill that all accountants and business analysts should
possess.
A spreadsheet is a computer program that is organised in a tabular format. The vertical and
horizontal arrangement of cells allows the input and processing of large amounts of data in
a systematic way.
Spreadsheets contain sophisticated formulae which can be used to operate on the data.
Instead of merely adding up columns of numbers, spreadsheet formulae can handle
discounting (i.e. net present value) calculations as well as simple logical (IF) functions.
Apart from processing a large volume of data quickly, spreadsheets permit analysis to be
performed with great efficiency. Thus, if an assumption is modified, then the spreadsheet
can automatically adjust all affected values (known as what-if analysis), meaning that the
management acccountant can focus on interpeting the output.
Page | 50

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Purpose of Management Information

The qualities of good information can be summarized in the word ACCURATE:

Financial and Non-financial information for managers

Strategic: Covers the big view of the organization and its

Tactical: Planning over the short-term (usually one year), and

Operational: Day-to-day decisions, implemented on-the-spot

Cost centres: Responsible for current expenses only

The Role of Information technology

Suitable formats for the presentation of management information according to purpose

In order to understand the relationship between Management accounting and Financial

There are a variety of ways in which one can classify costs:

Production vs. Non-Production

Fixed vs. variable

Other types of costs

The variable cost per unit is: 200 (120,000/600)

The high-low method can also be applied to the following situations:

When the variable cost per unit changes

of the product ordered.

Economic Order Quantity

D = quantity of product demanded annually

It is this total cost function which must be minimized.

PD does not vary;

7% of the purchase price

Assume a 50 week year. What is the optimal order quantity?

Direct and Indirect Labour

Outputbased (e.g. piecework)

No. of departing employees requiring replacement

Standard hours of output

Actual hours worked

Labour production volume

Standard hours of output

Direct and Indirect costs

Indirect costs (overheads)

2. Allocate/Apportion to Cost Centres

Costs re-apportioned from C:

3. Absorb the overheads into the units produced.

Toaster (cost per unit)

Summary Absorption costing

It addresses the problem of allocating factory overheads per product lines

Step 1: Identify total factory overheads to be absorbed

The absorption base should be highly correlated with incurrence of overhead

Step 3: Compute overhead absorption rate (OAR) as Step 1 / Step 2 ($/unit of

Over- and under-absorbed factory overheads

In practice, OARs are pre-determined on an annual basis, making

Features of Marginal Costing

Variable production O/Hs

There is a variable selling cost of $2 per unit

Budget (normal) production

Actual fixed production O/Hs