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ACCA Paper F2
(FIA Paper FMA)
Management Accounting
Contents
SI. No
Pages
1.
2.
3.
Budgeting
16
4.
Standard Costing
26
5.
Performance Measurement
35
Chapter 1
Page | 3
Accurate,
Complete,
Cost-beneficial,
User-targeted,
Relevant,
Authoritative,
Timely and
Easy to use
KEY KNOWLEDGE
Management Accounting
The process of identification, measurement, accumulation, analysis, preparation,
interpretation and reporting of information used by management to set targets, plan
resource allocation, evaluate investment choices and monitor/control the operating
performance and the orderly conduct of the business.
Differences in purpose and scope, compared to Financial Accounting
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)
Managerial Processes
The key processes which face management can be divided into:
Page | 4
Decision-making: Making choices, not only with regard to the selection of strategies,
but also along the way as implementation proceeds;
Planning
Planning occurs at different levels of the organisation:
Strategic
Tactical
Operational
Responsibility centers
Related to the above is the notion of responsibility that attaches to each level of an
organisation:
Responsibility centres
Cost Centres
Revenue Centres
Profit Centres
Investment Centres
Page | 5
KEY KNOWLEDGE
Sources of data
The sources of data are almost infinite, and they must be selected and evaluated carefully
based on reliability and relevance.
KEY KNOWLEDGE
Classifications of cost
KEY KNOWLEDGE
Production vs. NonProduction costs
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.
KEY KNOWLEDGE
Direct vs. Indirect costs
Page | 6
KEY KNOWLEDGE
Fixed vs. Variable costs
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 behavior.
Although a variable cost increases with the level of activity, the variable cost per unit
remains fixed, while a fixed cost per unit falls with a rise in the level of activity.
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.
Page | 7
Chapter 2
Page | 8
= PxD
+ C x D/Q
+ H x Q/2
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
Labor
Direct labor refers to work which is directly involved in the manufacture of a product. Indirect
labor (e.g. the supervisors salary or that of a security guard) forms part of
Overhead costs.
Page | 9
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
Production A
Production B
Service C
1. Allocate
3. Reapportion from
Service to Production
Production A
Production B
4. Absorb
Cost Unit
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.
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)
Page | 10
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.
Example
Below is data on a manufacturing company.
Selling price (per unit):
120
45
18
9
72
Year 2
(units)
1,100
1,100
Actual Production
Actual Sales
1,000
950
1,100
1,150
$16,500
$ 7,000
$16,500
$ 7,000
Based on the above data, a profit and loss statement for the Years 1 and 2 is shown on the
next page.
Assume that the beginning inventory is zero.
Page | 11
Year 2
$
114,000
138,000
3,600
Production costs:
o Variable
(1,000 x $72)
(1,100 X $72)
Less: closing inventory
(50 x $72)
72,000
79,200
(3,600)
(68,400)
(1,900)
(82,800)
(2,300)
Contribution
43,700
52,900
(16,500)
(7,000)
(16,500)
(7,000)
Profit
20,200
29,400
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.
Page | 12
45
18
9
15
87
Year 2
$
114,000
138,000
4,350
Production costs:
o Variable
(1,000 x $72)
(1,100 X $72)
72,000
o Fixed
(1,000 x $15)
(1,100 X $15)
15,000
79,200
16,500
(4,350)
Over/(under) absorption
1,500
0
(84,150)
29,850
Gross Profit
Less: Variable selling costs
(950 x $2)
(1,150 x $2)
1,900
7,000
Profit
Inventory is valued at the full production costs.
Page | 13
0
(100,050)
37,950
2,300
(8,900)
20,950
7,000
(9,300)
28,650
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
non-production costs
Fixed production/
non-production costs
Net Profit
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.
Page | 14
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.
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).
Equivalent units (EU)
This refers to the way in which partially-completed output (work-in-progress or WIP) is
expressed. If an unfinished unit of product contains 35% of the labour and materials costs
of a complete unit, then the unit has a degree of completion of 35% in terms of value. It is
therefore considered to have an EU of 35%, which is normally expressed in monetary terms.
Weighted average method
The weighted average method makes no distinction between units that were started (but
not finished) in a previous process and those started in the current process. Since all the
units, when completed, are visually identical, processing costs are averaged over all the
units.
First-In-First-Out (FIFO) method
The FIFO method does make a distinction between units that were started in a previous
process and those begun in a current process. FIFO costing separates the costs that were
incurred in the previous period from costs of the current period.
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.
Page | 15
Chapter 3
Budgeting
Budgeting: definition and purpose
a) Communicate
Objectives
b) Motivate
Employees
b) Control
Activities
b) Evaluate
Performance
Sales budget
Production budget
Ending inventory budget
Direct materials budget, Direct labour budget, Factory overhead budget
Cost of Sales budget
R&D budget, Marketing budget, Distribution budget, Customer service budget, Admin
budget
Pro-forma income statement
Page | 16
Capital budget
Cash budget
Pro-forma balance-sheet and pro-forma statement of cash-flows
Operating budgets
These are budgets that quantify the revenues and costs relating to a companys activities at
a disaggregated level, meaning that there is direct input from department and functional
levels. They require both volume (e.g. units of output, quantities, hours, etc.) and price
specifications. Operating budgets are modelled on what will emerge as the companys
income statement. Examples include:
Page | 17
Sales budget
Production budget
10%
20%
50%
18%
2%
100%
Expected
Value
34.0
153.2
139.0
81.0
-4.6
402.6
Regression analysis
This is a statistical tool used to describe the relationship between two sets of variables.
The correlation coefficient denoted by r -- measures the strength of the linear association
between the variables. The range for r is: -1 < r < +1
The coefficient of determination measures the degree to which the variation in the
dependent variable can be explained by the independent variable (x). It is denoted as r2 and
its range is: 0 < r2 < 1
The use of spreadsheets is a basic skill that all accountants should possess.
Discounted cash flow (DCF) techniques
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.
Page | 18
Interpreting r:
As risk-adjusted rate: representing the riskiness of not getting the money back.
As cost of capital rate: representing the return that capital providers expect
From a companys point of view, this is the rate of return that the business must generate
for its capital providers (shareholders and lenders). If a company has to raise the necessary
cash for its activities, then this is the rate it must pay.
It reflects the opportunity cost to the investors (what investment alternatives they have) on
a risk-adjusted basis.
Discounting
The above relationship between PV and FV:
PV x (1+r) = FV
PV = FV
(1+r)
Page | 19
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:
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
Page | 20
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
100
100
125
105
140
Investment: (200)
FV:
PV:
(200)
90.9
82.6
93.9
71.7
86.9
100
100
125
105
140
Investment: (200)
FV:
PV:
(200)
90.9
82.6
93.9
71.7
Page | 21
86.9
Relevance refers to cash flows that are relevant to the decision whether to accept a project
or not. Cash flows that are created (or discontinued) as a result of taking the decision (to
undertake the project) are relevant; these are also called incremental cash flows.
Included in relevant cash flows would be any investments in equipment and working capital
required by the project. More subtle, but no less important, are any opportunity costs
incurred as a result of accepting the project.
Cash flows which occur whether the project goes ahead or not are not relevant. Also not
relevant are:
Sunk costs;
Committed costs;
Non-cash expenses
Page | 22
EXAMPLE
Year
-5,000
6,000
-7,500
8,850
IRR
NPV:
10%
14%
16%
20%
454
263
172
18%
545
263
129
EXAMPLE
Year
IRR
-500
-500
NPV (9%)
100
600
20%
97
500
155
25%
89
Page | 23
Output:
1000
1200
Mats
75,000
90,000
Labour
200,000
225,000
Fix
100,000
100,000
Total
375,000
415,000
Page | 24
KEY KNOWLEDGE
Behavioural Aspects of Budgeting
There are numerous inter-relationships between types of budgets, budgeting processes and
the motivation of employees:
Top-Down budgets may be necessary from a coordination point of view; however they can
be de-motivating to employees;
Bottom-Up budgets allow useful employee input, but they may create exaggerated
expectations on the part of the employee that his/her voice will be heard.
Unrealistic budgets with unachievable targets can be de-motivating (as can budgets
which are easily achieved, since most people stop working when they reach the targets!).
Page | 25
Chapter 4
Standard Costing
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.
Fixed Overhead Absorption Rate (FOAR) =
Year 1
(units)
1,100
Year 2
(units)
1,100
$16,500
$16,500
Page | 26
45
18
9
15
87
Having established the OAR, we now have a basis on which the production department can
keep track of the fixed overheads being generated as the manufacturing process proceeds.
1,100 units
1,000 units
$120 / unit
Actual results
Production:
1,000 units Sales:
950 units
Materials:
4,900 kg, $45,025
Labour:
3,100 hrs, $19,050
Variable O/Hs: $9,250
Fixed O/Hs:
$17,000
Sales price:
$115 / unit
Cost card (per unit)
Materials (5kgs x $9 per kg)
Labour (3hrs x $6 per hr)
Variable O/Hs (3 hrs x $3 per hr)
Fixed O/Hs (3 hrs x $5 per hr)
Page | 27
45
18
9
15
87
Variance calculations
Sales volume variance (Absorption costing)
1,000
950
50 (A)
$1,650 (A)
1,000
950
50 (A)
$2,400 (A)
114,000
109,250
4,750 (A)
Material variances
(i)
Page | 28
44,100
45,025
$925 (A)
5,000 kg
4,900 kg
100 kg (F)
$900 (F)
$ 25 (A)
Labour variances
(i)
18,600
19,050
$450 (A)
3,000 hrs
3,100 hrs
Page | 29
9,300
9,250
50 (F)
3,000 hrs
3,100 hrs
$17,000
$15,000
$ 2,000 (A)
(ii)
$500 (A)
Budgeted production
1,100 units
Actual production
1,000 units
Page | 30
17,000
Interpreting variances
Material price
Favourable:
Adverse:
Material usage
Favourable:
Adverse:
Labour rate
Favourable:
Adverse:
Wage inflation
Labour efficiency
Favourable:
Adverse:
Overhead expenditure
Page | 31
Favourable:
Adverse:
Overhead volume
Favourable:
Adverse:
33,000
1,650 (A)
4,750 (A)
26,600
Cost variances:
Materials
Price
Usage
Labour
Page | 32
A
925
900
Rate
450
Efficiency
600
Variable
Expenditure
50
Efficiency
300
Expenditure
500
Fixed
Volume
950
1,500
4,275
Actual profit
3,325 (A)
23,275
2,400 (A)
4,750 (A)
48,000
40,850
Cost variances:
Materials
Price
Usage
A
925
900
Labour
Rate
450
Efficiency
600
Variable
Page | 33
Expenditure
Efficiency
50
950
300
2,275
Actual contribution
Fixed O/Hs Budgeted
Fixed O/Hs Expenditure variance
Actual profit
Page | 34
1,325 (A)
39,525
16,500
500
(17,000)
22,525
Chapter 5
Performance Measurement
Mission Statement
KEY KNOWLEDGE
Financial Performance measures
Included in financial performance measures is a range of ratios:
Efficiency ratios (e.g. asset turnover, debtor days and creditor days);
Gearing ratios (e.g. debt equity ratio);
Liquidity ratios (e.g. current ratio and quick ratio);
Profitability ratios (e.g. gross margin, operating margin and ROCE);
Interest ratios (e.g. interest coverage).
Page | 35
KEY KNOWLEDGE
The scope of performance measurement
Balanced scorecard
The balance scorecard addresses a number of parameters (or perspectives) in monitoring
business performance by asking the following questions:
Page | 36
Learning and growth: To achieve our vision how will we sustain our ability to
change and improve?
Net Profit
Capital Employed
ROI as defined above is commonly used for investment appraisal and for business sector
(divisional) performance, whereas ROCE is common at the overall corporate level.
EXAMPLE
A division head with an actual ROI of 20% may be reluctant to accept a project offering a
15% ROI, especially if his bonus is based on ROI achieved.
If the corporate overall ROI target is 12%, then the division head is missing a value-creating
opportunity.
Residual Income (RI)
Convert results into monetary magnitudes:
Residual Income
Where
Imputed interest
A positive result adds profits to the division beyond the incremental capital cost. An
Investment should be accepted if the RI is positive.
Page | 37
Page-38
Employees, especially at the operational level, can relatemore easily to NFPIs (no. of
tons of steel processed; length of time it takes to cook a cheeseburger);