Management Acc 301 Own Notes

MACN 301 Management Accounting: Notes Page |1
OWN Research to STILl:............................................................................................................................7

QUESTIONS:............................................................................................................................................8
Reconcilliation of Absorbtion profit to absorbtion profit(pg 142 viggio)..........................................................8
(GP%) GROSS PROFIT Percentage % RATIO: = Gross Profit/TURNOVER | =% ANSWER |.........................12
SHADOW PRICE OR OPPORTUNITY COST................................................................................................13
QUESTIONS CURRENT PLACE................................................................................................................14
To scan in/do still:..................................................................................................................................15
Rem: Notes special things to remember.....................................................................................................16
2-TERMS:(vig ch 1+2).............................................................................................................................18
Intro:....................................................................................................................................................18
the production point of indifference, :..................................................................................................18
analysis of the companies cost structure:.............................................................................................18
Capital structure...............................................................................................................................18
annuity:...........................................................................................................................................18
over-trading.....................................................................................................................................18
Cost Objects:......................................................................................................................................18
Direct and Indirect Costs.......................................................................................................................19
inventory valuation:(note).................................................................................................................19
DIRECT COSTS :...............................................................................................................................19
INDIRECT COSTS :............................................................................................................................19
Categories of manufacturing costs. – with direct/indirect costs...............................................................19
DIRECT MATERIALS :........................................................................................................................19
INDIRECT MATERIALS :.....................................................................................................................19
DIRECT LABOUR :.............................................................................................................................19
INDIRECT LABOUR............................................................................................................................19
DIRECT EXPENSE :............................................................................................................................20
PRIME COST.....................................................................................................................................20
MANUFACTURING OVERHEAD :...........................................................................................................20
COST ALLOCATIONS :.......................................................................................................................20
TOTAL MANUFATURING COST :..........................................................................................................20
Period and Product Costs...................................................................................................................20
PRODUCT COSTS :............................................................................................................................20
PERIOD COSTS :...............................................................................................................................20
Relevant and Irrelevant Costs:..............................................................................................................20
RELEVANT COSTS AND REVENUES :....................................................................................................20
IRRELEVANT COSTS AND REVENUES:..................................................................................................21
Avoidable or Unavoidable costs:.............................................................................................................21
AVOIDABLE=....................................................................................................................................21
UNAVOIDABLE..................................................................................................................................21
Opportunity Costs:...............................................................................................................................21
-Incremental /or Differential- and Marginal Costs.....................................................................................21
INCREMENTAL or DIFFERENTIAL COSTS :............................................................................................21
MARGINAL COSTS :..........................................................................................................................21
Job Costing and Process Costing systems:...............................................................................................21
JOB COSTING SYSTEMS:...................................................................................................................21
PROCESS COSTING SYSTEMS:...........................................................................................................21
ABSORPTION COSTING AND VARIABLE COSTING:and STANDARD COSTING...............................................21
inventory valuation:(note).................................................................................................................21
IAS 2 on INVENTORIES States the Following.:......................................................................................21
Absorbtion costing :..........................................................................................................................22
Cost Absorbtion Rate :.......................................................................................................................23
Fully Integrated Absorbtion costing System ( or “full” absorb. costing system).........................................23

Variable Costing (or Marginal or Direct Costing)....................................................................................23
Direct Costing...................................................................................................................................23
Marginal Costing...............................................................................................................................23
Standard Costing:.............................................................................................................................23
Sunk Costs:........................................................................................................................................24
SUNK COSTS :.................................................................................................................................24
Responsibility Accounting :....................................................................................................................24
RESPONSIBILITY ACCOUNTING :........................................................................................................24
PROFIT CENTRE :..............................................................................................................................24
COST CENTRE:.................................................................................................................................24
INVESTMENT CENTRE:......................................................................................................................24
Maintaining a cost database:.................................................................................................................24
Fixed and Variable Production Overheads : and Cost Behaviour of..............................................................24
VARIABLE COSTS :...........................................................................................................................24
FIXED PRODUCTION COSTS :.............................................................................................................25
SEMI-FIXED (or STEP-FIXED COSTS) :................................................................................................26
SEMI-VARIABLE (or MIXED COSTS) :..................................................................................................26
Relevant Range...................................................................................................................................27
Relevant Range:...............................................................................................................................27
Selling Costs.......................................................................................................................................27
Selling Costs :..................................................................................................................................27
Conversion Costs:................................................................................................................................27
Conversion Costs :............................................................................................................................27
HIGH-LOW COST ANALYSIS:..............................................................................................................27
contribution:....................................................................................................................................27
budget:...........................................................................................................................................27
“Standard Hours Produced”:...............................................................................................................27
“Standard PROFIT STATEMENT”:.........................................................................................................28
STATIC BUDGET...............................................................................................................................28
FLEXED BUDGET...............................................................................................................................28
BILL OF MATERIALS..........................................................................................................................28
STANDARD COST CARD.....................................................................................................................28
more definitions................................................................................................................................28
Formulas................................................................................................................................................29
SHARES..............................................................................................................................................29
ANNUITY:...........................................................................................................................................30
loan: periodic payment of a loan............................................................................................................31
Perpetuity:..........................................................................................................................................31
MARKET VALUE OF A COMPANY:............................................................................................................32
market Value of Convertible debentures or preference shares....................................................................32
CHAPTER 1: INFORMATION FOR DECISION MAKING :COST –VOLUME PROFIT ANALYSIS ch. 8 in Drury book....33
special things to remember:..................................................................................................................33
ECONOMIST VS ACCOUNTANTS VIEW....................................................................................................33
justification for accountants view over econ0mists:..................................................................................33
Economists VS Accountants COST-VOLUME-PROFIT graph :......................................................................34
ECONOMISTS GRAPH:.......................................................................................................................34
Accountants graph............................................................................................................................34
C.v.p. analysis. (cost-volume-profit.).........................................................................................................35
uses of cvp analysis:............................................................................................................................35
assumptions of cvp analysis:.................................................................................................................35

Standard Formula for CVP (write down once in exam- makes things easy)..................................................35
Fixed costs:.........................................................................................................................................35
RELEVANT RANGE................................................................................................................................35
Break-even analysis:............................................................................................................................36
target profit:.......................................................................................................................................36
Contribution :......................................................................................................................................36
margin of safety:.................................................................................................................................36
CHARTS/graphs...................................................................................................................................37
Break-even chart used as a “CVP” analysis:.........................................................................................37
cost –volume –profit chart/diagram shown in a different way(viggario)...................................................37
Alternative Presentation : Contribution graph used as a cvp chart...........................................................38
Alternative Presentation : PROFIT –VOLUME graph used as a CVP chart...................................................38
MULTI-PRODUCT cvp ANALYSIS.............................................................................................................38
The use of computer applications...........................................................................................................39
semi-variable costs : separation of fixed –variable...................................................................................39
key ratios for cvp.................................................................................................................................39
(PV ratio) Profit Volume ratio: ( or also called ‘contribution margin %’ )...................................................39
profit ratio.......................................................................................................................................40
(B/E sales) break-even sales revenue:( not a ratio)..............................................................................40
break-even sales volume:( not a ratio)................................................................................................40
margin of safety ratio........................................................................................................................40
OTHER TYPES:..................................................................................................................................40
abbreviations for ratio’s etc:..................................................................................................................40
analysis of cost structure USING CVP PRINCIPLES : (of a company)...........................................................40
METHOD: fORMAT OF SPREADSHEET FOR: full year FINAL ANALYSIS viggario page 247.........................40
Income statement (or budget) showing contribution separately................................................................42
Income statement showing manufacturing costs separately (or also called income &expenditure statement
showing...)..........................................................................................................................................42
CHAPTER 2 (11) relevant costs...............................................................................................................44
Context of relevant costs:........................................................................................................................44
terms:................................................................................................................................................44
Special nOTES:....................................................................................................................................45
1) general notes:..............................................................................................................................45
1) DETERMINING THE RELEVANT COSTS OF DIRECT MATERIALS............................................................45
2) DETERMINING THE RELEVANT COSTS OF DIRECT LABOUR................................................................45
3) THE THEORY OF CONSTRAINTS AND THROUGHPUT ACCOUNTING (TOC).............................................45
method of relevant cost decisions:............................................................................................................46
1) adding a new product.......................................................................................................................46
2)Decisions on Replacement of old equipment- the irrelevance of past costs...............................................46
3) Discontinuation decisions : (Dropping a product or division)..................................................................47
4) Outsourcing (Make or buy decision)....................................................................................................47
5) Special selling price decisions (special orders).....................................................................................48
6) Product MIX decisions where capacity constraints exist.(IMPortant : using the relevant costing decision
model as an aid in choosing amoung competing alternatives.)...................................................................49
Ch 23 COST ESTIMATION AND COST BEHAVIOUR.......................................................................................54
1) sPECIAL THINGS TO REMEMBER:.......................................................................................................54
2) tERMS............................................................................................................................................54
3) General: :.......................................................................................................................................54
4) Mathematical principles applying to cost estimation methods:...............................................................54
5)Cost Estimation Methods:..................................................................................................................55
1-Engineering methods......................................................................................................................55
2-Inspection of accounts method........................................................................................................55
3-Graphical or scattergraph method....................................................................................................55
4-High-low method...........................................................................................................................55
5-Least squares method....................................................................................................................56
6-TESTS OF RELIABILITY:..................................................................................................................57
..............................................................................................57
6)relevant range and non-linear functions:..............................................................................................57

7)summary of steps involved in estimating cost.......................................................................................57
8)MULTIple regression analysis:............................................................................................................58
9)learning curve..................................................................................................................................58
1-CUMULATIVE AVERAGE TIME-LEARNING MODEL................................................................................58
B-INCREMENTAL UNIT-TIME LEARNING MODEL:...................................................................................60
c- limitations of the learning curve.....................................................................................................60
d-learning curve is applicable to :.......................................................................................................60
10)INDEX VALUES:..............................................................................................................................60
CH25 THE APPLICATION OF LINEAR PROGRAMMING TO MANAGEMENT ACCOUNTING:....................................62
Special things to remember:....................................................................................................................62
TERMS:.................................................................................................................................................62
LINEAR PROGRAMMING...........................................................................................................................62
Assumptions underlying these calculations:.............................................................................................62
General...............................................................................................................................................63
GRAPHICAL METHOD...............................................................................................................................64
MARGINAL RATE OF SUBSTITUTION:......................................................................................................67
SHADOW PRICE OR OPPORTUNITY COST................................................................................................68
Solving problems with shadow price/opportunity cost & marginal rate of substitution...................................68
SIMPLEX METHOD...................................................................................................................................69
USES OF LINEAR PROGRAMMING..............................................................................................................71
CALCULATION OF RELEVANT COSTS:.....................................................................................................71
SELLING DIFFERENT PRODUCTS............................................................................................................71
MAXIMUM PAYMENT FOR ADDITIONAL SCARCE RESOURCES.....................................................................72
CONTROL............................................................................................................................................72
CAPITAL BUDGETING...........................................................................................................................72
SENSITIVITY ANALYSIS........................................................................................................................72
CH24 QUANTITATIVE METHODS FOR THE PLANNING AND CONTROL OF STOCKS............................................73
IMPORTANT NOTES.................................................................................................................................73
background............................................................................................................................................73
Why do firms hold stocks ?.......................................................................................................................73
RELEVANT COSTS For Quantatative Models Under Conditions Of Uncertainty..................................................73

determining the economic order quantity:..................................................................................................74
TABULATION METHOD :.....................................................................................................................74
GRAPHICAL METHOD:........................................................................................................................75
FORMULA METHOD:..........................................................................................................................76
Assumptions of the ECQ model:................................................................................................................77
Applications of the EOQ model in determining the optimum lot size for a production run..................................77
quantity discounts...................................................................................................................................78
determining when to place the order :.......................................................................................................78
uncertainty and safety stocks and probability theory...................................................................................78
control of stock through classification:.......................................................................................................80
The ABC classification method :.............................................................................................................80
other factors influencing the choice of order quantity:.................................................................................81
MATERIALS REQUIREMENT PLANNING(MRP)..............................................................................................81
JIT : Just in Time Purchasing arrangements................................................................................................81
Ch12 Drury Decision MAKING UNDER CONDITIONS OF RISK & UNCERTAINTY................................................82
Special Cases:........................................................................................................................................82
RISK AND UNCERTAINTY:........................................................................................................................82
PROBABILITIES:..................................................................................................................................82
PROBABILITY DISTRIBUTIONS AND EXPECTED VALUE:................................................................................82
Expected values :................................................................................................................................82
STANDARD DEVIATION : MEASURING THE AMOUNT OF CERTAINTY..............................................................83
Attitudes to risk by individuals:.................................................................................................................84
decision tree analysis:.............................................................................................................................85
buying PERFECT AND IMPERFECT IMFORMATION:.......................................................................................86
MINIMAX MAXIMIN AND REGRET CRITERIA:...............................................................................................87
Risk Reduction and Diversification.............................................................................................................87
1-Chapter 8 :BUDGETS(ch8Viggio book)....................................................................................................89
Principles of Budgeting:........................................................................................................................89
1. Define Budgeting:....................................................................................................................89
3 categories of budgets:....................................................................................................................89
Reasons for budgeting:......................................................................................................................89
financial & management budgeting:....................................................................................................89
Long term planning:..........................................................................................................................89
Positive factors of budgeting...............................................................................................................90
Budgeting & the human factor............................................................................................................90
STAGES IN BUDGETING:......................................................................................................................91
Method for Budgets:.............................................................................................................................91
1. Master Budget:........................................................................................................................91
Financial budget...............................................................................................................................92
Operating budget..............................................................................................................................92
Cash Budget: (or cash flow statement)................................................................................................92
sales Budget:...................................................................................................................................95
Purchases Budget : for raw materials / or retail stock /or any................................................................97
opening stock (finished goods or raw materials etc) Budget:..................................................................97
Production Budget:...........................................................................................................................98
Opening stock -Raw / direct materials- Budget:....................................................................................98
Labour Budget:.................................................................................................................................99
Budget income Statement/ statement of inc&expenditure:...................................................................100
FLEXIBLE BUDGETING...........................................................................................................................101
ZERO BASED BUDGETING......................................................................................................................102
abc budgeting (activty based costing) or Incremental budgeting.................................................................102
Computerised budgeting........................................................................................................................103
Web- based budgeting:.......................................................................................................................103
Line Item Budgeting..............................................................................................................................103
LINE ITEM BUDGETINGOWN RESEARCH TO

STILL:
1) Appropriate Target rate of WACC debt : EQUITY ratio FOR VARIOUS types COMPANIES ie “TARGET WACC”?.
QUESTIONS:
(1) See page 19 vigario – no ii roman figures at bottom –is there a printing error 'budget' should read 'actual"
(i) Same place no -4- last sentence – how is no fixed cost carried to balance sheet, or where are fixed
costs ever carried to balance sheet??? By not going and subtracting over/under recovery or how?
(2) Semi-variable NOT the same as mixed costs – vigio and drury books different.
(3) Google search for different learning curves for different industries/ mnftr. Types e.g. electr.etc.
(4) See page 224 viggio- how does example work- not include fixed costs? Why? Also is answer 268 or -268?
(5) Pg 246-example1- what means 'Other Costs are 20% VAR WITH PRODUCTION UNITS."?
(6) Differential cost driver ???? what's this mean?
(7) Absorption costing :
(i) The IAS statement on inventories states that ALL overheads,eg management salaries and depreciation
and administration MUST BE INCLUDED IN COST OF INVENTORIES on page 1 ch 1.But PAGE 27 CH2 it
says any costs that come after PRESENT CONDITION should not be included eg: selling costs. BUT WE
learn to do a COST OF SALES analysis in the INCOME statement where SALARIES ARE NOT INCLUED
nor admin nor depreciation, but opening and closing inventory is included in the calculation.SO how do
you use the figure above to do this calc. which needs opening - closing inventories + purchases ?
where does one get these figures then, or where do you use the IAS inventory rate then? ( the rest of
income statement has salaries, depreciation etc- you cannot charge it twice/double!! In income
statement.!!) I MEAN : DOES ONE SUBTTRACT/ADJUST THE COSTS CHARGED TO CLOSING STOCK
--OUT OF THE NORMAL SALARIES & OVERHEADS IN THE INCOME STATEMENT SO IT DOSNT GET
SUBTRACTED TWICE?
(ii) WHO MAY USE LIFO method of stock valuation??
(iii)STEP COST ALLOCATION METHOD
This tequnique does account for inter-service dept. cost allocation.
The method used here is to allocate the cost for the service dept. which services the greatest no. of other
service depts. first. Or if you get a situation where some service depts. service each other,as in example
here, then first to be allocated is the one with highest cost. SO WHICH GOES FIRST IF ONE GETS BOTH
TYPES AT SAME TIME?
(8)METHOD OF DOING OVERHEAD ACCOUNT AND OVER/UNDER RECOVERY INCOME STATEMENT.
(i) Overhead account CONTRA WIP account. : All estimated/charged overheads to CR , Actual
overheads to DR , Balancing amount as Over/Under recovery to Income Statement.
(ii) REM: ???????just remember the over/under recover amount that goes to income statement or comes
from this account , WILL NOT INCLUDE ANY OVER/UNDER RECOVERY FOR CLOSING STOCK?????????
SO FOR (8) WHAT IS THE ANSWER TO BETWEEN ????? QUEST. MARKS. YES/NO ? HOW
7) RECONCILLIATION of BUDGET to ACTUAL PROFIT.
a) When a STANDARD COSTING SYSTEM is used, the under/over recovery is shown as :
i) Volume Variance (difference between budget –actual)
ii) AND Expenditure Variance. (difference between budget –actual)
EXAMPLE: Example 1 on left and 2 on right are completely different exercises, both are Reconcilliations.The one
on the right seems the more correct one.-includes units- but not sure if both are equally correct- ASK.
8) Is marketing costs part of mnftring overheads for absorbtion costing? Delivery costs, packaging, etc?
9) On page 52 viggio, why does it say contribution instead of gross profit,3rd row from bottom far left,
because fixed manufacturing costs do and must get included in the the box above- to calc gross profit!
10)Next Qusetion – read the yellow carefully –there are 2 questions here!
RECONCILLIATION OF ABSORBTION PROFIT TO ABSORBTION

PROFIT(PG 142 VIGGIO)
1) METHOD :Whether it is a year to year or month to month recon . for the 1 company or whatever :
a) No units on left needed.
b) Start with 1st profit AFTER over/under adjustment, end with last profit after over/under adjustment.
c) Add any Variable Non-mnftr costs (eg:selling costs) subtracted before for net profit.(yes or no or what
–not shown in exercise)
d) Any non-mnftr fixed costs : Add them back in.{or maybe ; not sure but do other one rather- it seems
you want to see the gross profit somewhere)) if different you must do a separate item line to recon it :
just subtract one from the other then put difference in recon ( highly unlikely to happen anyway!) what do
you do? And dothey want to see the gross profit for both somewhere or not?
e) 1st :Do opposite to over/under to bring to first period gross profit( if added in income stat, -then
subtract it and visa-versa)
f) Now you have next periods Gross Profit.
g) Now add/minus previous months over/under- same as you would in income stat,(not add if
subtracted etc but add again – you are going toward getting NEXT PERIODS NET PROFIT now as if
it is a normal income stat.)
h) Now add next periods Variable and Fixed non-mnftr overheads in.
Next question:
Part (a)
For a Variable Standard Costing recon, in the” Volume Variance Part” at top top,,(ask : 1-but what do
you do with closing stock – or 2- opening stock with different fixed cost to this year?) you will also leave out
fixed-mnftring costs here, because you don’t do a special “Overheads Volume –variance subtraction” in the
expenditure section below, because you don’t have any fixed costs in the closing stock to wheedle out (if the
numbers are right it could cause a error, If You don’t do all this I think)
Part (b)
And for same issue as above : what do you do wuth the variable and fixed manufacturing costs whem yopu get a
closing stock for this year, or also Opening stock for this year from last year with different fixed costs to this
year.?????
8) For high –low costing, book vig and drury say you use activities as the one to choose for the HIGH-LOW
method- not price, but in test for last question in the 2nd CVP test, the memorandum uses the price to choose
the high + low one?? Which do we use?
9) What do you do with a closing stock in the budget – if you are doing a recon for budget to actual profit in
absorption or variable or standard costing?????? How do you handle this closing stock in the recon itself.
10)What does ‘full costing mean?test 3
11)What does constant price level terms mean? In test 3
12)In job costing for manufacturing accounts : where do you get wages from? (ALL WRITTEN OUT?)
a) You must pay taxes on all all wages in WIP, as asset or asset increase, esp. in closing stock- how does that
work?ie add the wages then subtract them again fior profit, but for plain retail they only use wages as tax
deductable( must a storemans wages go to closing inventory?) but for mnftring it is not tax deductable.
13)For overhead account; for 1st month could you CR transfer wages to WIP before any DR it all- so you have a
CR but not a DR in WIP?
14)For fixed costs in variable costing, must fixed go to cost of sales before gross profit or NOT?????/VERY
IMPORTANT: ie in vigg textbook it does both! See drury exercise 7.16: here it is NOT included –fixed costs in
cost of sales- also this was a test question and we got marked wrong for having fixed costs in cost of sales-
BUT in Viggio pg 137 he DOES put fixed costs in Cost of Sales! So what do we do????
15)Do you get a fully integrated STANDARD absorbtion costing system?
16)What for mat does one do the profit statements and income statements for variable costing, and also
absorbtion – drury and viggario each have 2 or 3 methods each , so 6 or more methods. I mean with cost of
sales , or using ccontribution as a heading or putting some stuff at the top first then others below- general
mix- up each has his own method – spo what is a standard accepted format one should use consistently???
BIG MESS!!!!!!!also with including fixed mnftring costs in variable cost of sales figure - or not - etc etc.
|
MACN 301 Management Accounting: Notes P a g e | 10
9) For reciprocal allocation (algebra method) of allocating costs to production depts., what happens if you get a
fraction at the end – like R0.345543 - how do you allocate these last fractions between depts.? On page 35
viggio at bottom of page.35 viggio
10)RECON OF PROFITS or also overheads : start at Budget and end at Actual.( or maybe any way you want?)
11)For a JOB COSTING system , part of fully integrated absorbtion costing ,on page 49 viggio , what is contra
for "JOB 1-5" accounts, ie:where does "Job completed" on cr side get posted to? Do these acc's go to trial
balance and Fin Stats? Where in fin stats do they go?
12)Fully integrated absorbtion : do you use budget or actual overheads for closing stock ?- if budget , then if
over/under –recovery is for all of production (incl closing stock) then why is it only added to sold production –
this will give a wrong value for 1-closing stock and 2-profit.OR is the overheads charged to incomplete jobs
already "actual' and not "budget"?
a) TRY PUT sales as only 1 for example pg 130 vig ? then this all becomes clear! (see pg 129 2nd paragraph
from bottom for rule to use budget.. in closing stock only!Also?? before it was said one could use actual or
budget)
b) Fully integrated absorbtion :On page 130 vig highlighted : if over –recovery is for all of production (incl
closing stock) then why is it only added to sold production – this will give a wrong value for 1-closing stock
and 2-profit.OR is the overheads charged to incomplete jobs already "actual' and not "budget"?
c) Over/Under recovery is only applied to sales,not closing stock, but at the full total for closing stock
+sales , so there is a mistake where sales takes ov/und recovery away from closing stock and visa versa,
and Opening stock dilutes it all a bit too wrongly.(say sales was only 1, then apply this to any example)
d) Pg 150 viggio blu highlight,: for variable costing , if asked for the GROSS PFOFIT, or COST OF SALES
BREAKDOWN, do you include fixed mnft costs or EXCLUDE them then?????
Chapter 9 standard costing :
a) Pg 345 vig – bottom o page, how do they get Standard = R165 000, shouldn’t it be 1.875X 110000?
b) If you have closing stock in a budget ,how do you do the recon for : sales variance: is it
mnftr profit less ‘sales variable costs” or [contribution less closing stock less fixed mnftr-
costs] .-before you div by units and X by difference in sales volume.?
c) From variable &
Chapter 6 Ratios & business risk.
2) DOES return on operating assets include long term loans to others? Or exclude it?
3) Is wages a fixed or variable cost????
4) In the book fin mngmnt b viggio, ch 6 , he uses 3 different ways to calc. the Operational Assets : in pg 236 for
4.3 it says at bottom- average over year,on pg227 it says we must use the beginning value,and only use
average if question asks for it, in solution for practice question it Just gets Average of fixed assets, but for
current assets it uses the year end one? Then in appendix it uses end of year for fixed and for current LESS
investing fixed assets(less investments)
5) For gross profit % ratio : on page 234 it says it is trading profit after cost of sales(so without subtracting all
admin &other expenses), but on pg 225 it says it is EBIT – so after all expenses& other fixed costs eg rent! So
which is it
6) The profitability ratIO’S – is this Net profit + gross profit ratio , or just GP% ratio?- and which GP% ratio is it:
Ebit or after cost of sales???? On pg 236 it says the profitability ratio is EBIT/Turnover EXACTLY!!!
7) What is EPS- how do you work it out? is it declared dividends or is it total net profit divided by the
number of shares issued?
8) Check all ratios and ask how you work each one out- some are weird and done different 2 ways in
same chapter.
Chapter 3 cost of capital and capital structure

1) (See yellow why amount-how can amount make a difference????). THE IMPORTANT QUESTION IN
THE LONG TERM FINANCING DECISION is: whether the cost of capital for a company is dependant on its
financial structure. If long term debt does affect the cost of capital, then the company should minimize its cost
of capital by borrowing an “amount” of debt capital that will give the company its lowest cost of capital.
2) ?Definition: Financial Structrure: : it seems like all 3 of: Total Assets & Issued Shares & Total Debt.? What
does it mean?exactly?
3) The key ratio is interest cover- how many times interest is covered by profit.
CHAPTER 1-3: financial management to Capital structure & Cost of
capital.
1) For calculating WACC, for the debt part, do you include bank overdrafts. And do you include any other
creditors like massive supplier credit or so.
2) What is yellow? : EQUITY = includes all of : Retained income + Non-Distributable + Distributable
Reseves + Share Premium + Any form of debt that has a conversion option to Ordinary Shares.+??
Share issue expenses pg7 note top??
3) For the method of calculating the WACC using the market value method : 1-how does it work, 2-
see yellow below Market Value of Equity: simply the net profit per year – not the dividends ,not the PV of
anything, or anything else.if they give you dividends&Ke, then 100/ke X dividends=answer! (????This answer
is called the present value of future cash flows in the book [PG7 vig] because it is the profit before part of it is
paid as dividends I think!???? Is it the book value of capital employed-ie DEBT+EQUITY- or is it something
else?what is the logic behind this? ALSO , WHY BRING IT ALL TO PRESENT VALUE- YOUR EVENTUAL DEBT
REPAYMENTS AND )
4) ????VALUE OF ORDINARY SHARES = Value of Company –less- Value of Debt .????how does this work,
see book pg11 vig fin.mngmnt.- isn’t it the other way around- the value of the company = value of ordinary
shares less value of debt???
5)See page 35 vig finance question is highlighter
6) Ask pg 35 at the highlighter
7) Page 36- ask if this is a printing error at the top- it looks like one for sure
a) See bottom of page it also seems wrong- not sure!
8) On pg 59 in solution when given a market rate for debentures & one for loans, it uses the
debentures one even though it is higher than the loan one. But in chapter 2 there is an exercise
where a market rate of debt is used to go and calculate the debentures Market value. When do you
use which ??
budgets
9) Pg 308/9 vig see green- july material and production is astuff up – looks like it is wrong- it seems the
figures on pg 308 in working capital’ of twinmate must be ignored for finished production&raw materials – if
you use them youy get wromg answer. Also he forgot the purchases for actual production for june.t
ratios
10) Contribution : High – Low method to get it from the income
statement.
You can get VARIABLE COSTS : by: given 2 years figures – then change in turnover Minus change in EBIT.
You can get CONTRIBUTION Margin by: change in EBIT / change in TURNOVER.
You can get CONTRIBUTION by : then use this % from contribution margin to MULTIPLY by any TURNOVER =
Contribution .
1. Note: For contribution,
a. If given both Revenue AND Turnover figures in an exam one above the other
(revenue PROBABLY INCLUDES “Other Income” and turnover is from normal
operations) , you don’t use you do not use REVENUE, you use TURNOVER , I THINK –
just check with lecturer on this.
1) For the operating leverage : is it ebit/ turnover or ebit over revenue ( if revenue includes other income eg:
rent or interest but turnover is from operations )
(GP%) GROSS PROFIT PERCENTAGE % RATIO: = GROSS PROFIT/TURNOVER | =% ANSWER
|
2) Remember for the GP% ratio , it is turnover , not revenue, so if there are figures for both use turnover
because GP% is for “operations”, not including “other income “ like rent or dividends (I THINK-CHECK WITH
LECTURER)
3) Note: not the following headings below:
i) The Profitablility ratios are: 1-net profit%, 2-GP%, 3-sales growth, 4-profitability ratio.
(not sure – just check)
ii) The liquidity ratios are: NOT SURE- check up (I think 1-debt2-liquidity3-acid-4times interest
earned
iii) Times interest earned ratio is also called the ‘gearing ratio’( I think – check)
Macn 301
:
RELEVANT COSTS
1) Are the following definitions correct for DRURY book

a) Differential cost
i) A differential cost is the difference in cost of alternative choices. If Option A costs an extra R300 Option
B costs an extra R360, the cost differential is R60, with Option B being more expensive. A differential
cost is the difference between the relevant costs of each option.
b) Incremental cost
i) The differential cost of an extra unit of production is the extra cost required to make that unit, ie it is
the difference in cost between making the unit and not making it. This type of cost is also called
incremental cost. Incremental costs are relevant costs.
LEARNING CURVE CHAPTER

1- for high low method – do you use the MONEY ie COSTS or do you use the cost driver ie hours/etc,
1a- Also , what if there are 2 values the same, with different value for the opposite one- which do you take, the
high or low one.
2. See question 23.21 : if look at answer in the back, they used 90% learning curve after they worked it out as
90.3. So if you use this it gives a COMPLETELY different answer- how do we know where to round off and
where not? Also, at the end of the question they left out the “opportunity cost’ of the extra time it takes for
the last 15th boat , when it is made using normal time over the 92 days.
3. GENERAL ROUNDING OFF: what are the rules? For learning curve 2 decimals, for normal money just rands &
cents or up to 4 decimals or how??? Problem is if you do it one way it gives a very different answer to
rounding off differently.!???
4. What is answer to IM23.7 (c) ?? cannot get it
5. Check im23.9& im23.10
LINEAR PROGRAMMING
SHADOW PRICE OR OPPORTUNITY COST
1.1.1.Definition: the Value of an independent marginal increase of a scarce resource . ok so this means the
marginal increase in contribution for any increase in the amount available of a limiting factor, like
more KGs of raw material are available etc.
1.1.2.To calc. this : METHOD : you just take it from above “Marginal Rate of Substitution” you worked
out , and MULTIPLY it by the CONTRIBUTION of each Product. So if Marginal Rate of Substitution of
Product Z = - 0.15, and Contribution of same product = R16, then the DECREASE in contribution from
R2.40] .Then work out the same for the other product. So say other
product Y = [-
product Z =[ +R2.80 ] Then The Answer is as follows :
SHADOW PRICE or OPPORTUNITY COST = R2.80 – R2.40 = R0.40c .
1.1.3. So we know that for any INCREASE in the QUANTITY of specific raw material available, the price of
any EXTRA raw materials can be increased by up to 0.40c above what we pay for the rest of the raw
materials, and up to this level we can accept the offer because the it will still contribute toward the
Fixed Costs.
1.1.3.1.NOTE: this does not mean all this specific raw material’s price can increase, it only means any
EXTRA material which might be offered to the factory , over and above the limited qty available
currently, can be up to just below R0.40 more expensive.
1.1.3.2.NOTE : this presumably means up to JUST BELOW R0.40 , NOT incl. RO.40 , that would be
ZERO increase in contribution (work for nothing-wear & tear) , and above 0.4 would cause a
Decrease in contribution.???is this true
CH 24 PLANNING CONTROL OF STOCKS

1. (don’t understand- it seems they did errors on the table on page 629) re-do
QUESTIONS CURRENT PLACE

TO SCAN IN/DO STILL:

(1) Pg 53/54 example 1 of absorbtion costing.
(2) Go through all the 'accountant will recomend ' stuff and summarise well : pg 199 vig top,175/176
vig,180 vig bottom,
(3) Scan pg 177 for abc costing + opdrag page before
(4) Scan Pg 181 for format of a "costing statement "
(5) Limiting factors calculations for abc costing : pg 186 + 187 vig scan + re-study
(6) See page 194 vig and put it all together with the rest of the verbal abc vs absorbtion costing notes
in abc costing chapeter in notes.(get 1 good answer to learn – not 100's)
(7) CHAPTER 4 variable costing: pg 144 to end of book- do the last 2 headings didn’t finish.
(8) Learning curves: scan in some good examples and the text out of textbook to explain better- your
explain is not very clear esp. example 1 page 218 viggio
(9) Fully integ absorb- get examples & exaplain rught pg 35 vig
(10)In RECONCILLIATIONS: do a over/under recovery of fixed overheads for Fully Integrated
Absorbtion Costing
(11)Get all the examples of relevant costing& practice exercises , as well as budgets & all execrcises &
any other major work –related chapters where you mght qickly have to have a look at the methods
in exercise if you get a very difficult opdrag.
REM: NOTES SPECIAL THINGS TO

REMEMBER
I) (1)SEE PAGE 244 in Viggario book for Quest. + Answers.

II) (3)REM: if they ask :the company gets an order for an extra 100 units, what will a profitable price be for
this –it means ONLY FOR THE LAST 100 – not all units,ie the differential/ price.
III)If asked to get the profit for extra hundred(not just 'last' –but 'extra') DONT FORGET TO LEAVE OUT FIXED
COSTS PER UNIT in your calculations!!!!! It is supposedly already paid by the first few –see pg 244 viggio.
IE:IN MANAGEMENT ACC. IF FIXED COSTS ARE GIVEN IN A BUDGET AS A PER UNIT WORKED
OUT COST – IT MEANS THAT THE TOTAL FIXED COSTS HAS ALREADY BEEN DIVIDED UP
BETWEEN THE NUMBER OF UNITS IN THAT BUDGET- ANY EXTRA UNITS WOULD NOT SIMPLY
INCUR THESE COSTS WITHOUT IT BEING STATED HOW-IE: IF PRODUCTION WOULD THEN AN
EXTRA MONTHS RENT UP ETC.SO YOU IGNORE THESE FIXED COSTS FOR ANY EXTRA UNITS
PRODUCED.unless told otherwise.
2) REM: NOTE: if you have to find out the fixed costs for a very large units- ONLY first convert variable costs to
single/per unit(because lecturer/book/everyone does this) ,but do not first convert total costs and fixed costs
to :per unit- use straight from large amounts because otherwise any- 0.33333 so R0.33 -recurRing fractions
will give you wrong ANSWERS.(because you cannot get all the recurring parts in)
3) If asked to redraft a budget for a learning curve question, do a full total profit/ costs/fixed/var/ budget and
also a per unit one next to it ,just to show, not just a per unit one even if the first budget was not even shown
on paper.
a) Also , if they say fixed costs of R50 each for 300 units, thyen for an extra 100 units the fixed costs will not
apply, it has already been paid.- so leave fixed out in any calc. for the last 100 units.
SEMESTER 2 ONWARDS:
1) How many decimals do we round off to?

2) Rounding off: For an answer above .5 round up / down for below 0.5.This is how viggario does it for all
CVP/costs/ and calculating variable costs per unit from variable costs per all produced etc.(to get his clean
answers! Without .3333 etc everywhere!)
3) EXCELLENT EXAMPLE of the difference between Variable and Absorbtion costing where the profit is different
in 2 years with same costs&price.
3)
2-TERMS:(VIG CH 1+2)
The Correct Method To Adopt When Looking At Product Decision-Making Is
As Follows:
1.1.Identify the main or flag-ship product that the company manufactures.
1.2.Maximise the profit on the main product by maximising production ,sales and contribution.
1.3.Sell other products manufactured by the company only if there is spare capacity.
1.4.Sell other products at a price higher than variable cost.
1.5.One can only Max contribution( using Variable costing) per limiting factor, not max profitability by using
ABC or Absorption costing unless you work it out from the start {incl. total activities/total cost drivers=to
get cost driver rate} for each price & production level.)
1) COST RECOVERY RATE.: the rate or basis eg machine hours. at which costs are recovered to a specific eg
production dept.
2) BASIS : the rate/basis is the measurement used to allocate costs eg: labour hours or machine hours.
3) COST PLUS BASIS :means you work out the final figure by starting with the cost price and then adding a
certain amount or % to it.
4) LIMITING FACTORS OF PRODUCTION: like a bottleneck at the machine dept – because machines only
produce a maximum amount each , or one cannot get more than a certain amount of some raw input product
per month etc
INTRO:
1) Management accounting is primarily concerned with producing budgets, setting performance standards, and
evaluating performance
2) Acc sys used for measure costs for profit measurement,inventory valuation ,decision making,performance
measurement, control.
THE PRODUCTION POINT OF INDIFFERENCE, :
Where the total cost of a capital-intensive company = the total cost of a labour-intensive
company.
ANALYSIS OF THE COMPANIES COST STRUCTURE:
Its fixed costs and contribution per unit.
CAPITAL STRUCTURE
means whether the company is using equity or debt and what combination of the 2 and interest rates etc etc.
ANNUITY:
The Receipt or Payment of a fixed amount over a number of years or periods.
ANNUITY DUE: if payment is made at the beginning of each period, it is called this
REGULAR /ORDINARY /DEFERRED ANNUITY : if payment is made at the end of the period.
OVER-TRADING
Means the company is selling too mush on credit and debtors are taking too long to pay- too many debtors and
too long to pay. This means it is taking chances with it’s selling on credit policy and over doing it.
COST OBJECTS:
1. COST OBJECT :Definition: ANY ACTIVITY for which a SEPARATE MEASUREMENT of COSTS is
desired.
a) Eg; cost of a product , of rendering a service to a bank customer ,of operating a particular sales
territory or dept.
The Cost Collection System works as such ; it accumulates costs-by assign into categories-eg labour,materials
,overheads.( or by fixed & variable).THEN assigns these costs to cost objects.
DIRECT AND INDIRECT COSTS

INVENTORY VALUATION:(NOTE)
IAS 2 : INTERNATIONAL STATEMENT ON INVENTORIES states that : Firstly, closing stock – work
completed but unsold- (??? What About inventories & work in progress???) must be valued at the lower
of cost and net realisable value.Inventories are valued at : all costs incurred in bringing to current state
– ONLY manufacturing direct and indirect costs-The Costs of conversion of inventories include costs
directly related to the units of production,such as direct labour.They also include a systematic
allocation of fixed & variable overheads that are incurred in converting material into finished
goods.Fixed production overheads are those indirect costs of production that remain relatively constant
regardless of the volume of production, such as depreciation ,maintenance of factory buildings and
equipment,and the cost of factory management and administration.
However FIXED OVERHEADS are only allocated at the normal production capacity(over anumber of
seasons or periods under normal circumstances,taking into account the loss of activity relating to
planned maintenance) .If idle plant /low production inventory costs are ONLY allocated at normal prod.
Capacity Levels.BUT in periods of abnormally high production, the amount of fixed averheads allocated
to each product unit is decreased so inventories are not valued at below cost.
As a result of this accounting definition ,the valuation of stock is carried out on a FIFO or weighted
average basis.LIFO is strictly prohibited.
DIRECT COSTS :
Costs that can be specifically and exclusively identified with a particular cost object. . ..
Eg:wood in a desk, maintenance labour in -(cost object maintenance dept)-but NOT Maint.Labour in
a –(cost object desk produced).The more direct cost and less indirect costs =the more accurate
the estimate.
INDIRECT COSTS :
Costs that cannot be identified specifically and exclusively with a particular cost object, but can only be identified
with a a number of depts.. /cost objects.
CATEGORIES OF MANUFACTURING COSTS. – WITH DIRECT/INDIRECT COSTS.
Direct Materials Xxx
Direct Labour Xxx
Prime Cost Xxx
Manufacturing Overhead Xxx
Total Manufacturing Cost Xxx
i) In manufacturing organisations traditional product costs accumulated as follows – ( developed esp.

from/for ext. accounting requirements.
DIRECT MATERIALS :
Cost of all materials that can be identified with a specific product.eg wood for desk is, but maintenance
materials on machine to produce with is not,that is an indirect materials cost.
INDIRECT MATERIALS :
cannot be identified with any one product, eg:because used for all.eg maintenance materials spares.
DIRECT LABOUR :
can be specifically traced to or identified with product eg:labour assemble product
INDIRECT LABOUR
can not be specifically traced to or identified with product eg:labour maintenance of many different
product lines machines.
DIRECT EXPENSE :
NOT labour/materials/overheads/ can be specifically traced to or identified with product eg hiring of
machine to produce a specific quantity of a product is a direct expense. (other than /not
labour/materials-in this context) anything else in this category would be classed as 'OVERHEADS' –see
below.
PRIME COST
= Direct materials+Direct Labour +Direct Expenses.
MANUFACTURING OVERHEAD :
All manufacturing costs exept : Direct materials+Direct Labour +Direct Expenses eg:rent of factory.
COST ALLOCATIONS :
process of assigning indirect costs(overheads) to products- using surrogate ,not direct measures.ALSO
– the assigning of eg: rent between mnftring and / non-mnftring depts.
TOTAL MANUFATURING COST :
Direct materials+Direct Labour +Direct Expenses+Mnfctring overheads
PERIOD AND PRODUCT COSTS.
2) Because of external fin acc rules in most countries that require that for inventory evaluation ONLY
MANUFACTURING COSTS /or RETAILER = PURCHASE COSTS + FREIGHT IN -should be included in the
calculation of product costs AS WELL AS ONLY costs related directly to the units of production- accountants
therefore classify costs as product costs and period costs.
a) BECAUSE OF THIS ONLY the FIFO or weidghted average methods may be used to calc. inventory- NOT
L.I.F.O.-ie. Costs must relate directly to units of production.
REASONS CITED FOR THIS:
b) Inventories represent a future probable inflow of revenue , period costs(overheads) do not
c) Many non-manufacturing costs are NOT incurred when the product is being stored-thus inappropriate
to include them in inventory valuation.
INTERNATIONAL STATEMENT ON INVENTORIES states that :Inventories are valued at : all costs incurred in
bringing to current state – ????ONLY manufacturing direct and indirect costs- ie:COSTS OF CONVERSION ???????
YES OR NO. Includes systematic allocation of fixed & variable overheads.
However FIXED OVERHEADS are only allocated at the normal production capacity.If idle plant /low production
inventory costs are ONLY allocated at normal prod. Capacity Levels.BUT in periods of abnormally high production,
the amount of fixed averheads allocated to each product unit is decreased so inventories are not valued at below
cost.
PRODUCT COSTS :
costs identified with goods purchased or produced for resale.-in mnftring is costs attached to product for
inventory valuation of finished goods ,work in progress, matched against sales for recording profits. ONLY
MANUFACTURING OVERHEADS may be INCLUDED as part of absorbtion costing in the valuation of closing
stock.Variable costing would treat it as a period cost and write it off in period it occoured.(IFRS/etc) =recorded as
an ASSET until sold ,then as an expense.(when you 'write out' last inventory count and write in new inventory in
the profit & loss statement at year end I THINK? ) ! Product costs= TOTAL MANUFACTURING COSTS =direct
labour+dir.material+direct expenses +Mnftring overheads( from last section) NOT eg: distribution+telephone for
telesales .as per book exactly: Admin Overheads or selling overheads may never be assosiated with production.
PERIOD COSTS :
costs treated as expenses in the period in which they occoured, BUT NOT included in the cost calc. of
inventory valuation.(or /sales/work in progress.)recorded as an expense ONLY,never as an asset! Period
costs= eg: sales expenses+ admin +distribution expenses.
RELEVANT AND IRRELEVANT COSTS:

RELEVANT COSTS AND REVENUES :
Those Future costs and Revenues that will be changed by any specific decision relating to production volume
or selling volume.eg: material costs change if choose to produce more
IRRELEVANT COSTS AND REVENUES:

Those Future costs and Revenues that will NOT be changed by any specific decision relating to production
volume or selling volume.. Eg: rent for factory will not change if higher production or selling volume.
AVOIDABLE OR UNAVOIDABLE COSTS:

AVOIDABLE=
relevant costs (sometimes used in place of other name)
UNAVOIDABLE
irrelevant costs (sometimes used in place of other name)
OPPORTUNITY COSTS:
3) OPPORTUNITY COST =The cost of a foregone opportunity in favour of having chosen another one :eg . if
the cost of selling a new product is to stop selling another one , the opportunity cost is the rvenue one used to
receive from the old one.
-INCREMENTAL /OR DIFFERENTIAL- AND MARGINAL COSTS

INCREMENTAL OR DIFFERENTIAL COSTS :
Accountants use this : means the different in total costs for ALL THE EXTRA PRODUCTS WHEREBY the
PRODUCTION HAS BEEN INCREASED.
MARGINAL COSTS :
Economists use this : means difference in costs for ONLY ONE extra product –ie. For each separate new
product whereby production has been increased.
JOB COSTING AND PROCESS COSTING SYSTEMS:

JOB COSTING SYSTEMS:
Relates to a costing system where all the costs associated with each job could be different for each job
completed and , so direct materials and labour are allocated at actual cost and fixed overheads are allocated
on a pre-determined cost rate for each separate job.This is also known as a fully integrated absorption
costing system. eg. In constructiion industry –where each house could be unique and have a completely
different set of costs to other houses.
PROCESS COSTING SYSTEMS:
The method used to value stock in mnftring where at end of period some of the closing stock is partially
manufactured-not all finished yet.
ABSORPTION COSTING AND VARIABLE COSTING:AND

STANDARD COSTING.
INVENTORY VALUATION:(NOTE)
IAS 2 ON INVENTORIES STATES THE FOLLOWING.:
IAS 2 : INTERNATIONAL STATEMENT ON INVENTORIES states that : Firstly, closing stock – work
completed but unsold- (??? What About inventories & work in progress???) must be valued at the lower
of cost and net realisable value.Inventories are valued at : all costs incurred in bringing to current state
– ONLY manufacturing direct and indirect costs-The Costs of conversion of inventories include costs
directly related to the units of production,such as direct labour.They also include a systematic
allocation of fixed & variable overheads that are incurred in converting material into finished
goods.Fixed production overheads are those indirect costs of production that remain relatively constant
regardless of the volume of production, such as depreciation ,maintenance of factory buildings and
equipment,and the cost of factory management and administration.
However FIXED OVERHEADS are only allocated at the normal production capacity(over anumber of
seasons or periods under normal circumstances,taking into account the loss of activity relating to
planned maintenance) .If idle plant /low production inventory costs are ONLY allocated at normal prod.
Capacity Levels.BUT in periods of abnormally high production, the amount of fixed averheads allocated
to each product unit is decreased so inventories are not valued at below cost.
Variable Production overheads are those indirect costs of production that vary directly,or nearly
directly,with the volume of production,such as indirect materials and indirect labour.
As a result of this accounting definition ,the valuation of stock is carried out on a FIFO or weighted
average basis.LIFO is strictly prohibited.
Cost accounting grew out of the need that financial accountants have for financial information ,and
gathers and analyses costs for the purposes of :product costing,job costing,stock valuation.
ABSORBTION COSTING :
IN EXAM, OR REAL LIFE, AS SOON AS ONE GETS AN INCOME STATEMENT OR FIGURES PREPARED
USING ABSORBTION COSTING, ONE MUST QUICKLY CALCULATE THE SAME FIGURES USING VARIABLE
COSTING – OR YOU WILL NOT BE ABLE TO DO PROPER COMPARISONS AND WORK THINGS OUT! Due
to fixed costs being in there- always take them out and convert to CONTRIBUTION ..
Method used to VALUE CLOSING STOCK that includes ALL MANUFACTURING COSTS-VARIABLE AND FIXED-
NOT any NON-MNFTRING COSTS AT ALL!!!!!! ((WHICH DOES/can INCL. RENT AND MAINTENANCE per book)–
The fixed cost element can be determined by budget or by actual,and is added to all variable mnftring
costs(eg direct material) to get the total per unit product cost for inventory valuation per the IAS definition
( which says ALL MNFTRING COSTS must be included in Inventory Valuation incl. fixed mnftring costs eg:
Maintenance etc.) .ONLY Financial Accounting uses it. NOTE: every time production volume changes
,the cost per unit will change because fixed costs get divided by a larger /or smaller number now.So it is an
inconvenient method requiring constant raising of under/over recovery charges to balance the figures.The 2
reasons for this is:
1-Actual volume is different to budget volume.
2-Actual manufacturing overhead being different to budget overhead.
That is why Management Accounting uses a different method –: called "Variable Costing".
FOR ABSORBTION COSTING THRE ARE 2 WAYS OF VALUING STOCK:1-BUDGET AND 2-

ACTUALVARIABLE PLUS FIXED COST OF PRODUCTION. But for variable costing ther are also these
2 ways , exept there it is only VARIABLE COSTS OF PRODUCTION, not fixed and variable in the
stock valuation(per book vigario pg14-concl.
ALSO, FOR ABSORBTION COSTING THERE ARE 3 POSSIBLE WAYS OF PRESENTING THE
INFORMATION IN THE FINANCIAL STATEMENTS.
1-FULLY INTEGRATED ABSORBTION COSTING (BUDGET COST)
2-NON-INTEGRATED ABSORBTION COSTING (BUDGET COST)
3-ACTUAL COST ABSORBTION COSTING. (all exactly per vig. Pg 14 book!)
IS ABSORBTION COSTING ACCEPTABLE:?
NO, because it will distort true company profits due to showing fixed costs as closing inventory
costs –you cannot compare 2 periods properly,or budget properly if you use include rent at a
pre-determined rate eh R300 per product it will not be accurate if production rises or falls.- it
will eg show excessive profits when stock holding is rising ? per book vig pg14.
HOW DO YOU MAKE IT ACCEPTABLE:
You explain on any budget that the Per Unit cost can vary by the TOTAL FIXED COSTS AMOUNT
included in the costing eg R500 –at any level above or below the no. of units that the budget was
calculated at.
However ,for calculating costs of products in a Job Costing environment, where the costs are used to quote
on future jobs eg: Printers , when using absorbtion costing, one must remember that one company allocates
fixed costs differently to another one,and there is no right or wrong method to allocate fixed costs really, ie
some allocate all overheads, some only admin + management , some only maintenance and depreciation etc.
COST ABSORBTION RATE :

the cost rate at which a group of costs or fixed costs or overheads are charged to a specific product eg:
machine hours divided between no. of products.(it is used by fin . accountants to calculate absorbtion costing
system.
FULLY INTEGRATED ABSORBTION COSTING SYSTEM ( OR “FULL” ABSORB. COSTING SYSTEM)
If the fixed element is pre-determined .So when fixed elements eg: rent+maintenance ,are pre-calculated in
the previous years as a per unit cost, from per average normal production levels,so eg R1000 rent /
500products made per mnth= R2 rent per product ;and these amounts are added to normal vriable costseg
direct material, to get a (estimated/ avg)total cost per product unit . (NOTE: not all fixed costs need to be
allocated as such ONLY mnftring costs MUST BE(WHICH DOES INCL. RENT AND MAINTENANCE per book),
other fixed costs eg admin and computer,marketing costs(more 'sales costs' types get left out)can be left out
and the system would still be called Fully Integrated absorbtion Costing) ONLY where the fixed cost element is
pre-determined though and not based on actual fixed costs ,which is another type of absorbtion costing.The
actual amount will differ from the allocated amount though and OVER or UNDER recovery of fixed overhead
will occour, which must be balanced by a BALANCING AMOUNT known as the over/under –recovered fixed
overhead.This amount is included by 'raising a charge' (possibly it's very own ledger account-CRJ/CPjournal)
and including it in the Cost of sales breakdown in Income statement for Gross Profit calc.
Do NOT ASSUME every company uses fully integrated abs.cost. to allocate costs in order to arrive at the cost
of a product.Only companies that have a JOB COSTING environment , require a pre-determined FIXED COST
to allocate to FUTURE production.Very few companies will allocate costs to production and service depts. ,
followed by re-allocation from service depts. to production depts. However , when using absorbtion costing,
one must remember that one comapny allocates fixed costs differently to another one,and there is no right or
wrong method to allocate fixed costs really, ie some allocate all overheads, some only admin + management ,
some only maintenance and depreciation etc.
VARIABLE COSTING (OR MARGINAL OR DIRECT COSTING)
IN EXAM, OR REAL LIFE, AS SOON AS ONE GETS AN INCOME STATEMENT OR FIGURES PREPARED
USING ABSORBTION COSTING, ONE MUST QUICKLY CACULATE THE SAME FIGURES USING VARIABLE
COSTING – OR YOU WILL NOT BE ABLE TO DO PRPER COMPARISONS AND WORK THINGS OUT! Due to
fixed costs being in there- always take them out and convert to CONTRIBUTION ..
The method used to VALUE CLOSING STOCK using variable manufacturing costs only- fixed costs are written off
as period costs.(as per book- fixed mnfrtring costs are charged to the Income statement as an expense for the
period.So closing stock is valued on manufacturing variable costs only. Ie: the valuation excludes all mnfring fixed
costs.The System is representative of managerial accounting for decision making.
Variable costing is consistent with CVP analysis,ie fixed costs are treated as period costs.(per book exactly)
FOR VARIABLE COSTING ,THERE ARE 2 WAYS OF VALUING STOCK – 1-BUDGET OR 2-ACTUAL.
DIRECT COSTING.
MARGINAL COSTING.
STANDARD COSTING:
Another method of VALUEING CLOSING STOCK – but at a pre-determined rate for BOTH VARIABLE AND
FIXED COSTS.
A) STANDARD VARIABLE COSTING:
(a) when only pre-determined variable costs are used.
A) STANDARD FIXED COSTING:
(a) when only pre-determined fixed costs are used.
SUNK COSTS:
SUNK COSTS :
These are COSTS created by a decision in the PAST that cannot be changed by any future decision – or which has
a zero value when making future decision: eg:depreciation,or money spent on material that is no longer required/
or sellable.-OR buy a car for 10000, when you sell it the 10000 is sunk cost because selling price depends on
what the buyer will pay –it can be above or below 10000 .
RESPONSIBILITY ACCOUNTING :
RESPONSIBILITY ACCOUNTING :
accounting for a RESPONSIBILITY UNIT -an organisation unit or part of a business for which a manager is
reponsible.Revenues & Costs so deviations from performance budget can be attributed to resposible
individual.
PROFIT CENTRE :
same as above :Accountability for profitability of assets placed under a managers control.
COST CENTRE:
SAME AS above but AREA or DEPT. for which a manager is responsible.
INVESTMENT CENTRE:
term defines accountability for profit generation AS WELL AS choices in what will or will not be purchased by
way of capital expenditure in running a business.
MAINTAINING A COST DATABASE:

1) Database to be maintained so relevant cost info can be extracted easily.
2) Need eg: By products, responsibility centres,depts.,distribution channels, + categ. of expense eg direct
labour + categ. of cost behaviour eg fixed and variable.
3) For cost control and performance measurement:
a) Reports by resposibility centre per week/ etc
b) Future reports for eg: possible price changes.
c) Standards costs stored & used to evaluate
FIXED AND VARIABLE PRODUCTION OVERHEADS : AND COST

BEHAVIOUR OF
a) Measurements of volume needed to :patients seen-one more patient/day?=costs/revenue/(or units sold ?
reduce price to sell more?,or units produced ,guests booked etc)
VARIABLE COSTS :
vary directly or very nearly directly according to incr./decr. in volume(eg:of production).See chart below : total
variable costs are linear/direct and Unit var. cost is constant.
UNITS vs VARIABLE COSTS GRAPH

VARIABLECOSTS: (a)TOTAL Variable Costs:(b)Per Unit (cost =R10per

unit)
TOTAL Variable
5000 5000
UNIT Variable
4000 4000
40
Cost
3000 3000
2000 2000 30
Cost
1000 1000 20
0 0 10 10 10 10 10 10 10
0
0 100 200 300 400 500 0 100 200 300 400 500
ActivityLevel
ActivityLevel (unitsofoutput)
PROFIT vs VARIABLE COSTS GRAPH.
FIXED PRODUCTION COSTS :

basicaly stay constant regardless of volume of production –OVER a specific period of time- (before inflation
pushes up input prices etc),but also called ‘long term variable costs’ because over the long term ALL costs are
seen a variable-due to inflation etc. eg:rent, municipal rates
UNITS vs FIXED COSTS GRAPH

FIXEDCOSTS:(a) Total FIXED COSTS:(b) unit (supposed hyperbolic!)

Total Fixed Costs
Unit Fixed Cost

50
1000
500
0
0 0 2 4 6
0 100 200 300 400 500 ActivityLevel : Output -no ofunitsproduced
ActivityLevel (no.of units)
PROFIT vs FIXED COSTS GRAPH
SEMI-FIXED (OR STEP-FIXED COSTS) :

They are fixed in (Relevant Ranges )at specific activity levels :eg at 100 – 5000 products ,-within a specific time
period (same as fixed –to exclude inflation etc)- but if production goes above that they change to the next level
etc.– usually in steps-
STEP FIXEDCOSTS
Total Fixed Costs
300
250
200
150
100
50
0
0 100 200 300 400 500
ActivityLevel
SEMI-VARIABLE (OR MIXED COSTS) :

These include both a FIXED and a VARIABLE component eg:maintenance = fixed cost + a variable cost according
to amount of activity ; or sales rep. costs =salary + commission per amount of sales. Eg rent= rent +10%gross
revenue
RELEVANT RANGE
RELEVANT RANGE:
A limited level of activity under which costs are analysed as either fixed or variable,eg for production of 1-1000
units, over that another costing structure is used,or another range.
SELLING COSTS
SELLING COSTS :
relate to sales, written off in period incurred. Eg :commission costs,etc.
CONVERSION COSTS:
CONVERSION COSTS :
All costs other than Direct Material costs that are incurred in manufacturing a product.The word conversion is
normally associated with process costing and refers to all costs exept direct material directly related to the
manufacturing process.
ADMINISTRATION Costs:
Administration Costs: treated as a manufacturing overhead only if relate to work being carried out in mnftring
process – but in most instances they are written off as a period cost- not mnftr. Cost. Eg: cost of accountant=
period cost , cost of person who records all manufacturing processes number produced, materials used etc only
in mnftring = manftring admin cost .
HIGH-LOW COST ANALYSIS:
REFERS TO ANALYSIS OF SEMI-VARIABLE COSTS where the var. & fixed. Elements are calc. by analysing incr. in
cost in comparison to incr. in prod. Volume.
CONTRIBUTION:
CONTRIBUTION is the SELLING PRICE of a product LESS all VARIABLE COSTS.The term used by Management
accountants to describe the incremental profit that a company will make as the company sells one more unit of
production.(DOES NOT include FIXED COSTS, ONLY SELLING PRICE – VARIABLE COSTS = contribution, then after
that ,CONTRIBUTION-FIXED COSTS=NET LOSS/PROFIT.) Variable costs would include
selling,marketing,distribution costs etc,so ALLl variable costs,none are left out. Mngmn acc only concerned with
contribution,not profit since incr. sales = incr.contribution where fixed costs stay constant. Means ' Profit
contributed toward total profit of firm before fixed costs' so.This happens because fixed costs do not change , but
production volume does, so once all fixed costs have been paid by current production volume, any increase in
production volume above this results in a higher profit than before the fixed costs were paid for.Thus before fixed
profit is paid for , PART OF THE CONTRIBUTION goes to fixed costs, but after the fixed cost is paid for, ALL OF
THE CONTRIBUTION goes toward profit.
SALES
- Variable Costs
(incl.marketing,selling,distribution
ie: ALL.
= CONTRIBUTION
- Fixed Costs
= PROFIT
BUDGET:
A budget is a quantitative analysis of a plan or corporate action.It is intended that production/sales etc be co-
ordinated by various depts. to achieve expectations about future income/cash flows/fin pos , fin perf and
supportin plans.
“STANDARD HOURS PRODUCED”:
-“– is the time it takes to produce one product ,used as a common denominator to divide up costs into different
products.
“STANDARD PROFIT STATEMENT”:

This is an income statement , using pre-determined standard cost rates , showing what profit we can expect from
a given sales volume.The volume is usually estimated from known sales and production capacity, but could also
just mean the volume for the flexed budget, when using standard costing.
STATIC BUDGET
The plain original realistic budget for the year drawn up at beginning of year.
FLEXED BUDGET
Standard Budget : The budget the is drawn up using the ACTUAL sales VOLUME, but with the original costs
from the Original Budget, not the Actual Costs. This can then be compared to the actual Income statement to
see what the difference in each cost was once converted to the actual sales level.
BILL OF MATERIALS
A list of all the actual materials needed to manufacture a specific product. Does not include labour/overheads
etc. like the ‘Standard Cost Card.’
STANDARD COST CARD
Card with the costs of all the Inputs used to make 1 output product.(That should (actual) be used to produce a
product.)1 card is kept for each different product made. (-historical cost -not a goal type cost).Nowdays on
computer.
MORE DEFINITIONS
1.1. Indirect (common) fixed cost : applies to all products eg rent
1.2. Direct (avoidable) fixed costs : applies only to single 1 of many products.
1.3. Sales mix: the ratio to each other of the different products which are made eg 1: 5: 8
FORMULAS
1) Future Value FORMULA : FV= PV(1+i)n
a) Where FV= future value
b) PV= present value
c) I = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
d) n= number of years/periods
2) Present Value Formula : PV = FV/(1+i)n
3) PV of DEBT Formulas :There are 2 possible situations & formulas here:
a) For “Perpetuity Type ” Loan :PRESENT VALUE (PV) formula of Debt :
PV= Cash-Flow/Kd this is where the loan is indefinite/infinite with no repayment date specified. The answer is
not fixed- it changes if looked at from a PV or FV.
b) For “Repayment Time Specified ”Loan : (PV) formula of Debt : PV=
Cash-Flow
/(1+Kd)n here you must work out the PV with this formula for every year of the loan
individually, and then add up all the answers to get the total.- but you still only use the current market
interest rate for Kd.
c) Where
i) Cash-Flow = the FV – ie money that is to flow in the future- the Future Value =this is the interest in
Rands OR/AND the capital repayments that will be paid back in the future.
ii) Kd = the interest rate charged for debt- if tax is deductable then first deduct the tax % from the
rate before you use it. Interest After Tax = interest rate X [100% - tax rate% ]%. This Kd is the
current market value of debt , not at the actual interest rate actually being paid back by company, but
at the lowest you could get today instead- even if it is.
SHARES
a) STATIC DIVIDENDS FORMULA(no growth )
i) There are 2 Ways this can get calculated: depending on if the shares are to be held “for ever” or to be
“sold” after a specific time. The difference is for the “for ever” one it works similar to the ‘perpetuity’
formula = [ Do/Ke ] and the second works similar to the Present Value formula [ like =FV/(1+i) ]
(1) PERPETUITY Type FORMULA: where the share is to held for an indefinite period ie: ‘in perpetuity’.
Do
(a) Ex-Dividend formula: Value = /Ke X Number of shares : means
if the shareholder receives a dividend today that dividend is EXCLUDED
(b) Cum-Dividend formula: Value = Dividend + (Do/Ke X TOTAL
number of shares.) means if the shareholder receives a dividend today then that
dividend is INCLUDED in the calculation of value of share (you just add the dividend
to answer-simple)
(c) Remember: you can ALSO get the PV of an ANSWER from this formula if it only will
occour in eg 3 yrs time. : say that for the next 2 years the share price will fluctuate ( or grow
etc) but in 3 years time it will start to remain the same from there on- static. If you are looking
for the value of the share today, you must first calculate the PV of the next 2 years separately
using another method ( directly or using growth formula below etc.) THEN you can calculate the
value of the 3rd year onwards using the above formula and bring this to PV by substituting your
FV you got in the for it to bring it to PV. : ie: [Do/Ke] = FV , so PV today = [D0/Ke ] / (1+i)n ……
where we would use ‘Ke’ for ‘i’ here.!
(2) “TO BE SOLD “ Type PRESENT VALUE FORMULA : where the shares are to be sold after a specific
period of time :now it’s a PV calculation.
Do n
(a) Ex-Dividend formula: Value = /(1+Ke) X Number of shares :
means if the shareholder receives a dividend today that dividend is EXCLUDED You use
this formula once for each separate year to come, so for 3 years you must do the calc. 3 times
and add the answers up to get the total.
(b) Cum-Dividend formula: Value = Dividend + (Do/(1+Ke)n X

TOTAL number of shares.) means if the shareholder receives a dividend today
then that dividend is INCLUDED in the calculation of value of share (you just add the dividend
to answer-simple)
(c) Remember you could do the above calc. for years 3 & 4 but do years 1&2 with another
formula for eg.”growth” and just add the answers up to get the total.( say there was growth for
first 2 yrs then no growth for 2 yrs.)
b)GROWTH / FALLING DIVIDENDS (growth or getting less)
i) PERPETUITY Type FORMULA: where the share is to held for an indefinite period ie: ‘in perpetuity’. Do not use year
0 dividends, only end year 1
D1
(a) Ex-Dividend formula: Value = /Ke - g X Number of shares :
means if the shareholder receives a dividend today that dividend is EXCLUDED
(b) Cum-Dividend formula: if they ask for cum-dividend then (probably) just add the dividend
you are receiving to the answer per share.
ii) “TO BE SOLD “ Type PRESENT VALUE FORMULA : where the shares are to be sold after a specific period of
time :now it’s a PV calculation.
D1 n
(a) Ex-Dividend Formula : Value = /(1+Ke ) X Number of shares
: (ie cash flow/for this one you MUST work each year out separately using the PV formula
given here. To accommodate the growth (g) in dividends each year you cannot do it with the
formula, you must manually increase the dividends each year, then work out the Present Value
for each separate year using the above formula .THE SELLING PRICE AT THE END OF THE
PERIOD MUST BE INCLUDED IN THE final year PV calculation.(ie just add it to the final year
dividends and get the PV of the total, no need to do a separate calculation!)Then add all the
years up to get the present value of the shareholding.
(b) Cum-Dividend Formula: Cum-Dividend: probably just add the dividend you are receiving to
the answer
(c) Remember:you might have to work out the PV for only 2 years using this formula,
then switch to another formula if question says there will be no more growth from the
3rd year onward : that new answer then gets in turn brought to P.V.
iii)
2)Debt : Present value of debt:

1. There are 2 possible situations & formulas here:
a. For “Perpetuity Type ” Loan :PRESENT VALUE (PV) formula of
Debt : PV= Cash-Flow/Kd this is where the loan is indefinite/infinite with no repayment date
specified. The answer is not fixed- it changes if looked at from a PV or FV.
b. For “Repayment Time Specified ”Loan : (PV) formula of Debt :
PV= Cash-Flow/(1+Kd)n here you must work out the PV with this formula for every year of
the loan individually, and then add up all the answers to get the total.- but you still only use the
current market interest rate for Kd.
ANNUITY:
1) Future Value FORMULA for ORDINARY/DEFERRED/REGULAR ANNUITY. : FVa = I x
[ (1+i)n – 1 / i] (1+i)
a) I = Constant Amount invested each year
b) FVa = future value of the annuity.
c) i = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
2) Future Value FORMULA for ANNUITY DUE : FVa= I x [ {(1+i)n – 1 }/ i] (1+i)


3) Present Value FORMULA for Regular ANNUITY : PVa= I x [ {1 – 1/ (1+i)n } / i]

DO A SCAN)
b) PVa = present value of the annuity.
e) This is where the payments are at the end of the year.
4) Present Value FORMULA for ANNUITY DUE : PVa= I x [ ({1 – 1/ (1+i)n } / i) +

1]( DO A SCAN)
e) This one is where payments are at the beginning of the year.-annuity due.
LOAN: PERIODIC PAYMENT OF A LOAN

1) CHANGING the Present Value FORMULA for Regular ANNUITY to MAKE I THE SUBJECT
below:
a) PVa= I x [ {1 – 1/ (1+i)n } / i]
PVa
i) Becomes : I = / [ {1 – 1/ (1+i)n } / i]
PVa X i
ii) Or: I = / [ {1 – 1/ (1+i)n } / i] : this formula is easier to use than the one
above for manual calculations – the /I is just changed mathematicaly to go on top as “X PVa “
iii)Where:
(1) I = Constant Amount invested each year
(2) PVa = present value of the annuity.
(3) i = interest rate – in DECIMALS eg for 15% Use 0.15 NOT 15%
(4) n= number of years/periods
PERPETUITY:
1) A Perpetuity is a normal Annuity but with an infinite life.
2) You only work it out by using a special formula:
3) PRESENT VALUE of a PERPETUITY FORMULA : PVp= I/i
a) PVp = Present Value of a Perpetuity.
b) I = Constant Amount invested each year
d) This one is where payments are at the end of the year.- I think- it does not say in the book what it is.
Also it does not say what the formula for at begin of year (annuity due) is.
I
4) PRESENT VALUE of a -growing- PERPETUITY FORMULA : PVp= /i-g where g=
growth in decimals eg 0.08
MARKET VALUE OF A COMPANY:

1) The Market Value of a Company : there are 2 formuals :Formula 1: V0 = MVe +
MVd
a) The Market Value of a Company Formula : is simply the Market Value of Equity ( ie the PV valuation of
the shares) PLUS the Market Value OF all Debt (ie PV valuation of debt) ,these valuations of debt and
equity above must be done using the “FV of cash flows” at “current market rates” to get the Present Value
of all future cash flows.
2) The Market Value of a Company : there are 2 formulas :Formula 2 : V0 =

Y
/WACC = Dividends(Do) + DebtInterest Paid in Cash
/WACC (AFTER TAX)
MARKET VALUE OF CONVERTIBLE DEBENTURES OR

PREFERENCE SHARES.
1) The Valuation of Convertibles is carried out in 2 steps:
a) At the option date, compare the value of each option and choose the option with the highest value.
b) Calculate the value of future cash flows and the terminal value of the option chosen, back to year 0. (date
at which the you want to know the value – not date of option but date today)
2) If You Convert From One Type Of Security To Another, (Eg: Debentures To Shares, Or Pref. Shares
To Debentures). Use The Current Type’s Ke Or Kd To Bring The “Future Market Value Fv” At Date Of
Conversion To Todays Present value- NOT the Kd or Ke of what it will be when its converted. So: if you are
going to choose to convert to ordinary shares at the date of the option in say 3 years , from debentures , then
there is one complication : TO GET THE Present Value OF THE MARKET VALUE OF THE NEW ORDINARY
SHARES today in order to add it to the PV of any cash flows up to the date of conversion = Market Value of
DEBENTURES, TOU MUST USE THE DEBENTURE Kd (LESS TAX), AND NOT THE ORDINARY SHARE Ke at
which the FV market value of the shares were worked out
CHAPTER 1: INFORMATION FOR DECISION

MAKING :COST –VOLUME PROFIT ANALYSIS
CH. 8 IN DRURY BOOK
SPECIAL THINGS TO REMEMBER:
1. Know graphs, cvp assumptions,
2. NOTE: It is incorrect to unitize fixed costs since if fixed costs are 10000 for a period and 5000 in the next
period then unit profit will therefore not be constant over varying output levels due to absorbtion
costing/variable costing effect..
SP :Sales
les VC :(Variable costs)
s
CM :Contribution Margin
=
Les FC :(Fixed Cost)
s
OP :Operation Profit
=
Les Tax :(Taxation)
s
NP :Net Profit
=
3. Definitions:
3.1. Indirect (common) fixed cost : applies to all products eg rent
3.2. Direct (avoidable) fixed costs : applies only to single 1 of many products.
3.3. Sales mix: the ratio to each other of the different products which are made eg 1: 5: 8
ECONOMIST VS ACCOUNTANTS VIEW

1) The economists view is different from the accountants view for following reasons:
a) Economists view whole range of activity zero - end Accountants view only relevant range + short
run period where costs behave in a linear relationship.
b) Economists assume info.on price, cost, volume is available all levels activity , Accountants assume
limited availability of this info , and linearity over relevant range.
c) Economists view is EXPOSITIONAL , Accountants view is PRACTICAL.
2) Mathematical difference :
a) For economist there are 2 break-even points, for accountant there is 1 .
JUSTIFICATION FOR ACCOUNTANTS VIEW OVER ECON0MISTS:

1) Justification for accountants viewpoint as opposed to economists (exam question) = The accountants view is
only in the relevant range over a short-run period of time(<1year) .Thats why all graph lines are linear and
not curved.
2) Accountant assumes non-price competition.
ECONOMISTS VS ACCOUNTANTS COST-VOLUME-PROFIT

GRAPH :
ECONOMISTS GRAPH:
a) TOTAL REVENUE LINE IS CURVILINEAR : Firm cannot increase sales by holding selling price constant- thus
total revenue will be max where slope is zero(starts to fall as sales volume increase) or marginal revenue
from n'th sale = zero.
b) INCREASING AND DECREASING RETURNS TO SCALE :Costs at start (A-B) increase direct linear (normal
increase) then (B-C) as bulk buy discounts & division of labour, kicks in , costs level out (decrease ) then
(C- end) costs increase sharply again due to bottlenecks & production beyond normal capacity& production
beyond normal capacity & overly complex production schedules.
c) Note : there are 2 break –even points for econ. View. ,profit max where distance between cost/revenue
lines is greatest.
ACCOUNTANTS GRAPH.
i) CONSTANT FIXED COST LINE :Assumption that costs are constant in relevant range only
ii) CONSTANT VARIABLE COST & SELLING PRICE /UNIT: these 2 are also constant in relevant range –
because range is small.(sales increase from promotion etc)
iii) This is representative of a VARIABLE COSTING SYSTEM method.
C.V.P. ANALYSIS. (COST-VOLUME-

PROFIT.)
USES OF CVP ANALYSIS:
1. Powerful Tool used to provide answers on consequences of particular courses of action eg: ? many units to be
sold to break-even , effect on profit from reducing selling price and selling more units, ? should we pay
salespeople on commission or salary basis or both etc.
2. It is a systematic method of examining relationship between output(sales) and changes in sales
revenue/expenses/net profit.
ASSUMPTIONS OF CVP ANALYSIS:

1) CVP is a MODEL which simulates real world activity. Like most models it is subject to certain underlying
assumptions & limitations.
(1) All other variables remain constant (when you calc. change from another variable)
(2) A single product or constant sales mix exists.
(3) Total costs and and total revenue are linear functions of output.
(4) Profits are calc. on the variable (direct) costing basis. ( absorbtion costing can only be used if
production=sales for the period otherwise the fixed costs will get included in closing inventory and
not get charged as a period cost/ expense )
(5) Assumes a short term (normally 1 year) planning period –( ie inflation/ market changes/salary
changes/tax/prices do not change)
(6) Analysis applies to relevant range only
(7) Costs can be accurately divided between their fixed and variable elements.(this can be extremely
difficult in practice)
STANDARD FORMULA FOR CVP (WRITE DOWN ONCE IN EXAM- MAKES

THINGS EASY)
SR :Sales Revenue ( or use SP=selling price for

per unit calc. )
l VC :(Variable costs)
ess
CM :Contribution Margin
=
L FC :(Fixed Cost)
ess
OP :Operation Profit
=
L Tax :(Taxation)
ess
NP :Net Profit
=
FIXED COSTS:
1. NOTE: It is incorrect to unitize fixed costs since if fixed costs are 10000 for a period and 5000 in the next
period then unit profit will therefore not be constant over varying output levels.
2. Accountant assumes Step-Fixed costs with CVP analysis - per relevant range - which would be 1 step at a
time.
RELEVANT RANGE
1. The CVP model only applies to the “relevant range” ( short run period where costs behave in a linear
relationship.)that is being studied. Anything over or under that would be incorrect because of :
1.1. Restricted to period where output is restricted to that available from current operating capacity.- ie to
time where plant facilities cannot be expanded, or reduced.(both take a long time to effect.)
1.2. Outside This Range the unit selling cost as well as the variable cost are no longer deemed constant per
unit.
BREAK-EVEN ANALYSIS:
1. Calculation of break even :
1.1. Method 1 : Contribution margin approach :The number of units that must be sold to break even = Fixed
Costs / Contribution.
1.2. Method 2 : The break-even point is where ( [Selling price * Units Sold]- Net Profit) = (Fixed
Costs) + (Unit Variable Cost * Units Sold)
2.
TARGET PROFIT:
1. If a company requires a certain profit during a period- we must determine whether it is fixed or varies with
each unit sold. If profit required is fixed we treat it in same way as fixed cost – if variable we treat it in same
way as a variable cost. So you just add it to those costs and work out the ‘break-even’ point in units sold
(or in sales price if given a specific number of units to be sold) from there.
2. You can just use the Standard Formula(in heading above) for CVP and substitute in there to calc. it.
CONTRIBUTION :
CONTRIBUTION is the SELLING PRICE of a product LESS all VARIABLE COSTS. The term used by Management
accountants to describe the incremental profit that a company will make as the company sells one more unit of
production.(DOES NOT include FIXED COSTS, ONLY PRICE -less– VARIABLE COSTS = CONTRIBUTION, then
after that ,CONTRIBUTION-FIXED COSTS=NET LOSS/PROFIT.) Mngmn acc only concerned with
contribution,not profit since incr. sales = incr.contribution where fixed costs stay constant. Means ' contribution
contributed toward total profit of firm before fixed costs subtracted .This happens because fixed costs do not
change , but production volume does, so once all fixed costs have been paid by current production volume, any
increase in production volume above this results in a higher profit than before the fixed costs were paid for. Thus
before fixed profit is paid for , ALL OF THE CONTRIBUTION goes to fixed costs, but after the fixed cost is paid
for, ALL OF THE CONTRIBUTION goes toward profit.
Semi – variable costs : note these are not proper variable costs , they have a fixed cost component which must
first be removed using the high-low method., before you use them to calc. contribution.
OR Total Sales revenue

less Variable Costs
= CONTRIBUTION
less Fixed Costs
= PROFIT
Change in Variable Costs

(NOT change in UNITS)
Divided by Change in SALES VOLUME
= CONTRIBUTION per unit
MARGIN OF SAFETY:
a) Indicates by how much sales may decrease before a loss occurs.
b) Difference between : (Budgeted Sales Volume MINUS Break-Even Sales Volume)
c) Sometimes Expressed as % of Budgeted Volume or Budgeted Revenue.
d) Standard Formula : (Expected Sales – Break-Even Sales) / Expected Sales * x 100/1 = % answer
CHARTS/GRAPHS
BREAK-EVEN CHART USED AS A “CVP” ANALYSIS:
1. You must know how to construct these charts. Watch out for the units on side.(work it out before)
2. Notice: Rands on Y axis, Sales units on the x axis. ( this is the same in ALL graphs types done here)
COST –VOLUME –PROFIT CHART/DIAGRAM SHOWN IN A DIFFERENT WAY(VIGGARIO).

1) Simply draw a diagram as shown below detailing all totals shown with arrows/labels /units /zero/x&y axis etc
all marked.The prices/units are a bit difficult to get precise on graph-think carefully.
Cost-Volume Profit diagram
Sales Revenue
4055
Rands
Profit/Contribution
(Fixed +Variable) Costs
Fixed Costs
0
0 69925
Units
|____________|
Margin Of Safety.
A) LABELS:
i) "Margin of safety" (break-even point to selling price- write below the x-axis)
ii) "Variable costs" : arrow from fixed costs line up to var.costs line –labeled.
iii) "Fixed costs" : arrow from fixed costs line down to x –axis-labelled.
iv) "Revenue/sales"
v) "Total costs( fixed + variable costs)"
vi) "Break-even point"
vii) "Increase in profit /contribution"-arrow showing along Profit&Contribution Line +++ from break-even
point.
viii)"DECREASE in profit /contribution"-arrow showing back Profit&Contribution Line ---- from break-even
point.
ix) Loss area
x) Profit area
ALTERNATIVE PRESENTATION : CONTRIBUTION GRAPH USED AS A CVP CHART

1. TYhis is exactly the same as the above graph , exept here a variable cost line is added below the total cost
line.This MANAGES TO SHOW THE CONTRIBUTION AS THE DIFFERENCE BETWEEN THE vc LINE AND THE sr
LINE .( between variable cost line and Sales Revenue line) The fixed cost line can or cannot be left out- as one
would wish. Difference between variable cost line and total cost line = fixed cost.
ALTERNATIVE PRESENTATION : PROFIT –VOLUME GRAPH USED AS A CVP CHART

1. Notice that “rands” on the left is not “sales” like the other 2 graphs but “profits” !
2. Only 2 points are required to plot the profit line.
3. When units sold = 0 a loss equal to the fixed costs is incurred.
4. The break-even point is on the X axis- ie where profit is equal to zero (remember that it is profits & costs on
the left, not rands)
MULTI-PRODUCT CVP ANALYSIS

1. To apply the normal CVP analysis to many products at the same time.
2. Where there are many products each product has its own fixed costs called direct fixed costs (disappears if
product is dropped) and then all products together also have a single communal fixed cost called indirect or
common fixed costs , which cannot be avoided by just dropping 1 or 2 products-it must be paid.( eg rent)
3. There are a number of different methods , each for a different multi-product problem : the methods are the
following
3.1. Calc. Break- even point for multiple products: First calc. the product ‘sales mix’, this is the normal ratio
in which products are sold- eg 1 pen : 5 pencils. Then calc the total contribution for that sales mix : (add
1*pens contribution + 5* pencils contribution). Then calc [total fixed costs / total sales mix contribution]
= Break–Even units. Note: total fixed costs here means all direct fixed+ indirect fixed costs. Then don’t
forget to convert your answer to how many of each must be made ie:Ans.*1= xxx pens and
Ans.*5=xxxx pencils.
3.2. Use the average contribution per unit : if they ONLY give you the sales mix ratio & contribution to sales
percentage.; or some other tricky kind of question where you have to use the average contribution or
something.
3.3. Calc. break-even when unit costs are not given. : use : Fixed costs / PV Ratio = Break-Even Sales
Value ( PV ratio = total sales/total contribution)
4. Note: increase in proportion of sales of higher contribution margin product will decrease the break-even point
& visa-versa.
5.
CVP method of Manipulating Multi-Product Analysis
Pens Pencils
Sales Volume (units) 1200 600
Unit Selling Price 300 200
Unit Variable Cost 150 110
Unit Contribution 150 90
Total Sales Revenues 360000 120000 480000
LESS: total Variable costs 180000 66000 246000
Contribution (to 180000 54000 234000
Indirect+Direct costs)
LESS :direct (avoidable) fixed 90000 27000 117000
costs
= contribution to indirect 90000 27000 117000
fixed costs.
LESS: indirect(common) fixed 39000

costs.
=Operating profit 78000
THE USE OF COMPUTER APPLICATIONS

1. The output is as good as the input. There are applications developed which managers can use without waiting
for reports from man.acc.
2. Sensitivity Analysis: this is a technique where the result is calc. for how the scenario will change if the original
estimates change. Eg: if sales mix changes, fixed costs up by 10% & VARIABLE COSTS down by 5%.
SEMI-VARIABLE COSTS : SEPARATION OF FIXED –VARIABLE

1. Use the high-low method or statistical methods to do this.
2. Eg: maintenance is an example of a semi-variable cost: it has 2 components :planned maintenance = fixed
cost + activity level dependant variable element.
KEY RATIOS FOR CVP

(PV RATIO) PROFIT VOLUME RATIO: ( OR ALSO CALLED ‘CONTRIBUTION MARGIN %’ )
= Contribution / Sales. =0.abxy or ( * 100/1= ab.xy %) TO 4 decimal places OR to 2 decimal places
for %
PROFIT RATIO
=Profit / Sales =0.abcd or ( * 100/1= ab.cd %) TO 4 decimal places OR to 2 decimal places for %
(B/E SALES) BREAK-EVEN SALES REVENUE:( NOT A RATIO)

=Fixed Expenses / PV Ratio = Rands ,2 decimal cents.
REM: FIXED expenses is NEVER just the totals that do not change –it could also be in the
totals that do change -you must FIRST CHECK EVERY TOTAL eg: labour-MATERIALS-
OVERHEADS ETC FOR THE FIXED PART AND VAR. PART BEFORE you calc. the total fixed
costs.(ie watch out for semi-variable costs mixed up as fixed costs)
BREAK-EVEN SALES VOLUME:( NOT A RATIO)

=Fixed Expenses / Contribution per unit. = units (round- off unwards only –ie: per unit)
MARGIN OF SAFETY RATIO

Sales - (B\E Sales revenue) / Sales = =0.abcd or ( * 100/1= ab.cd %) TO 4 decimal places OR to 2
decimal places for % {sales means budget sales revenue. –but could also be actual... depends on needs)
OTHER TYPES:
1.1. contribution ratio or contribution margin % or ratio = marginal contribution/marginal sales
1.2. variable cost ratio = marginal variable costs / marginal sales
ABBREVIATIONS FOR RATIO’S ETC:

(1) FC -fixed costs
(2) VC -variable costs
(3) SP -selling price
(4) OP - operating profit = net profit before tax
(5) UCM -unit contribution margin IE: contribution per unit

(6) UVC -unit variable costs :the variable costs per unit.
(7) CM or ContM. – contribution margin
(8) USP -unit selling price : the selling price per unit
ANALYSIS OF COST STRUCTURE USING CVP PRINCIPLES : (OF A

COMPANY)
1. If sales ‘NUMBER OF UNITS’ not given –do the same ‘analysis spreadsheet’ but calculate ratios TO FIND
ANSWERS instead of using the per unit cost to calculate them:
1.1. ie: contribution ratio = marginal contribution/marginal sales
1.2. variable cost ratio = marginal variable costs / marginal sales
1.3. Use the var cost ratio to find fixed & var. costs from sales – then you can firn break-even sales volume
etc etc from here.
1.4. Use the contribution & var. cost ratios to also find increase in sales effect on contribution etc etc. IF NO
UNITS OF PRODUCTION ARE GIVEN
i) REM: if selling price goes up by 10% -you cannot just * profit by 10% to get new answer- because
fixed cost : var. cost ratio will stuff it up.You must first * ‘contribution’ by 10% then subtrACT fixed
costs to get new profit (esp if . it was a loss at first)
METHOD: FORMAT OF SPREADSHEET FOR: FULL YEAR FINAL ANALYSIS VIGGARIO PAGE 247
i. Simply divide costs up into a spreadsheet of 4 columns with totals at bottom(see where
to write names):
a. Names/itemised
b. all Variable costs PER UNIT/ea – Not Totals
c. All Fixed costs PER TOTALS – Not per Unit/ea.
d. Total column Per Item (multiply Variable cost column * Number sold
Then add Fixed Costs)
Name Variable per Unit Variable Cost Fixed Total (R) Initial (TO ILLUSTRATE
Totals figures from ONLY)
budget.
Units 100000 (TO ILLUSTRATE
units ONLY
(Put R here to split Note format!!!R Format!R R R Note (TO ILLUSTRATE
lines) ONLY
FORMAT:
Sales 58(see calc.below) 5800000 5800000 (to illustrate) (TO ILLUSTRATE
ONLY
Mnftr Costs: (to illustrate) (TO ILLUSTRATE
ONLY
Direct materials (20) 2000000 2000000 2000000 Only var
Labour Costs (8) 800000 200000 1000000 1000000 80% variable
Overhead Costs (2) 200000 300000 500000 500000 40% variable
Non-Mnft Costs
Rent 400000 400000 400000 fixed
Accounting 200000 200000 200000 Fixed
Marketing (1.2) 120000 180000 300000 300000 40% var
Salaries 500000 500000 500000 Fixed
Other Costs (0.2) 20000 80000 100000 100000 40% var.with
prod.units.
(to illustrate)
CONTRIBUTION 26.6(=sales-all var 2660000 (to illustrate) (TO ILLUSTRATE
costs) ONLY
FIXED COSTS NOTE ABOVE 1860000 (to illustrate) (TO ILLUSTRATE
ONLY
PROFIT 800000 (to illustrate) (TO ILLUSTRATE

ONLY
II )METHOD: fORMAT OF SPREADSHEET FOR: Pre-Calculations of Variable & Fixed Costs from multiple years
figures.
Name Variable per Unit Variable Cost Fixed Total (R) Initial (TO ILLUSTRATE
Totals figures from ONLY)
budget.
Units 100000 (TO ILLUSTRATE
units ONLY
Note format!!!R Format!R R R Note (TO ILLUSTRATE
FORMAT: ONLY
Sales 58(see calc.below) 5800000 5800000 (to illustrate) (TO ILLUSTRATE
ONLY
Mnftr Costs: (to illustrate) (TO ILLUSTRATE
ONLY
Direct (20) 2000000 2000000 2000000 Only var
materials
Labour Costs (8) 800000 200000 1000000 1000000 80% variable
Overhead Costs (2) 200000 300000 500000 500000 40% variable
Non-Mnft Costs
Rent 400000 400000 400000 fixed
Accounting 200000 200000 200000 Fixed
Marketing (1.2) 120000 180000 300000 300000 40% var
Salaries 500000 500000 500000 Fixed
Other Costs (0.2) 20000 80000 100000 100000 40% var.with
prod.units.
(to illustrate)
CONTRIBUTIO 26.6(=sales-all 2660000 (to illustrate) (TO ILLUSTRATE
N costs) ONLY
FIXED COSTS NOTE ABOVE 1860000 (to illustrate) (TO ILLUSTRATE
ONLY
PROFIT 800000 (to illustrate) (TO ILLUSTRATE
ONLY
INCOME STATEMENT (OR BUDGET) SHOWING CONTRIBUTION

SEPARATELY.
INCOME STATEMENT OF XYZ FOR PERIOD 123 R
Sales(Revenue) 58000000
Variable Costs: Total Var.
Direct materials Xxx
Labour costs Xxx
Overhead costs Xxx
Marketing –variable costs Xxx
Other –variable costs Xxx
Contribution: = (sales – variable 2660000
costs)
Fixed Costs: Total Fixed
Marketing- non-variable costs xxx
Other costs – non-variable costs xxx
Rent xxx
Accounting xxx
Etc xxx
Profit/Loss =(contribution – fixed 800000
costs)
INCOME STATEMENT SHOWING MANUFACTURING COSTS

SEPARATELY (OR ALSO CALLED INCOME &EXPENDITURE
STATEMENT SHOWING...)
1.1.1.Normal inc. Stat just you can show "Manufacturing Costs" under "Cost of sales" breakdown as a
heading and Manufacturing Profit as Gross profit instead. The rest can go under NON-Manufacturing
costs and Profit / Loss at the bottom.
INCOME STATEMENT OF XYZ FOR R

PERIOD 123
Sales(Revenue) 58000000
Cost of Sales Xxx
Manufacturing Costs Blank
Labour costs Xxx
Overhead costs Xxx
Direct Material Xxx
Other –costs Xxx
Less : Closing Inventory Xxx
Manufacturing profit Xxx
Non-Manufacturing Costs Blank
Marketing- Xxx
Other costs Xxx
Rent Xxx
Profit/Loss 800000
CHAPTER 2 (11) RELEVANT COSTS

SPECIAL NOTES:
1) GENERAL NOTES:
1. Question: explain the misconceptions relating to relevant costs&revenues = 1-var.costs are not always
relevant,they can be irrelevant if they are the same for both choices,2-fixed costs are not always irrelevant,
they can be relevant if they are different for both choices.
1) DETERMINING THE RELEVANT COSTS OF DIRECT MATERIALS
1. Where materials are taken from stock the original purchase price of the materials is a sunk cost , and only the
replacement cost of the materials should be taken into consideration when making decisions.
2. BUT if the materials have no value – useless exept for that 1 activity- then their relevant cost will be zero.
2) DETERMINING THE RELEVANT COSTS OF DIRECT LABOUR
1. Direct labour can be a relvant or irrelevant cost – casual = relevant , full time cannot fire = irrelevant over
short term, but relevant over the long term. If there is other work to be done = contribution opportunity cost
+ hourly labour rate etc etc, each case is different,on its own basis.
3) DO NOT COMPARE UNIT COSTS, THERE IS THE DANGER THAT FIXED COSTS WILL BE
UNITIZED AND TREATED AS VARIABLE COSTS. IN MOST CASES ONE SHOULD COMPARE TOTAL
AMOUNTS OF REVENUE & COSTS RATHER THAN UNIT COSTS.(PER TEXTBOOK VERTABIM)
1. Students have a problem with presenting info. clearly. DO put same cost down for each alternative next to
each other in columns. Common fixed costs should never be allocated to the alternatives( the exam marker
will have different figures there –leave it out)
CONTEXT OF RELEVANT COSTS:

1) Management accounting is primarily concerned with producing budgets, setting performance standards, and
evaluating performance.
2) Relevant costs Requires an understanding of:
1) Special Orders: A special order is one that will not affect a companies current sales to its regular
customers (often as an export). It is usually sold at below full cost – by using contribution to work out an
extra low price, because overheads are covered by sales to normal customers. { {Note : Be careful : even
doing this for export can cause the goods to re-appear on the local market at lower price than you usually
even sell at.}
a) 2 Alternative Decisions: is about comparing a capital–intensive business to a labour intensive-business.
b) Limiting Factors: always look out for when assessing any exam question: eg: production bottlenecks/raw
material supply problems ie:quotas.
TERMS:
1) Relevant Cost:
i) a future cash flow arising as a direct consequence of the decision under review.-ONLY RELEVANT
COSTS should be considered in decision making , because it is assumed that in the long run future
profits would be maximized if the ‘cash profits’ of the company, ie: the cash earned from sales minus
the cash expenditures incurred to sell the goods, are also maximized.
ii) COSTS WHICH ARE NOT RELEVANT INCLUDE:
(1) Past sunk costs, or money already spent.
(2) Future spending already committed by separate decisions.
(3) Costs which are not of a cash nature eg: depreciation
(4) Absorbed overheads (only cash overheads incurred are relevant to a decision)
iii) The relevant cost of a unit of production is usually the variable cost of that unit plus (or minus) any
change in the total expenditure of fixed costs.
2) Differential cost /cash flow

a) A differential cost is the difference in cost of alternative choices. If Option A costs an extra R300 Option B
costs an extra R360, the cost differential is R60, with Option B being more expensive. A differential cost is
the difference between the relevant costs of each option.
3) Incremental cost / cash flow
a) The differential cost of an extra unit of production is the extra cost required to make that unit, ie it is the
difference in cost between making the unit and not making it. This type of cost is also called incremental
cost. Incremental costs are relevant costs.(can also be used as another way of saying differential
costs in some books- not marginal per unit - so it could mean plain differential costs in some questions,
you cannot be sure)
4) Opportunity cost
a) An opportunity cost is the benefit foregone by selecting one alternative in preference to the most
profitable alternative. If, for example, a company is currently making a cash-flow of R100 000 from the
use of a machine and it now has an opportunity of investing in a new machine, the choices are:
i) Continue with the existing machine
ii) Replace with the new machine
iii) Sell existing machine (opportunity cost)
5) Sunk costs
a) A sunk cost in decision-making terms is a past expenditure incurred as a result of past decisions, which
the Present Decision about a specific problem will not change , nothing can be done about it -it is gone
and past:
i) It could have been charged as a cost of sale in a previous accounting period, OR Will be charged in
a future accounting period, although the expenditure has already been incurred (or the expenditure
decision irrevocably taken). An example of this type of cost is depreciation. if the fixed asset has been
purchased, depreciation may be charged for several years but the cost is a sunk cost about which
nothing can now be done. Or Eg: if you want to decide between travelling by train or car, say you
decide to keep the car no matter what your decision, then the car of car licence and insurance is
irrelevant , only petrol and train ticket is relevant , the licence&insurance is a sunk cost.
6) Special Studies : decisions that are not routinely made at frequent intervals.
7) Decision making problem - either adding a new product or make or buy decision or special orders etc
each one is a problem for making a financial decision
8) Decision relevant approach : used to describe the specific costs and benefits that should be reported for
special studies ie what is relevant and what is not
9) Qualitative factors : those factors which cannot be expressed in monetary terms are classified as
qualitative factors- eg if you close a division down then the employee moral that you might loose is a
qualitative factor. It does count a lot, and must still be taken into Account, but cannot be measured
accurately.( eg *customer satisfaction* from better quality control OR more on time deliveries from new
production process causes better *customer satisfaction*)
10)Production Point Of Indifference: ie where the total cost of a capital-intensive company = the total cost of
a labour-intensive company
11)Optimized production technology: new method of reducing bottlenecks & increase production- see notes
12)Theory of constraints :new method of reducing bottlenecks & increase production- see notes
13)Throughput accounting: new method of reducing bottlenecks & increase production- see notes
14)
METHOD OF RELEVANT COST DECISIONS:

1. The relevant costing decisions could be over any time-horizon the decision maker wants, but generally we
concentrate less on short term and because the objective is generally to increase long–term net cash inflows.
2. The following types of Special Studies involving relevant costs are dealt with in this chapter as an introduction
to relevant costing:
2.1. Adding a new product
2.2. Decisions on replacement of equipment
2.3. Discontinuation decisions (dropping a product or division)
2.4. Outsourcing (make or buy)decisions
2.5. Special selling price decisions (SPECIAL ORDERS)
2.6. Product –mix decisions when capacity constraints exist
1) ADDING A NEW PRODUCT

Following factors are to be considered: 1- working capital :cash to be invested in stock and debtors , as well as 2-
incremental admin.costs, 3-advertising ,4-incremental marketing costs, etc.
2)DECISIONS ON REPLACEMENT OF OLD EQUIPMENT- THE

IRRELEVANCE OF PAST COSTS
1. To make this decision you might have to take into account : depreciation on both machines , new cost (an
expense), old selling value(an income),higher variable costs on old etc etc. See scanned example below for
setout method for a solution.
3) DISCONTINUATION DECISIONS : (DROPPING A PRODUCT OR DIVISION)

1) Following factors are to be considered:
i) Production capacity taken up by product :
(1) Under-utilisation condition of capacity : if it at least contributes to fixed costs it should not be
dropped.
(2) Operating At Full Capacity: strong consideration should be given to an alternative product if it has
a higher ‘Contribution’ .
ii) Long term prospects for recovery of demand
iii) Market competition
iv) The cash break-even point /CHART
(1) The cash break-even point is only a short term solution where the long term prospects for recovery
are good.
(2) Where the CVP chart shows the profit break even point below which a company is said to be
making a loss,
(3) the CASH BREAK-EVEN CHART is an analysis based on the receivable cash from sales minus the
outflow of all cash payable.It ignores all NON-CASH OUTLAYS and takes account of time lags in
accounts receivable and payable. Eg depreciation could make a difference between the 2 chart
types. So if cash outflows are low the company could SAFELY continue to operate at a financial
actual loss without big risk of INSOLVENCY.
v) NOTE :
(1) “Cause and Effect Allocation” : means the thing it is apportioned to causes its cost, if that thing is
discontinued the cost is GONE-taken away-less. It is a RELEVANT cost.
(2) “Arbitrary Apportionments” : this is not a relevant cost, it means it is the departments share of the
‘fixed costs’ basicly.- it will have to be paid anyway. (eg rent) arbitrary seems to mean ‘sundries’
4) OUTSOURCING (MAKE OR BUY DECISION)

1) Includes outsourcing a service (eg: IT Dept functions. )
2) Method: ALLWAYS work out the COST of each alternative separately in 1 column. So ‘extra income’ (would
REDUCE costs(brackets) and costs would be the positive(no brackets) + figures. Then compare the total of
each column to see which is LOWEST costs!
3) IQualitative as well as Quantitative aspects must be considered:
a) QUALITATIVE ASPECTS:
i) Consideration of competitiors economies of scale
ii) Consideration of inhibited future expansion due to the tying up of available capacity.
iii) Reduction in dependence on outside supplier
iv) Internal quality control, rather than relying on outside companies quality control dept.
v) Risk of destroying long term relationships with suppliers which may prove to be harmful and disruptive.
vi) Technology change often makes internal production more costly than purchasing from outside.
b) QUANTITATIVE ASPECTS :
i) This means the Actual numbers involved : see example below.
c) Note: in example below in Section B there are 3 choices, not just 1.
5) SPECIAL SELLING PRICE DECISIONS (SPECIAL ORDERS)

1) In This case, a product is sold at less than its cost price (or far less than normal price) as a special once off
order- the logic behind it is the fixed overheads portion of its cost price will remain the same to company
whether it is made or not, so it is an irrelevant cost and can be left out. So the order is only evaluated on
whether the variable costs – ie: the relevant costs- will be covered and still make a profit.
2) A special order is one that will not affect a companies current sales to its regular customers (often as an
export). It is usually sold at below full cost – by using contribution to work out an extra low price, because
overheads are covered by sales to normal customers. {Note : Be careful : even doing this for export can
cause the goods to re-appear on the local market at lower price than you usually even sell at.}
3) The following aspects must be considered for special orders:
a) The effect of selling at lower prices to use excess capacity: the buyer might undersell you to your normal
customers.
b) One might have to use normal customers capacity to fulfill a large order and loose normal sales.
c) Also be careful if you do too many of theses orders because then costs which were fixed in the short
term(for 1 special order) will suddenly start going up from all the extras that go into doing a special order(
eg set up time/complication break downs etc etc)
d) Competitors may engage in similar practices which may then start the market price falling which would
lead to a price war.
e) The special order may be packaged in a different brand so as not to compete with the normal sales, or sold
on a foreign market.
f) Price must cover variable costs, special shipping& production costs and some contribution.
g) For a short term order , direct labour&fixed costs are likely to be irrelevant costs –they wont change
quickly- but over a long term they are likely to be relevant. So in the long compared to the short term you
will probably have to deduct rent saved, labour saved, overheads saved, as well etc etc. Remember , if
there will be additional income from NOT doing the special order eg: from renting out part of the factory
to others, then this goes separate at the bottom , below all costs , and you add it separately. (when you
arrange everything in columns)
h) Opportunity cost of tying up the plant must be considered.
i) Effect on commissions paid to company staff.
j) Accommodation of sales to existing customers
k) Future long term contracts from company requesting a special order price.
l) Market factors: how will the special order affect our competitiors attitude to pricing.
4) To present the difference between the profit if you take the job and the profit if you don’t take the job you can
do it in 3 ways:
a) In 2 columns only show the Relevant costs &income for if you leave it in 1 column and if you take it in the
other
b) Or in 2 columns show relevant&irrelevant costs & income for both options in each column
c) Or in 1 column only show the differential costs & income(difference between taking & leaving the job)
5) Example:
6) PRODUCT MIX DECISIONS WHERE CAPACITY CONSTRAINTS

EXIST.(IMPORTANT : USING THE RELEVANT COSTING DECISION MODEL AS AN AID IN CHOOSING AMOUNG COMPETING
ALTERNATIVES.)
1) Remember when you work out a no. of products,round off DOWN. Ie: as 3.7 of product A : you bring this
down to 3 : because you normally cannot produce the extra o.3 with limited resources, you must usually bring
it down to the number below, not above.
2) Type 1 :Contribution per Limiting factors: with these, profit is maximized where the greatest contribution
to profit is achieved per limiting factor
a) The ”Contribution” per limiting factor could be measured by limiting factor eg: machine hours / material
available /labour hours etc.
3) Type 2 :DIFFERENTIAL Contribution PER LIMITING FACTOR: When there is a comparison between 2
contributions eg: for importing or producing localy, which to produce more of &which a bit less AS WELL as a
limiting factor like only a certain amount of raw materials available–so here First minus contribution no.1 from
no.2 , then with this new ‘differential contribution’ , if there is still a problem left with raw material usage, you
go and work out the ‘differential contribution’ per limiting factor ie per kg raw material used for each
‘differential contribution’– then you find the greatest differential contributing factor per limiting factor, and
choose that one.
4) LABOUR VS CAPITAL INTENSIVE EVALUATION: To Evaluate by Normal Method:
a) first calc. the fixed costs, then evaluate how long it will take to break even.
b) Next calc. indifference point: fixed+variable x X = fixed + variable x X.
c) Draw a graph to see which is more profitable ABOVE the indifference point.
d) To evaluate a decision with limiting factors, choose the one which maximizes profit on the basis of
contribution per limiting factor.
5) LIMITING FACTORS EVALUATION: How To Evaluate Management Accounting Information For All
Questions And In Particular Where There Is A Limiting Factor
a) Step1-5 Simplified: 1-sort variable/fixed costs+ work out totals.2-do contribution VS limiting
factors(bottlenecks).
Step 1
Sort out the information given by evaluating fixed costs and variable costs, both budget and actual. Virtually
all questions require an analysis of the cost structure. Have headings, eg fixed costs, variable costs, high /
low, absorption costing, variable costing. You will invariably be given information on a variable costing or
absorption costing basis that requires you to sift through the information and show the costs as variable costs
or fixed costs.
Step 2
Identify maximum production capacity for machinery or labour and show whether there is a limiting factor.
Headings should read “Potential limiting factor — machine hours”, (or labour hours or material, etc). You must
also conclude whether there is a limiting factor for each cost analysed.
Step 3
When there is a limiting factor, you must determine the contribution per unit, followed by the cost per limiting
factor.
Step 4
Do the budget.
Step 5
Evaluate possible alternative information that may change the contribution per unit determined in Step 3
above.
NOTE :EXAMPLE OF CONTRIBUTION PER LIMITING FACTOR WHERE BUYING IN IS A PROBLEM.

This is often a problem for students . Where there is an option to buy in , the correct method is to calc. the
contribution per limiting factor.Method is shown here:
6) 2 Alternative Decisions: is about comparing a capital–intensive business to a labour intensive-business.

7) When evaluating a business decision or when answering an examination question that requires an opinion on
how a business should be structured you should consider the following:
a) BUSINESS COST STRUCTURE
Business is about maximising contribution and minimising ‘overheads’.The goal should be lower fixed costs to
be able to generate a positive contribution or profit faster.When starting a company it is therefore better to
start small and not ‘too flashy’ in order to minimise the fixed costs. If the business does not work, your losses
will be restricted to the fixed costs. Low fixed costs, however, tend to go hand in hand with high variable
costs. The contribution per unit for new companies will normally tend to be relatively low.
b) FIRST MILESTONE
The first objective of a business should be to break even. If a company cannot break even in the short to
medium-term, it is probably a bad investment. You should therefore always determine the break even point
and the margin of safety. Companies with a low fixed cost structure or low overheads be less risky than
companies with high fixed costs. In an examination question asking for advice how a company is performing,
focus your answer on an analysis of the companies cost structure, ie its fixed costs and contribution per unit.
c) MEDIUM /LONG TERM OBJECTIVE:
Once a company has established itself and has passed the break-even point, the company will look to
changing its cost structure so that the contribution per unit increases. Invariably, this means moving from a
‘low fixed cost, high variable cost’ cost structure to a ‘high fixed cost, low variable cost’ cost structure. It
therefore becomes important at this point to determine the Production Point Of Indifference, ie where the
total cost of a capital-intensive company = the total cost of a labour-intensive company
d) LONG-TERM OBJECTIVE
The long-term objective should be to maximise return on investment. Companies should therefore aim at
increasing sales and reducing variable costs. In the long-term, a company will aim at minimising the variable
costs of production, and therefore maximise contribution. Targeting fixed costs is counter-productive. Fixed
costs are the engine-room of the company and represent the manufacturing assets that generate sales profit.
If the overheads are too high, it is because the sales are too low. Target sales, and the costs will look after
themselves. Most companies, when faced with difficult times, tend to target fixed costs such as salaries and
the infrastructure of the company, which often leads to a slow death. It is better to target variable costs which
will increase contribution and sales rather than a cost reduction. Always focus on sales.
THE THEORY OF CONSTRAINTS AND THROUGHPUT ACCOUNTING (TOC)
1. 1980’s Goldratt & Cox started “optimized production technology.(OPT)” The theory behind this new approach
was called “The theory of constraints and throughput technology (TOC) “ this approach identifies bottlenecks
and fixes them or makes sure they are fully utilized at all times.Also non-bottleneck stations should only
produce what the bottleneck can handle so as not to increase inventory too much.
2. The difference to normal relevant costing(contribution type) is that throughput accounting is more short term
orientated abd assumes that direct labour and var. overheads cannot be avoided within the short term. (it
tries to jack up production instead of the usual Man. Acc. method of cutting costs and bringing down
production volume somehow in the process)
3. The process involves 5 steps:
3.1. Identify the systems bottlenecks
3.2. Describe how to exploit the bottlenecks
3.3. Subordinate everything else to the decision in step 2
3.4. Elevate the systems bottlenecks (means elevate it to Non-bottleneck status by eg :buy a new machine so
botttleneck goes away,and so another station becomes the new bottleneck)
3.5. If in the previous step a bottleneck has been broken go back to step 1
4. three key measures are used here:
4.1. Throughput contribution :rate at which the system generates profits through sales-defined as sales less
direct materials
4.2. Investments(inventory) :inventories+R&D costs +costs of buildings and equipment
4.3. Other operational expenses : all operating costs incurred to earn ‘throughput contribution’ except direct
materials.
5. The priority orientation is :
5.1. Throughput is given first priority (increase, not reduce)
5.2. Inventories second (reduce , not increase)
5.3. Operational expenses last (decrease)
6. It adopts a short-term time horizon & regards all operating expenses as fixed, exept direct materials.This
implies that variable costing be used for all calcs.
7. Basically you just use the method of ‘maximizing contribution per limiting factor’ as far as bottlenecks go.
8. Galloway&Waldron (1988) devised ‘Throughput Accounting”: to apply the TOC effectively : they developed the
TARatio.it is just a restatement of contribution per limiting factor. The product with the highest TA Ratio wins.
9. TA Ratio = Return per factory output/cost per factory hr.
9.1. Where “return per factory hr”= (Sales Price-Material Cost )/ Cost per factory hr
9.2. And “ Cost per factory hr” = total factory cost/total time available on key resource
9.3. NOTE : sales less direct material = “throughput contribution” from above
9.3.1.AND return per factory hour is same as contribution per most limiting factor
9.3.2.AND total factory cost= “other operational expenses” above
a) EXAMPLE: NOTE: the examples below are very simple, to get the idea of all the angles, incl.
multiple limiting factors at the same time where you must use ‘linear programming’ to solve it,
you must go through examples in the book.
The example below evaluates two production options, high fixed costs, low variable costs vs. the option of low
fixed costs and high variable costs. In examinations, you must focus on the overall discussion.
1- Effects of different cost structure

2 -Break-even point
3 -Point of indifference
4 -Long-term cost structure
EXAMPLE B: A BIT MORE DIFFICULT: CHOOSE BETWEEN 1-IMPORTING & 2-LIMITING FACTOR.
CH 23 COST ESTIMATION AND COST

BEHAVIOUR
1) SPECIAL THINGS TO REMEMBER:
1. Be careful where the a set of cost data does not necessarily show the real relationship because it is over a
certain timeframe or other factors.
2) TERMS
1. Cost Driver or Activity Measure : Any factor whose change causes a change in the total cost of the activity
eg direct labour hours / machine hours / units of output / no of production run setups.
2. Semi-Variable costs :have a fixed and a variable component which must be separated for accounting
processes. –
3. Cost function: refers to a regression equation that describes the relationship between a dependant variable
and an independent variable.
1. Coefficient of variation / or of determination : r2 is a ‘goodness of fit’ measure. It is always a number
between 0-1 , and shows the % of the data that is precisely explained by the regression line you are using
to show the data as a straight line.
1.1. So if r2 = 0.82 it means 82% of the data fits the line , the rest can be explained either by random
variation or ‘random variation plus the combined effect that other omitted explanatory variables
have on the dependant variable.(meaning it might either have more than 1 cost driver, not just one ,
affecting this number ; or there are just a lot of outliers .)
1. Correlation Coefficient : r It measures the degree of association between 2 variables. When you square it
ie: r X r , then you get the coefficient of variation. this latter is what you use to judge your answer. The
following formula just gives you the answer to r, then you must still square it to get r2.
2. Steady state production levels: where no further improvement on the learning curve takes place – ie the
time taken stays the same each time.
3. Cumulative average learning time : the average per unit , of all the units up to now , eg the first 8 , or
first 16 etc.
3) GENERAL: :
1. Semi-Variable costs have a fixed and a variable component which must be separated for mant accounting
processes eg CVP analysis/ variable costing etc. Often for semi –variable costs all that is available is the cost
of the activity and the measure of the usage- nothing else on what part is fixed or variable. The following
tecniques were developed to calculate this.
2. Examples of semi – variable costs :
2.1. NORMAL : EG : 1-maintenance has a fixed part ( planned maintenance) and A variable part (related to
activity level –breakdowns , oiling etc.) 2- Depreciation – some types can be variable ,if asset value
declines in proportion to usage, other are fixed- eg straight line method; so to separate the 2 if added
together
2.2. TIME DEPENDANT : eg maintence staff salaries are fixed in short term, but in long term related to activity
level- the more activity the more staff are needed eventually.
4) MATHEMATICAL PRINCIPLES APPLYING TO COST

ESTIMATION METHODS:
1. Dependant Variable : cost , usually on the x axis
2. Independent Variable : activity , usually on the y axis
3. Regression equation : identifies the estimated relationship between a dependant & one or more
independent variables. :
3.1. Y= a + bx
3.1.1.Where b= slope (or variable cost per unit)
3.1.2.a = y intercept .
3.1.3.x = cost driver eg number of units or machine hours.
4. Cost Function: regression equation about costs, from past cost data.
5.
5)COST ESTIMATION METHODS:

1. There are 5 +1 methods used here; they are not mutually exclusive and different methods can be used for
different cost categories the bottom method is used to test if you got the right answer.:
1.1. Engineering methods
1.2. Inspection of accounts method
1.3. Graphical or scattergraph method
1.4. High-low method
1.5. Least squares method
1-ENGINEERING METHODS
1. Based on engineering analysis of tech relationship between inputs & outputs eg :Time&Motion studies ; Work
sampling, Methods study.
2. You basicly do a direct observation of the physical qty needed for an activity. Suited to engineers on a
production line making estimates of what the exact costs are.
3. Cannot be used for separating semi-variable costs into fixed & variable. – if one can not directly observe and
record.
2-INSPECTION OF ACCOUNTS METHOD
1. This method involves arbitrary individual judgements on the cost info. It is usually based on the latest cost
info. and does not necessarily portray the true character of the costs. It is not suited for analyzing large sums
of money that are sensitive to measurement errors.
2. Method : the accountant & dept. manager sit down and decide which costs are fixed, which variable, and
which semi-variable. Then they estimate by rule of thumb how much of the semi-variable costs are fixed &
how much variable.
2.1. Y= A + bx : Then the fixed part of the semi-variable costs become the A(y
interept). The variable cost part is the b. And the cost driver eg no. of units
or machine hours is the x.
3-GRAPHICAL OR SCATTERGRAPH METHOD
1. You plot all the costs on the Y axis and all the activity levels on the X axis- . Then you visually try and draw a
line through the points to get the regression line .(you just plot as they come, does not matter which is first or
second. Then try to draw a line through resultant mess )
1.1. Y= A + bx From this line you derive the Y intercept and b slope: Y= A + bx, where the variable costs
would be slope ‘b” and then the cost driver eg no. of units or machine hours is the x. .
1.2. It is a very subjective method and not very accurate- as to where the line is drawn . It is better to do it
mathematicly.
4-HIGH-LOW METHOD
1. This method cannot be recommended because it relies on the highest & lowest numbers , which are normally
very likely to be abnormal measurements. – also it only uses 2 points on the line – not all the data.
METHOD: identification of fixed & variable components.
Warning 1: You ONLY EVER calculate the TOTAL FIXED COSTS spent per period , NEVER the per unit fixed
cost for any calculations with the high low method- OR you will definitely get wrong answers!!!!
Warning 2 :ALLWAYS USE THE ACTIVITY LEVEL (COST DRIVER) to choose the high&low values- not the
costs.
1) This is a very simple method, and not very accurate because only 2 values are used, not all the values like
some other mathematical methods.Very commonly well known method.Managers sometimes use very simple
methods to estimate cost functions-
2) The high / low method is used where MULTIPLE cost differences are given for MULTIPLE LEVELS OF
PRODUCTION eg: values at 100,300,500,700 etc etc -not where just 2 levels are given eg:at 30 units and
100 units, as in previous Standard Method & example.
3) – METHOD: Simply Take the HIGHEST and LOWEST values of the COST DRIVER (some books use costs
instead)(eg:a cost driver is = total.units -NOT total.cost- ) and use these as the 2 different values , then carry
on as in Normal Standard method above.–ie subtract low from high and carry on as in Normal Standard
method above.
4) Note ‘units produced’ or any other cost driver could also be used as the COST DRIVER in a high-low method ,
to calculate any similar type of exercise , it does not have to be ‘units produced’.
5) Cost function is y=a+bX ,so variable= slope=b. Any of high or low can be used to compute constant from here
('because both equations are linear with 2 unknowns-slope+constant-as per book' !). So fixed is =a ,and X = cost driver eg
machine hours or units produced.
6) PROBLEMS WITH HIGH/LOW METHOD.:
a) Highest & Lowest values may not be representative of entire population.
b) The 2 values may be outliers(extremes – not part of average).
c) Ignores all other values (not like regression analysis,which dos'nt)
7) Only works in relevant range(eg: minimum wage for performance based pay for production causes a 'range')
THIS method only works in IN RELEVANT RANGE – not out of rel. range .eg:idle plant. One CANNOT use a
value that came from an idle plant where it is exceptionally low , because this will not be an accurate value to
base a calculation on-_ie there was no real production taking place.So it would be wise in real life to also
check the line on the graph of the plotted values of all values given to choose from, and look for outliers or
stepped fixed costs or relevant ranges before using high-low method NOTE: sometimes another 2 values are
chosen which are more representative if managment suspects outliers/non-representative BUT for exam ,
unless specifically mentioned, just use the highest and lowest values.
COST BUDGET
MARGINAL (Differential Units VARIABLE Per Unit Costs
=A-minus-B) (Tot. Price/Tot.Units= change per
unit)
UNITS produced: 60000 80000 80000-60000= 20000 .
R R R R R
Direct Materials 600000 800000 =(800000-600000)=200000 200000/20000=R10 per unit
Labour 400000 500000 =500000-400000=100000 100000/20000=R5 per unit
Production Overheads 380000 440000 =440000-380000=60000 60000/20000= R3 per unit
Rent 120000 120000 0 0/0=0 per unit
Power 200000 260000 =60000 60000/ 20000=R3 per unit
ANSWER Cont. TO SHOW THE FIXED COSTS AS WELL you basicly now do a Full analysis of costs worksheet for CVP
Units Variable Unit Total Cost LESS variable costs at Per Unit Fixed Costs
Cost(from that level(use any level-say 60000)
above) Remember: FIXED costs cannot be
worked out for a PER UNIT basis–
only as a “total value” per relevant
range
Direct Materials R10 600000 –(60000*10)= 0
Labour R5 100000
400000 –(60000 * 5)
Production Overheads R3 380000 –(60000 * 3) 200000
Rent R0 120000-(60000 *0) 120000
Power R3 200000-(60000 *3) 20000
5-LEAST SQUARES METHOD

1. This method determines mathematicly the regression line of best fit .It is based on the principle that the sum
of the squares of the vertical deviations from the line that is established using the method,is less than the sum
of squares of the vertical deviations from any other line that might be drawn.
2. This method uses the following 2 equations to estimate a and b , then one can use the equation Y=a + bx.to
work out anything from there.
2.1.
2.1.1.Note: the above a formula means the same as (avg Y) – (avg x)*b.
2.2. Regression line : Y= a+ bx
2.3. Where : a = fixed costs (Y intercept) b = variable costs (slope ) and x = cost driver ( eg machine hours ,
or units produced.)
3. Method : first calculate the value of b above , then use it to calculate the value of a.Now you can fit it in the
“regression line” equation and work out the variable costs for your current level of activity. The fixed costs are
already given- it will be = “a” VERY EASY.
4. VERY EASY – YOU ARE DONE!
5. Now you can use the ‘TEST OF RELIABILITY’ below to see how close your answer is to the truth.
6. Note : if given a question where you are not sure what is x and what is y, then just decide by seeing which is
the dependant variable=y, and which is independent=x. Eg sales revenue is dependant on advertising cost –
the more advertising(cost driver), the more sales revenue.
6-TESTS OF RELIABILITY:
1. There are many methods to test how reliabile potential cost drivers are going to be in predicting info. about
data.One could plot the line on a graph and see how far all the actual data lies from it. Or one can use the
following mathematical method:
2. The Coefficient Of Variation (known as r2) OR Coefficient of Determination : is a ‘goodness of fit’
measure. It is always a number between 0-1 , and shows the % of the data that is precisely explained by the
regression line you are using to show the data as a straight line.
2.1. So if r2 = 0.82 it means 82% of the data fits the line , the rest can be explained either by random
variation or ‘random variation plus the combined effect that other omitted explanatory variables
have on the dependant variable.(meaning it might either have more than 1 cost driver, not just one ,
affecting this number ; or there are just a lot of outliers .)
3. The CORRELATION COEFFICIENT = R. (NOT R2) . It measures the degree of association between 2
variables. When you square it ie: r X r , then you get the COEFFICIENT OF VARIATION. This latter is
what you use to judge your answer. The following formula just gives you the answer to r, then you must still
square it to get r2.
3.1.
4.
5. Look at the graph to spot any outliers and investigate if they are correct.
6. DON’T FORGET TO SQUARE THE ANSWER FROM THE FORMULA (MUTIPLY BY r) , TO GET THE COEFFICIENT
OF VARIATION.
6)RELEVANT RANGE AND NON-LINEAR FUNCTIONS:

1. It is misleading to use cost estimation techniques outside of the relevant range , and specificly outside the
range of the observations that were used to calc. the regression line, because they may be completely
different.
2. Extrapolation is also to be treated with care.
3. Therefore it is always best to also plot all data on a graph so any deviations can be easily observed. (outliers
can also be investigated)
7)SUMMARY OF STEPS INVOLVED IN ESTIMATING COST.

1. Select dependant variable
2. Select potential cost drivers
3. Collect data on the dependant variable and cost drivers
4. Plot the observations on a graph
5. Estimate the cost function
6. Test the reliability of the function.
8)MULTIPLE REGRESSION ANALYSIS:

1. Not covered on syllabus. Basicly where there are more than 1 cost driver, for each extra on you get an extra
+bx in the regression formula. So Y= a + bx + bx + bx is for 3 cost drivers influencing the dependant variable
Y.
2. Multicoliniarity is where 2 independent variable like “ bx” and another “bx” both influence Y at very nearly the
same rate. So it is very difficult to distinguish them.one can use the ‘coefficient of correlation’ to compute the
correlation between the 2 problem drivers, it will tell you how close they are to each other.
9)LEARNING CURVE
1) This is a method to calc. how much faster it gets to produce units as workers get more experienced.It is only
quoted as a percentage % -all else works from or around this %.Time decreases exponentially and learning
continues at same rate till conditions change or a steady state is reached.
1-CUMULATIVE AVERAGE TIME-LEARNING MODEL.
1) The whole formula works in a funny way- the % quoted as the learning curve ONLY applies to the
time it takes to DOUBLE the production from one level to another.(stats type maths funny thing).IF
you multiply this % by a time taken for the first unit ever made – it gives you :NOTE FUNNY
THING: the average of 1st unit +2nd / 2 =average time per unit.(and that includes the extra in 1st +
little less extra in 2nd ...to end.SO IT DOES NOT GIVE YOU THE EXACT TIME TO PRODUCE THE VERY
LAST UNIT – YOU MUST MULTIPLY THIS ANSWER BY THE nth value of unit-eg: No.16th unit so
multiply answer from (% X learning curve) by 16 and then if you could do the same for unit no
15,which is difficult because it only works in “doubles”, then If you could subtract final figure for
15th from 16th- you now get the exact time how long unit 16 actually took(true MARGINAL time).The
first figure from the learning curve % is thus just an average of TOTAL TIME TO NOW / final unit
you land on eg :16th etc. ALSO :To get in-between % of say 3 units- between 2 & 4 –you
must??? (1) Make a Graph –read off. (2) try use algebra mathematical model instead
2) BATCHES: because factory production is mostly in batches,if you get ANY QUESTIONS QUOTED IN
BATCHES of eg:100 units –DO NOT CONVERT TO SINGLE UNITS – all answers get done per
batches(as if each batch is a single product) and learn.curve %'s only apply to each full batch.
3) Note : Funny Thing :TO WORK OUT YOUR OWN LEARNING CURVE % :
I) You DO NOT just say time 2 / time 1 –
II) YOU MUST SAY : (only use average times, never work with the real time EVER at all,to
work out learning curve)
a) FOR 2nd one made : Avg of first time / Avg of first 2 times *100/1
b) FOR 4th one made (not 3rd) : Avg of first 2 times /Avg of first 4 times
III)If they give you times for 2 units & 3units & 4units etc, then you use average of all the units up
to the last one.
IV) If required to do this by using the Logarithm Equation Y= axb , do the following:
a) Calculate the average of all times up to the last one (total/n=Avg)
b) Fil in the blanks in the following formula:
c) Y= axb
d) Y is the answer you got above,(Avg), a is the first ‘time’ and to calc ‘b’ and the learning %
do as follows
e) Use trial and error- so work out the formula above until you get eg : 4b=0.815
f) Then work out b for 90% , 80% 70 % etc. now see for which one 4b will be the closest – so
that is your answer then.(don’t go near the log / log 2 thing , cut it short as above)
4) If given average time for 1 and 4 or 8 ,and required to find the learning curve % from this, you
can do it by equation ie : x/100 * x = (time for 4th one) or (x/100 *x * )(x/100*x) for 8th etc. OR
you can use the following method :
I) SAY learning curve is 80% :then you just work out 4th time / 1st time and get the 3rd square
root of the answer like this:
a) 1 = 100%
b) 2=80%
c) 3=(80% * 80% =)64% ….. to get 80% say = 2 (square) root of 64
d) 4=(80%*64% =) 51.2% …..to get 80% say = 3rd root of 51.2
Example : using 80% learning curve : 40hrs to make first unit

½ way MARGINAL
times
Units Learning ProductionCumulative Average Time Total Total Average Note : this
Produced Curve % :for last Production.(per unit) Time (all Time (last Unit marginal is
half of units) ½ of total Time(per cockeyed – it
total units units each of is only for the
made made) last half last ½ of
of total units made ,
units an average
made) for them only
1 100% 1 1 40 40 40 40
2 80% 1 2 80%*40=32 32 64-40=24 24
(Or 40*80%) X2=64(note)
3
4 64%(80*80) 2 4 32*80=25.6 25.6*4=102.4 102.4- 19.2 38.4/2=19.2
(Or 40*64%) 64=38.4
5
6
7
8 51.2%(64*80)4 8 25.6*80%=20.48 20.48*8=163.8 163.84- 15.4 61.44/4=15.4
(Or 40*51.2%) 4 102.4=61.44
16 40.96% (51.2*80 8 16 20.48*80%= 262.14 98.3 12.3 98.3/8=12.3
16.384
%)
(Or40*40.96%
)
Previous Average AverageTime . Current TotalPrevious
X 80% X multiply Time –minus column
(Or new Cumulative Previous divided by
learning curve Production KNOWN Number
* hours for 1st Total Time of units in
one ever made) this last
half of
TOTAL
units
made.
e) Etc. next is 4th root,5th root etc.
II)
5) MATHEMATICAL ALGEBRA FORMULA FOR LEARNING CURVE:(use esp.to work out

between doubles ie: 3,5,6 etc.)
I) y=axb
II) y= cumulative total average time /units when x units are produced (ie: it gives you avg. time
per unit as an answer,same as the answer you get when you multiply {learning curve % by
hours taken sort of thing})
III)a=time to produce first unit

IV) x= cumulative number of units produced (eg: if you want to know avg. time ea. For for 15
units, then x=15)
V) measure of learning (where b = log % / log 2 )rem: on calculator 80% =0.8 NOTE )
a)
VI) NOTE: to get b – you do it on calculator : b= log (learning%as decimal) / div by / log (2)
VII)You type in log on calc. like this: first : 2ndfunct. Log second :0.8
VIII)Use this formula esp. to work out between doubles ie: for number 3,5,6 etc.)
IX) You can use it to make a % TABLE for units 1-200 etc where each no.of units has a simple %
next to it to use.
B-INCREMENTAL UNIT-TIME LEARNING MODEL:
1) THIS method works exactly the same as the other model, incl. the formula exactly ,exept that the
final figure one gets for the answer eg: 30,5 hours for 4 units , IS NOT THE AVERAGE TIME per unit
, but the marginal time for only the last one .If you want to calc. the average time from this, to
compare to other method – you must add all the cumulative values to here- from unit 1 upwards-
then divide by the no. of units of course.
2) TO CHOOSE BETWEEN 2 MODELS : Each industry different – so best to study workflow and make
graphs – then compare answers between 2 models to find the one that fits best to that
industry.This model will only differ in some weird exponential / type way from first.
C- LIMITATIONS OF THE LEARNING CURVE
1. Learning curve data to work on/from May be difficult to obtain
2. Staff may resist scheduling based on declining times
3. Different % rates may apply through the process, rather than just 1 right through.
4. Changes in production techniques may result in % changing
D-LEARNING CURVE IS APPLICABLE TO :
1. Standard costing standard setting , and using these standards up to variance analysis and budgeting
2. Work scheduling enables input prediction(no waiting) so that customer delivery schedules can also be
accurately scheduled
3. Better cost predictions enable better Quotations.
4. Get an unbeatable lead on competitors by keeping your price low in the beginning and thereby getting more
orders and staying ahead of your competitors.
5. Enables you to MODIFY products if you know the learning curve of then also learning to produce these new
styles, this can keep your price low AS YOU do modifactions and keep ahead of your competitors.
10)INDEX VALUES:
1. If an index value is quoted in relation to any question which IS NOT a learning curve , it means a %, ie 120
means multiply by 120/100.
2. If an index value is quoted in relation to a LEARNING CURVE QUESTION it means the b in formula Y=aXb ,
which is the logarithim formula for the learning curve- so it is just the logarithm worked out for you.
CH25 THE APPLICATION OF LINEAR

PROGRAMMING TO MANAGEMENT
ACCOUNTING:
SPECIAL THINGS TO REMEMBER:

1. A common error is to state the objective function in terms of profit, not contribution per unit. This would be
wrong because fixed costs would end up being included in the thing.
TERMS:
1. DEFINITION: Linear Programming is a powerful mathematical technique to use in relevant costing in order
to determine the maximum contribution per limiting factor in cases where there are more than 1 limiting
factor to consider for more than 1 product. It can only be used where relationships can be assumed to be
linear and where an optimal solution does in fact exist.
1.1. To comply with the linearity assumption it must be assumed that the 1- contribution as well as the 2-
raw materials usage per product will remain the same within the relevant range of output being
considered.
1.2. It must also be assumed that 1-units produced and 2-resources allocated are infinitely divisible.
2. Objective Function: refers to the quantification of an objective , and usually takes the form of maximizing
profits or minimizing costs.
LINEAR PROGRAMMING
1. Linear Programming is a powerful mathematical technique to use to ration limited resources among alternative
uses to gain max benefit. (EG in relevant costing in order to determine the maximum contribution per limiting
factor in cases where there are more than 1 limiting factor to consider for more than 1 product).
1.1. It can only be used where relationships can be assumed to be linear
1.2. and where an optimal solution does in fact exist.
1.3. To comply with the linearity assumption it must be assumed that the 1- contribution as well as the 2-
raw materials usage per product will remain the same within the relevant range of output being
considered.
1.4. It must also be assumed that 1-units produced and 2-resources allocated are infinitely divisible.
ASSUMPTIONS UNDERLYING THESE CALCULATIONS:

1. Linearilty over the relevant range for costs, contribution&revenue , qty of materials/labour used.
2. Divisibility of raw materials units
3. Divisibility of products/output units
4. All the available opportunities for using the raw materials have been put in linear programming model
5. Objectives of the firm : that they want to max contribution on the short term. ( not long term or something)
GENERAL
1. There are 2 methods one can use to solve these problems. The Graphical method only works for Max 2
products with multiple limiting factors, and the simplex method works for any no. of products with any no. of
limiting factors.
2. NOTE – for the methods below : if all the contribution per limiting factor for all of the limiting factors follow
the same trend ie: in each case you would definitely say product 1 is first because it gets the most
contribution in EVERY one of the limiting factors , and 2 is second and 3 is 3rd in every case, then THERE IS
NO NEED TO DO A GRAPH or anything, if you can just see which is 1st,2nd etc. You only have to use this linear
programming method if the order of max contributions is different for every limiting factor.
3. NOTE – IF THE OBJECTIVE IS TO MINIMISE COSTS, THEN the points on the graph will be nearest the
bottom / left, not the top/right .- because bottom left means lower values and top/right means higher values.
4. BASIC STEP 1 PROCEDURE for both METHODs:
4.1. 1st Formulate the problem algebraicly
4.2. 2nd Specify the objective function eg to maximize contribution OR to minimize costs
4.3. 3rd Formulate the Input/Output Constraints and Limits
4.4. 4th Include a non-negativity requirement , to prevent nonsensical negative (below 0) results : eg:
For Product X and Y : Y> 0 or 420 < X > 0
4.5. Example Problem Layout eg for product Y and X with certain limitations as follows:
4.5.1.[do 1+2 above] : Algebra Equation : Maximise (Contribution) C = 14Y + 16 Z
4.5.2.[do 3] : Material Constraint : 8Y + 4Z <= 3440
4.5.3.[do 3] : Labour Constraint : 6Y + 8Z <= 2880
4.5.4.[do 3] : Machine Constraint : 4Y + 6Z <= 2760
4.5.5.[do 4] : Negativity Requirement : Z >= 0
4.5.6.[do 4] : Negativity Requirement + MAX : 0 <= Y <=420 (say product Y sales MAX
is up to 420, no more)
5. The following example is used to illustrate BOTH methods : PTO

GRAPHICAL METHOD
1. This method can only be used for Max 2 products with any no. of limiting factors.
2. You convert each Constraint to a line on a graph and ID the area where it applies, then the intersection of all
the AREAS is the answer.
3. You just make X and Y alternativey 0 to find the intercept of each and draw a line to get the lines.
1.1.1.1.The book says one of the points ABCD or E is ALLWAYS the solution. Why they say this I don’t
know.
1. The Point where the MAX contribution will be, will be the point the furthest to the “right & above” in the
intersection area, which will be point C in the example below. Remember all numbers on the graph only ever
increase by going up, or to the right ,and the higher the numbers the higher the contribution will end up
being. The reason is supposedly that if you construct & draw 1 line within the intersection area by using the
original equation for Max Contribution (C= 14Y +16Z from above) , then if you move this line to the
right&above in a parallel fashion you will hit the MAX point at the top/right point [you get this line by :
‘estimating’ a value for C and then again find Z if Y = 0 and Y if Z = 0 and see if this line falls within the
graph. As soon as you get 1 that falls in within the graph, you can begin moving it parralell to itself to see
where it touches the relevant area. again-remember C is not given like max labour or max materials, C can
change to anything. ] – You do a simultaneous Equation using only 2 of the equations of the lines that
intersect at the point to get the pint mathematicly because you cannot see it so well on a graph.(point C here)
1.1. In Example they took : 8Y + 4 Z = 3440 and

6Y + 8Z = 2880
You can do 2 things to these equations 1-you can multiply any one of individually by any
number ,and not do it to other one.(you must just do it to all no.s in the equation) , and 2-
you can subtract one full equation from the other and work with the resulting answer.
1. BASIC STEP 1 PROCEDURE for both METHODs:

1.1. Example:using the example given in (I) LINEAR PROGRAMMING above :
1.2. 1st Formulate the problem algebraicly

1.3. 2nd Specify the objective function eg to maximize contribution
1.4. 3rd Formulate the Input/Output Constraints and Limits
1.5. 4th Include a non-negativity requirement , to prevent nonsensical negative (below 0) results : eg:
For Product X and Y : Y> 0 or 420 < X > 0
1.6. Example Problem Layout eg for product Y and X with certain limitations as follows:
1.6.1.[do 1+2 above] : Algebra Equation : Maximise (Contribution) C = 14Y + 16 Z
1.6.2.[do 3] : Material Constraint : 8Y + 4Z <= 3440
1.6.3.[do 3] : Labour Constraint : 6Y + 8Z <= 2880
1.6.4.[do 3] : Machine Constraint : 4Y + 6Z <= 2760
1.6.5.[do 4] : Negativity Requirement : Z >= 0
1.6.6.[do 4] : Negativity Requirement + MAX : 0 <= Y >=420 (say product Y sales MAX
is up to 420, no more)
2. GRAPHICAL METHOD STEP 2 PROCEDURE:
2.1. Convert each constraint/limitation (all the [do 3]’s from above) equation onto the graph, one by one.
2.1.1.Materials Constraint : 8Y+ 4Z < = 3440 : calc. y intercept & x intercept : you just simply say –
if Y=0, what is Z
8x0 + 4xZ <=3440
So (3440 -0 ) / 4 <= Z
So Z <= 860 so if Z is put on x axis , then x intercept is 860
Similarly solve for Y , (just make Z=0) , then Y intercept is 430
SO JUST DRAW A STRAIGHT LINE BETWEEN X & Y INTERCEPT TO GET IT ON THE GRAPH.: note:
YOU must now figure out the AREA that is affected on the graph- is it below/left of the line or
above/right of it? You can lightly shade it to indicate where it could intersect with the other AREAS.
(it is probably below the line – check your equation, if it says Z<= 860 then area must be BELOW or
ON this line only, same for other intercept. If it says Z = 860 then it means AREA is only ON the line,
not below or above it at all )
2.1.2.Labour Constraint : 6 Y + 8 Z <= 2880 : calc . Do the same for this limiting factor, on the
same graph. Now you are starting to get an intersection of the areas that are ‘possible’.
2.1.3.Machine Constraint : 4Y + 6Z <= 2760 : . Do the same for this limiting factor, on the same
graph. Npw you are starting to get more of intersections of the areas that are ‘possible’
2.1.4.Negativity Requirement : Z >= 0

2.1.5.: . Do the same for this limiting factor, on the same graph. Npw you are starting to get more of
intersections of the areas that are ‘possible’
FOR THIS ONE , IT WOULD BASICLY JUST BE A STRAIGHT LINE ON THE Y
AXIS (if we put Z on the x axis)and all values of Z would have to be to the
right of it(similar to the one for Y below , type of style)
2.1.6.Negativity Requirement + MAX : 0 <= Y <=420 (say product Y sales MAX is up to 420,
no more) Do the same for this limiting factor, on the same graph. Npw you are starting to get more
of intersections of the areas that are ‘possible’
Also a line would basically have to be drawn on the X Axis to show that Y must always be above zero
ie: on the x axis itself(seems you can leave that out and just remember it)
2.1.7.FINAL GRAPH: This would be all the graphs put together. So the final intersection of the all
the areas is the area where all the limitations will be satisfied. BUT to find the 1 single point where
the maximum contribution will be attained is the next process. The textbook says it will be ONE OF
THE CORNERS of the intersection area- below either ABCD or E. To find which one is the solution do
as follows:
2.1.7.1.The book says one of the points ABCD or E is ALLWAYS the solution. Why they say this I don’t
know.
2.1.7.2.The Point where the MAX contribution will be, will be the point the furthest to the “right &
above” in the intersection area, which will be point C in the example below. Remember all
numbers on the graph only ever increase by going up, or to the right ,and the higher the
numbers the higher the contribution will end up being. The reason is supposedly that if you
construct & draw 1 line within the intersection area by using the original equation for Max
Contribution (C= 14Y +16Z from above) , then if you move this line to the right&above in a
parallel fashion you will hit the MAX point at the top/right point. NOTE : this point could easy
be on the intersection of the x axis and one of the lines, it does not have to be 2 of the
main lines, the x axis counts too. As long as the parallel line C CANNOT be moved to
the right any more. [you get this line by : ‘estimating’ a value for C and then again find Z
if Y = 0 and Y if Z = 0 and see if this line falls within the graph. As soon as you get 1 that falls in
within the graph, you can begin moving it parralell to itself to see where it touches the relevant
area. again-remember C is not given like max labour or max materials, C can change to
anything. ] – see small graph example below,where coloured area is the intersection area.
2.1.7.3.To get the Y and Z value for point C mathematicly , you do it as follows: (it is “difficult” to read
it off correctly from graph)
2.1.7.3.1.You do a simultaneous Equation using only 2 of the equations of the lines that intersect at
the point.(point C here)
2.1.7.3.2.In Example it is : 8Y + 4 Z <= 3440 and
6Y + 8Z <= 2880
You can do 2 things to these equations 1-you can multiply any one of individually by any
number ,and the not do it to other one.(you must just do it to all no.s in the equation) , and
2- you can subtract one full equation from the other and work with the resulting answer.
METHOD: Get rid of 1 of one of the equations , and also either the Z or Y in the
answer, by :
1st: multiply all numbers in one of the equations to bring either the Z or X to equal the
value of the one in the other equation. So above you can multiply equation 1 by 2 to make
the 4Z equal to the 8Z in other equation below, so you can get rid of it by when you
subtract one equation from the other. So from 8Y + 4 Z = 3440 [X 2]you get
16Y + 8Z = 6880.
2nd So now subtract 1 equation from the other so you are left with only equation to work
with. So above we say :
16Y + 8Z = 6880
Minus 6Y + 8Z = 2880
Equals 10Y= 4000
So Y= 400
3rd Now we know Y=400. So substitute in IT IN ANY ONE OF THE 2
INTERSECTING EQUATIONS USED IN THIS CALCULATION. :in the above
example it will be : 6Y + 8Z = 2880
NOTE: do not use the Max Contribution equation , or of the other equations, only these
2.The others WILL GIVE WRONG ANSWER DEFINITELY.
6Y + 8Z = 2880
So: 400 * Y + 8Z = 2880
So: { 2880 – (6 X 400) } / 8 = Z
Z= 60.
ANSWER : Z=60 AND Y=400.
MARGINAL RATE OF SUBSTITUTION:

1.1.1.Definition : This is the optimal response from an independent marginal increase in a resource. Okay,
so this means if you manage to get more qty of a limiting factor , eg limited scarce resource like more
Kg’s of raw materials etc, then what will be the amount by which Production of Product A and of each
other Product must be increased or Decreased above or below the optimal Production level worked
previously out that would have maximized contribution per limiting factor. The answer could be to
increase production of both products by a certain amount, or increase one and decrease the other, or
anything like that.
1.1.2.To calc. this :METHOD : you just go and work out the whole thing above again for any one limiting
factor , eg KG’s of raw material , after increasing the amount available by JUST +1 Kg + . Then
calc. the difference between old amount of Product Z and Y to produce and the new amount of
Product Z and Y to produce. This difference is the “ marginal rate of substitution” So your answer
would be maybe : INCREASE Product Z by 0.2 …..and DECREASE Product Y by 0.15. That is the
marginal rate of substitution.
1.1.2.1.METHOD: you just increase the value by one and then do the whole graph thing above all over
again. BUT basicly instead of drawing any lines again, all you do is re-do the final 2 simultaneous
equations – so you subtract the final equation from the other again, but this time just use 1 kg
extra. Then you get your answer. (just re-do the final 2 equations to re-determine the point on
the graph mathematicly, instead of drawing lines etc.)
1.1.3.The same thing must be done for each and every different limiting factor eg: labour etc, and then
you have all the facts at your fingertips.
1.1.4.
SHADOW PRICE OR OPPORTUNITY COST

1.1.1.Definition: the Value of an independent marginal increase of a scarce resource . ok so this means the
marginal increase in contribution for any increase in the amount available of a limiting factor, like
more KGs of raw material are available etc.
1.1.2.To calc. this : METHOD : you just take it from above “Marginal Rate of Substitution” you worked
out , and MULTIPLY it by the CONTRIBUTION of each Product. So if Marginal Rate of Substitution of
Product Z = - 0.15, and Contribution of same product = R16, then the DECREASE in contribution from
R2.40] .Then work out the same for the other product. So say other
product Y = [-
product Z =[ +R2.80 ] Then The Answer is as follows :
SHADOW PRICE or OPPORTUNITY COST = R2.80 – R2.40 = R0.40c .
1.1.3. So we know that for any INCREASE in the QUANTITY of specific raw material available, the price of
any EXTRA raw materials can be increased by up to 0.40c above what we pay for the rest of the raw
materials, and up to this level we can accept the offer because the it will still contribute toward the
Fixed Costs.The same can be done for labour so eg: per 1 extra hour of scarce labour.
1.1.3.1.NOTE: this does not all mean the specific raw material’s price can increase, it only means any
EXTRA material which might be offered to the factory , over and above the limited qty available
currently, can be up to just below R0.40 more expensive.
1.1.3.2.NOTE : this presumably means up to JUST BELOW R0.40 , NOT incl. RO.40 , that would be
ZERO increase in contribution (work for nothing-wear & tear) , and above 0.4 would cause a
Decrease in contribution.???is this true
SOLVING PROBLEMS WITH SHADOW PRICE/OPPORTUNITY

COST & MARGINAL RATE OF SUBSTITUTION.
1. Say they tell you that 100 KGs of Raw Materials are available from a supplier at 0.20 c more expensive than
normal. If this is a limiting factor because you never used to be able to get more of this material, should you
accept? And what will the new optimum level of production for each product be?
2. ANSWER:
2.1. well we worked out that the Shadow Price for these specific materials is R0.40c above. So we can accept
the price anywhere up to 0.4c above current price and it will still contribute to fixed costs. Thus we
should accept this offer.
2.2. WHAT LEVEL MUST THE PRODUCTION BE CHANGED TO DUE TO THIS NEW LOAD OF MATERIALS
AVAILABLE ? Answer : since we worked out the Marginal Rate of Substitution above, we know that
Product Z must be Decreased by 0.15 and Product Y must be Increased by 0.2 for each extra Kg of raw
material used above current level. So for 100 KG’s more we just say:
2.3. Product Z : 100 * - 0.15 = 20 Units MORE MUST BE PRODUCED INCREASE
2.4. Product Y : 100* + 0.2 = 15 Units LESS MUST BE PRODUCED DECREASE
SIMPLEX METHOD
I. The simplex model is used where : 1-there are more than 2 products with more than 2 limiting factors ,
because the graphical method cannot do over 2 products. 2-it provides additional information on opportunity
costs and marginal rates of substitution that is particularly useful for decision making .
II. The textbook does not give the formula, it is too complex. It only shows how to use a spreadsheet program to
solve it.
III. Exams require you to formulate formulate initial model & interpret the output.
IV.METHOD:
A. Example Problem Layout eg for product Y and X with certain limitations as follows:
1. [do 1+2 above] : Algebra Equation : Maximise (Contribution) C = 14Y + 16 Z
2. [do 3] : Material Constraint : 8Y + 4Z <= 3440
3. [do 3] : Labour Constraint : 6Y + 8Z <= 2880
4. [do 3] : Machine Constraint : 4Y + 6Z <= 2760
5. [do 4] : Negativity Requirement : Z >= 0
6. [do 4] : Negativity Requirement + MAX : 0 <= Y >=420 (say product Y sales
MAX is up to 420, no more)
B. Step 1 : Slack Variables : first we must introduce slack variables to the model in order to
EXCLUDE any inequalities. A slack variable is added to each individual limiting factor equation in order to
ACCOUNT FOR ANY PORTION OF THE LIMITING FACTOR THAT IS UNUSED, EG some available labour hours
not used ,or unused but available KG’s of raw material - using the same equations as in graphical method.
An “inequality” means where the optimum mix is found, some limiting factors(constraints) might not be
used to full capacity because making another product takes “contribution precedence” due to another
constraint, and it means less of this one. So the slack variable will ONLY mean the amount -not used- at
the optimum contribution production mix.
It is done as follows (using same example as for graphical method)
: Material Constraint : S1 + 8Y + 4Z <= 3440
: Labour Constraint : S2 + 6Y + 8Z <= 2880
: Machine Constraint : S3 + 4Y + 6Z <= 2760
: Negativity Requirement S4 + Z >= 0 we just say: leave it out- just
remember it must be above 0
: Negativity Requirement + MAX S5 + 0 <= Y <=420 we just say: S5 + Y =< 420
C. STEP 2: Initial Matrix: Construct it

1. You just re-arrange the info above to display like shown below.
2. Baiscally you take the above equations and make “S” the subject in each one. Just the
Contribution equation is done otherwise- see note 4.3.4 below.
3. After this ‘matrix algebra’ must be applied to this matrix to get the solution ie: the “final
matrix”. This matrix is entered into spreadsheet and then you get the final solution “final matrix”
from the spreadsheet.
4. Note that c=contribution beneath the bottom line is always c=0 , and the + 14Y and +16Z do
not mean the same as the numbers for the other Z & Y above it, the bottom Y &Z merely serve as
an indicator of what C = if production would be 1, not for 0 as shown. (bottom line is just an
indicator)
D. STEP 3 : Final Matrix : Interpret it.

1.
2. Note; examination questions often present the final matrix in a different format – not the same
as this. Sometimes the + and minus signs are REVERSED on both the Input Matrix and the Output
matrix- (so student do’snt reverse for a extra unit , you reverse for one unit less. Also sometimes
the final matrix is presented as a computer printout.See Question 25.14 in textbook for some
practice with if they do this .
3. The optimal solution occours when the signs in the contribution row are all negative.(why , I
don’t know)
4. HOW TO INTERPRET THE FINAL MATRIX :The final matrix can be interpreted using the
same approach that was used for the initial matrix but the interpretation is more complex. The
contribution row (equation 5) of the final matrix contains only negative items, which signifies that
the optimal solution has been reached. The quantity column for any products listed on the left hand
side of the matrix indicates the number of units of the product that should be manufactured when
the optimum solution is reached. 400 units of Y and 60 units of Z should therefore be produced,
giving a total contribution of £6560. This agrees with the results we obtained using the graphical
method. When an equation appears for a slack variable, this indicates that unused resources exist.
The final matrix therefore indicates that the optimal plan will result in 800 unused machine hours
(Si) and an unused sales potential of 20 units for product Y (S4). The fact that there is no equation
for S1 and S, means that these are the inputs that are fully utilized and that limit further increases
in output and profit.
The S column (materials) of the final matrix indicates that the materials are fully utilized. (Whenever
resources appear as column headings in the final matrix, this indicates that they are fully utilized.)
So, to obtain a unit of materials, the column for S1 indicates that we must alter the optimum
production programme by increasing production of product Z by of a unit and decreasing production
of product Y by 1/ of a unit. The effect of removing one scarce unit of material from the production
process is summarized in Exhibit 25.1.
Look at the machine capacity column of Exhibit 25.1. If we increase production of product Z by 3/2o of
a unit then more machine hours will be required, leading to the available capacity being reduced by
9/10 of an hour. Each unit of product Z requires six machine hours, so 3/20 of a unit will require 9/10
of an hour (3/20 x 6). Decreasing production of product Y by unit will release 4/5 of a machine hour,
given that one unit of product Y requires four machine hours. The overall effect of this process is to
reduce the available machine capacity by 1/10 of a machine hour. Similar principles apply to the
other calculations presented in Exhibit 25.1.Let us now reconcile the information set out in Exhibit
25.1 with the materials column (S) of the final matrix. The S column of the final matrix indicates that
to release one unit of materials from the optimum production programme we should increase the
output of product Z by 3/20, and decrease product Y by 1/5 of a unit. This substitution process will
lead to the unused machine capacity being reduced by 1/10 of a machine hour, an increase in the
unfulfilled sales demand of product Y (S4) by 1/5 of a unit and a reduction in contribution of £2/5. All
this information is obtained from column S1 of the final matrix, and Exhibit 25.1 provides the proof.
Note that Exhibit 25.1 also proves that the substitution process that is required to obtain an
additional unit of materials releases exactly I unit. In addition, Exhibit 25.1 indicates that the
substitution process for labour gives a net effect of zero, and so no entries appear in the S column of
the final matrix in respect of the labour row (i.e. 5).
The contribution row of the final matrix contains some vital information for the accountant. The
figures in this row represent opportunity costs (also known as shadow prices) for the scarce factors of
materials and labour. For example, the reduction in contribution from the loss of one unit of materials
is £2/5 (0.40) and from the loss of one labour hour is £1 4/5 = (1.80). Our earlier studies have
indicated that this information is vital for decision-making, and we shall use this information again
shortly to establish the relevant costs of the resources.
The proof of the opportunity costs can be found in Exhibit 25.1. From the contribution column we can
see that the loss of one unit of materials leads to a loss of contribution of £0.40.
5. SUBSTITUTION PROCESS WHEN ADDITIONAL RESOURCES ARE OBTAINED:

a) One can use the fractions & numbers given in the FINAL MATRIX as MARGINAL RATE
OF SUBSTITUTION and as the SHADOW PRICE/OPPORTUNITY COST , to calculate how to
change the production mix if more materials or labour hours become available. The only
thing you have to do is REVERSE THE SIGN IN FRONT OF THE FIGURE ON THE FINAL
MATRIX. Remember on the final matrix the +/- sign is for if you REDUCE the qty by 1. So if
you want to increase the qty by 1 you reverse the sign.
b) Note : The same applies to the S3 and S4 in example- if you increase qty by 1, then
S3(hours) available (unused/free) will increase by 1/10 of a hour and S4(sales of Y) will
decrease by 1/5 of a unit.
USES OF LINEAR PROGRAMMING

CALCULATION OF RELEVANT COSTS:
1. The relevant cost for a scarce resource is calculated as = 1: acquisition of resource + PLUS + 2:
opportunity cost.
2. So where more than 1 scarce resource exists, the opportunity cost should be established using linear
programming tequniques.and the above formula means that the RELEVANT COST is the normal cost you pay
PLUS what you would be prepared to pay extra over and above this price – ie the opportunity cost.
3. This is then used as explained above.
SELLING DIFFERENT PRODUCTS

1. Once you have calculated the opportunity cost/shadow cost of the different raw materials , per KG or Hour
etc. then you can use this info to work out for if you want to ADD A NEW PRODUCT, for all the limiting factors
that new product will use and take away from the old products, what will be the total contribution lost from
old products , to compare to contribution from new product.
2. So you just say : if you worked as in Graphical Method example shown above: opportunity cost of 1 KG of
raw materials is R0.4 and of 1 labour hour is eg R5, then if new product uses 2 hours and 10 kg, you know
you loose (2hrsx R5) + (10kgx R0.4) contribution from old products foe each new product made. – to
compare.
MAXIMUM PAYMENT FOR ADDITIONAL SCARCE RESOURCES

1. Eg if you want to know how much overtime you are prepared to pay for a certain product , or how much
extra you will pay for raw materials over the current price- ie the opportunity/shadow cost like in (A) above.
CONTROL
1. So for material wastage, ID the responsibility centre : if it is identified as having wasted R 500 of raw
materials , it should also be identified as having lost the Opportunity cost of that material ie : eg R100
because you had to change over to another product due to materials being finished for the other. So 500
+100 = 600
CAPITAL BUDGETING
1. Can be used to determine the optimal investment program when capital rationing exists. Refer to Learning
Note 25.2 on website to study further because it is not prescribed for this course in textbook.
SENSITIVITY ANALYSIS
NOT TIME- REDO THIS ONE BEFORE EXAM
CH24 QUANTITATIVE METHODS FOR THE

PLANNING AND CONTROL OF STOCKS
IMPORTANT NOTES
1. For rounding off – it seems from answers in book that if you get an EOQ of 300.03 you round off down, so 1
less to 300, NOT up to 301 due to logic .
BACKGROUND
1. There are conflicting 2 problems with stock :

1.1. there must be enough for production & sales – not too little
1.2. there must not be surplus stocks that are
1.2.1.unnecessary ( money tied up in stocks) and
1.2.2.increase the risk of Obsolecence
2. the models here can apply to any company/non-profit, not just mnftring.
WHY DO FIRMS HOLD STOCKS ?

1. There are 3 motives for holding :
1.1. TRANSACTIONS MOTIVE : enough to meet sales & production requirements.
1.2. PRECAUTIONARY MOTIVE: if raw material supply will be unreliable
1.3. SPECULATIVE MOTIVE : - eg :if the price of certain stock items are going to be going up soon, then you
buy alot now to beat the price rise.
RELEVANT COSTS FOR QUANTATATIVE

MODELS UNDER CONDITIONS OF
UNCERTAINTY
1. There are only 2 types of relevant costs for optimal stock levels:
1.1. HOLDING COSTS :
1.2.ORDERING COSTS :
2. These in turn consist of:
2.1. HOLDING COSTS : -(normally expressed as a % rate per Rand of average investment)
2.1.1.opportunity costs of investing in stocks( the required return lost from investing in stocks rather
than some alternative investment.eg interest from bank)
2.1.2.Incremental insurance costs
2.1.3.Incremental warehouse and storage costs
2.1.4.Incremental material handling costs (normally less critical)
2.1.5.Cost of obsolescence and deterioration of stocks (normally less critical)

2.2. ORDERING COSTS:
2.2.1.receiving deliveries
2.2.2.paying invoices,
2.2.3.preparing purchase order
2.2.4.etc.
DETERMINING THE ECONOMIC ORDER

QUANTITY:
1. E.O.Q (economic order quantity) : the optimum order size is known as the EOQ. This means if you make
larger orders, then you also have to make fewer orders so your total ‘ORDERING COSTS” come down, BUT
then at the same time you HOLDING COSTS go up because you have to keep the larger orders in the
warehouse.
2. There are 3 methods for balancing the 2 :
2.1. TABULATION METHODS :
2.2. GRAPHICAL METHOD:
2.3. FORMULA METHOD :
TABULATION METHOD :
1. (see example below) You make a table up with columns for a range of order qty’s you just make up and try
out - eg 10 , 20 , 30 etc.And then you just see which order qty causes the lowest overall relevant cost-
THAT’S IT.
2. You must put the average stock that will be in the warehouse in the table, because you need it to calculate
the AVERAGE holding costs. You get the average stock by dividing the order qty in half and ADD safety
stocks to this– since it will be zero when you order and Max when you receive order- so avg is half.
3. Remember – if they quote opportunity costs as a yearly interest % * cost price of each item, then your costs
are YEARLY not MONTHLY –don’t mix them up with other costs which are monthly. In a question they might
not say what time period other costs they give you are measured in so, so it could mean all the same
timeframe or be tricky – check carefully . but it seems it is normally done on TOTAL YEARLY COSTS.
GRAPHICAL METHOD:
1. (See example below)YOU must get info like above for various order qty’s. in a table form .
2. Then make a graph with x axis = ORDER QTY and y axis = ANNUAL COSTS.
3. You plot the holding costs on one line , then make another line with ordering costs. where these 2 lines cross,
will be the lowest Total Relevant Cost. You make a 3rd line with both line added together to make a third. The
lowest point of this 3rd line will also the answer, ie Lowest Total Relevant Cost.
4. Note that (interesting) in example below the annual costs are not that sensitive to order qty – a 25% increase
in order qty leads to just a 2.5% to 4 % increase in annual costs.
FORMULA METHOD:
1. All the holding costs & ordering costs below are ANNUAL costs, not monthly costs.
2. ORDERING COST =
3. HOLDING COST =
4. TOTAL COST =
5. To get the special formula you use to work out the E.C.Q. , you must ‘differentiate the total cost formula
above with respect to Q and set the derivative equal to zero .’ what ever that means : then you get the
following formula . Just solve for Q to get the lowest order qty possible.
5.1. Use the following :

5.1.1.HOLDING COSTS : per unit per year (note , for the tabulation method you use the average annual
holding costs of all units (ie order qty/2 + safety stock * holding costs) but for this method you only
use the annual holding cost of 1 one uno een eins unit. ( which might have to be calculated using
the average holding cost method, but only for 1 unit, not all.
5.1.2.ORDERING COSTS : per any 1 complete order
5.1.3.DEMAND : per year
ASSUMPTIONS OF THE ECQ MODEL:

1. Holding cost per unit will be constant. – note that this might not be true as holding costs might increase
in steps, not constant , as more storemen might be needed as stocks increase, and less casual labour as
stocks decrease.
2. The Average Stock holding is one half of order qty : Seasonal&cyclical factors and if a constant amount
of stock is not used per day, this assumption will be violated.
3. HOWEVER : due to the way the curves generally interact with each other, even if your holding costs were
estimated 50% lower than they actually are by accident, it would only mean a 6% difference from the optimal
financial result. So the EOQ method is still very valuable as an indicator even if some of the variables are
estimated incorrectly.
APPLICATIONS OF THE EOQ MODEL IN

DETERMINING THE OPTIMUM LOT SIZE
FOR A PRODUCTION RUN.
1. The EOQ model can be adapted to determine the optimum length of the production runs when a set – up cost
is incurred only once for each batch produced.
2. You just use “SET-UP COSTS” instead of of purchase “ORDERING COSTS”- That’s it.
3. So just substitute symbol S for the symbol O in the formula and go.
4. NOTE : after working out Q = EOQ, you know how many to make in each production run. Now, to work out
from this, if asked in exam, at what stock level one should start to manufacture the next run : you do a huge
complex calc., saying total demand per year / working days = how many per day to make. Then calc how
many days it will take to make the previously calculated EOQ, at this number per day. This is the length of a
production run ,and now see how much stock you will need to carry you from the begin to the end of 1
production run. This is the minimum stock re-production level.
QUANTITY DISCOUNTS
1. Buying in larger consignments to take advantage of quantity discounts will lead to the following savings:
1.1. Lower purchase price (from discount)
1.2. Lower total ordering cost because fewer orders are placed to take advantage of discounts.
2. METHOD :
2.1. To work out if it is better to order more and get a discount , or order less and decrease holding costs, you
have to take 3 factors into account : 1-holding costs, 2-ordering costs , 3-discount
2.2. What you do is : first work out the normal EOQ. Using any method.
2.3. Then work out your savings from taking the discount : it will be 1-discount 2–lower ordering costs.
2.4. Then work out your HIGHER holding costs from taking discount/ordering higher Qty’s.
2.5. NOW SEE IF THE SAVINGS IS MORE THAN THE EXTRA COSTS YOU WILL INCUR. = answer
3. That’s it – no clever formulas. Bopa.
DETERMINING WHEN TO PLACE THE

ORDER :
1. Simple :
2. Lead Time is the time it takes between placing the order till you get the delivery. (or between starting
production and getting the finished products)
3. The Time to Place an Order : is when the stock level reaches a point just before where you will not have
enough to carry you through the “lead time” till you get more. This is easy to work out, just move figures
around till you get it.
1. Take demand needed per year , and after working out Q = EOQ, you know how many to make in each
production run/or order each time. Now, to work out from this, if asked in exam, at what stock level one
should start to manufacture the next run/ or order the next load : you do a huge complex calc., saying total
demand per year / working days = number needed/sold per day . Then take your lead time . This is the
length of a production run ,and now see how much stock you will need to carry you from the begin to the end
of this lead time. This is the minimum stock re-order or re-production level.
UNCERTAINTY AND SAFETY STOCKS AND

PROBABILITY THEORY.
1. SAFTEY STOCKS : to protect itself from uncertainty, a firm will maintain a level of raw material, WIP and
finshed goods Thus when lead time & demand are uncertain there must be safety stocks added.
2. The 2 factors are the stockout costs (cost of running out of stock- lost sales etc) VS cost of holding
extra stock
3. STOCKOUT COSTS (Cost of running out of stock)=
3.1. Loss of contribution from loosing sales
3.2. OR by permanently loosing regular customers = discounted value of the lost contribution on future sales
3.3. OR cost of : stoppage in production (idle labour +
4. : HOLDING COSTS :once the stockout costs have been established, the costs of holding safety stocks for
various demand levels should be calculated.
5. MAXIMUM LEVEL OF STOCKHOLDING POSSIBLE: = re-order level + order qty – ( Minimum lead time X
Min. daily usage) note : minimum!!!!=least use possible, not max use possible.
6. WITHOUT PROBABILITY THEORY : to calculate the level at which stocks must be re-ordered :
6.1. Re-order level= MAXIMUM daily usage X MAXIMUM lead time (do not use averages for any of these 2,
unless they give you probabilities for each as well to work with)
7. WITH PROBABILITY THEORY :It is better to attach probability levels to potential demand levels,
and from this work things out.
7.1. NOTE : the EXAM ANSWER for re-order level ALLWAYS = safety stock + average usage during lead
time (not just the average usage in the lead time)
7.2. METHOD type 1 : for COST OF STOCKOUT METHOD
7.2.1. FIRST :You get a table with different possible “usages during the lead time” and with probailites
for each. You ALLWAYS work out the total “average usage during the lead time “ by multiply each
usage by its probability and add all the answers up. This gives the statistical average lead time.
7.2.1.1.If demand varies : throughout the year, then you must do this calculation for each separate
period and adjust your ‘safety stock” at the beginning of each successive period.( instead of just
having one “safety stock level”, you have more than one.
7.2.2.SECOND :they give you “stockout costs per unit” and “holding costs per unit”. So you make up a
table with (don’t understand- it seems they did errors on the table on page 629) re-do
7.3. METHOD type 2 : for Maximum Probability OF RUNNING OUT OF STOCK to be Allowed Method :
7.3.1. If the firm cannot easily estimate ‘stockout costs’ it might just say it does not want the probability
of a stockout to exceed say 10 %. Then you go to your given table of probabilities of each ‘usage in
lead time “ and ADD UP THE probabilities starting at the HIGHEST USAGE downwards .As soon as the
answer gets above the say 10% specified you stop there-that single one is your re-order point. You
still use your “total average usage during the lead time” as the basis of your calculation , and then
your “safety stock level” is just the difference between your ‘stock re-order point” and your “total
average usage during the lead time “ – so you will have to quote both figures for an answer.
CONTROL OF STOCK THROUGH

CLASSIFICATION:
1. In large firms it is possible to have tens of thousands of different types of items . So it is impossible to apply
these tequnques in this chapter to all of them. So then stocks are classified in to categories of importance so
that elaborate tequniques are then used on ONLY the most important items, and easier , less time consuming
tequniqes are used on the rest ( like subjective methods ie: asking how much is needed per past experience.
THE ABC CLASSIFICATION METHOD :

1. This is a common method of classifying stock in order to guage which ones to apply complex tequniques to
and which not.
2. METHOD :
2.1. You class all your stock in 3 categories A,B,C.
2.1.1.CATEGORY A : top 10 % of ANNUAL PURCHASE COST (not price per unit, but total cost of all units of
the same type bought per year eg: total price of all 10 mm bolts bought per year )
2.1.1.1.Then the most sophisticated tecniuques from this chapter are done on CATEGORY A , also you
try to keep safety stocks as low as possible ( avoid high storage costs) but high enough to avoid
high stockout costs.
2.1.2.CATEGORY B : next 20 %
2.1.2.1.you use the same quantitative techniques but slightly less sophisticated.
2.1.3.CATEGORY C : last 70 %
2.1.3.1.Here use more subjective methods like per past experience , and also higher safety stocks
( storage costs will be lower here) and larger orders because of that.
3. In most manufacturing concerns, the normal levels are usually that 10-15% of items account for 70-80 % of
total purchases value, and on the other extreme normally 70-80% of items only account for only 10% of total
value.
OTHER FACTORS INFLUENCING THE

CHOICE OF ORDER QUANTITY:
1. Shortage of future supplies :one may ignore these results form these methods and over-order if eg there is
going to be a country wide shortage of some item in the near future etc
2. Future Price increases : you over-order here
3. Obsolecence : you under- order here if there is a danger of imminent obsolescence
4. Steps to reduce safety-stocks : if one puts pressure on suppliers to reduce lead time, or find a better
supplier, you can reduce the level of safety stocks.
MATERIALS REQUIREMENT
PLANNING(MRP)
1. MRP 1 originated in the 1960 s as a computereised approach to coordinating the planning of materials
acquisition and production.
1.1. You type in the approximate finished goods needed, then the system works out how many of each sun-
components, and sub-sub-component and so forth is needed, until only DIRECT MATERIALS(DM) ie goods
to be purchased in, are left.
2. MRP II is another similar type of system known as Manufacturing Resource Planning which is an upgraded
version of MRP I , and extends to labour scheduling and machine capacity planning.
3. EOQ method can be used together with this system to organize the whole process, as long as the major
assumption of the EOQ model- constant demand -applies
JIT : JUST IN TIME PURCHASING

ARRANGEMENTS.
1. JIT seeks to ensure delivery of materials just before their use, to minimize stock holding needs and costs.
2. Normally it requires suppliers to do quality inspections on stock before delivery to guarsntee quality.they must
get production schedules to estimate their deliveries, and have a close commitment to JIT to be chosen as
suppliers. So not any supplier can be chosen for JIT- it takes commitment to JIT.
3. This co-operation from suppliers is achieved by placing higher orders with fewer suppliers and for a longer
term It has a few goals :
3.1. eliminating non-value adding activities – like some activities related to purchasing
3.2. a batch size of 1
3.3. zero inventories
4. It can cause savings in - purchase costs, volume discounts, holding costs
CH12 DRURY DECISION MAKING UNDER

CONDITIONS OF RISK & UNCERTAINTY
This chapter involves situation where no single set of costs and revenues is available for a specific outcome, but
where there are more than 2 possible sets of costs & revenues to choose from, for a single decision. These
techniques help one to decide which path to choose , so to decide which will be the most profitable/least costly.
SPECIAL CASES:
1. These are certain special cases where the mathematical outcome of a solution is not the only criteria and one
must use your noggin a bit.
2. Case 1 : where the profit range of possiblity A =is between 5 – 15 and the other B =is between 8-10,
although
It may be possible to earn a higher profit(15) with A, management might still want to choose B because the
lowest profit possible is 8, not 5 like A, and management don’t want to risk getting a lower profit than 8.
3. A
RISK AND UNCERTAINTY:

1. RISK : Where there is relevany past experience to enable statistical evidence to be produced for predicting
the possible outcomes
2. UNCERTAINTY : where there is little statistical evidence to enable the possible outcomes to be predicted.
PROBABILITIES:
1. EVENT OR STATE OF NATURE : uncontrollable factors which could occour eg similar product launched by a
competitor, at higher price or lower or same price etc. each of these is an EVEN which can have a probability.
2. PROBABILITY: normally expressed with a value of between 0 and 1. 0.7 means it is likely to occour 7 times
out of 10. ALL THE PROBABILITIES added TOGETHER MUST = 1. The advantage of this method is that it
provides more meaningful info. than stating the most likely outcome – ie not probably cold, but 0.6 probably
cold and 0.4 probably hot.
3. PROBABILITY DISTRIBUTION: list of all outcomes and the possibility they will occour.
4. OBJECTIVE POSSIBILITIES : where a probability can be established mathematicly eg toss a coin:heads
=0.5
5. SUBJECTIVE POSSIBILITIES : where on must use judgement – or just estimate the possibility because it
cannot be worked out mathematicly- these estimates are bound to be subject to error.
PROBABILITY DISTRIBUTIONS AND

EXPECTED VALUE:
EXPECTED VALUES :
1. By showng a Probability Distribution the advantage of this method you gain is that it provides more
meaningful info. than stating the most likely outcome – ie not probably cold, but 0.6 probably cold and 0.4
probably hot.
2. EXPECTED VALUE : this is the sum of all the probabilities together, added up and mathematicly adjusted to
give one final answer. It can be a better method than just choosing one of the possibilities as the ‘single most
likely estimate’ you think will happen.
3. METHOD TO CALCULATE : you just multiply each Value/Amount by its corresponding probability and add
all the answers up to get the ‘EXPECTED VALUE’. REM all the probabilities together must add up to 1 exactly
or this method will not work. See example below.
STANDARD DEVIATION : MEASURING THE

AMOUNT OF CERTAINTY
1. STANDARD DEVIATION : basicly it is how far on average the values are from the mean. It is the
‘conventional measure of dispersion of a probability distribution.’ It is the sq root of the mean of the squared
devations from the expected value.
1.1. One cannot use standard deviation for comparing the results of 2 different probability distributions with
different expected values , esp if the different values in the probability distribution are much larger than
the other- because the higher all the amounts, the greater will be the distance from the mean.(if you talk
thousands , then it is maybe 100 from the mean, but if you talk 100’s then it is maybe 10 from the mean
– even though it is the same % wise.To compare you must use ‘coefficient of variation’ below.
1.2. METHOD :To calc. Standard Deviation use the following formula :
2. Coefficient of Variation : it is basicly standard deviation converted to % .This is useful because you can
compare 2 completely different Probability Distribution tables- which you cannot do using plain standard
deviation.
2.1. METHOD : it is simply the “standard deviation” divided by the “expected value” = a fraction eg : 0.24
which means 24%.
3. USEFULLNESS : in some instances it is easy for management to compare ‘probability distributions’ but where
there are many of them it may be easier to compare “expected values’ and ‘coefficients of variation’.
ATTITUDES TO RISK BY INDIVIDUALS:

1. There are 3 different types of investor:
1.1. RISK SEEKER ( takes high profit option)
1.2. RISK NEUTRAL ( dos’nt matter)
1.3. RISK AVERSE. ( takes least risky option)
2. Studies of security market show most investors are risk averse.
3. Due to the nature of expected values it is unwise for managers to make a choice based only on expected
values, it should be supplemented by standard deviations and also ‘probaibility distrubtion’ table of all possible
events to actually compare each one. :REASON if 2 investors toss a coin for 5000, then the expected value for
each guy would be 250 (o.5 x 500 + 0) . So half the of all the investors here would be making a bad decision
based purely on expected values.
DECISION TREE ANALYSIS:

1. In practice more than 1 variable may be uncertain and also the values of some variables may be dependant
on the values of other variables. A useful tool here is the ‘decision tree’
2. METHOD:
2.1. each alternative course of action is sown by a branch, which in turn leads to subsidiary branches for
further courses of action or possible events.
2.2. Boxes on the diagram indicate where a decision must be taken , and circles indicate where
‘events’ /’different environmental factors’ will affect the consequences of prior decisions(see example
below).The branches from ‘events’ indicate the different possible types of ‘states of nature’ that may
occour.
2.3. Each branch gets a possibility assigned to it. The sum of probabilities for each branch from any 1 single
point must be 1. (not counting the probabilities of sub-branches)
2.4. At the very end of each long joined line must be a value – an amount how much that end point will be
worth- eg a loss of 100 or a profit of 1000.
2.5. You just multiply the final probability of each end of line by its amount to get the “Expected Payoff” from
choosing that option.
2.6. Joint Probability :Note that the Joint Probability of 2 events occouring together is the probability of 1
event X probability of other event. So if there are many different sub-branches leading to an end point,
each with its own probability, then the final probability of that end point is all the probabilities leading to it
multiplied together.
2.7. Management should be presented with a table of 1- final probability 2- actual possible amount from that
probability 3- expected value (statisticly)from that probability ie 1 X 2 = 3. They must look at all 3 figures
because just looking at (1) and (2) because looking at (3) can be very misleading .(explained above in no
3 of former heading)
BUYING PERFECT AND IMPERFECT

IMFORMATION:
1. This is where one wants to know what the value we are prepared to pay for certain information about a
product or other decision is.
2. The method one uses is to compare the expected value of a decision oif the info. is acquired against the
expected value with the absence of the info.
2.1. What you do is to first find the expected value of each option.
2.2. Then find the expected value if you were to know exactly whci option to choose( since you don’t know yet
you must find multiply the ‘highest expected values’(since you will have the info.) by the possibility of
each occouring. (this goes the other way from rows to columns compared to the task in step 1). take the
highest value in each case/possible EventWantingKnowledge and multiply it by the possibility of that
event taking place.(event is high or low demand in example below).
2.3. The answer is to first find the difference between the ‘expected value’ difference with the market survey
from the expected value without the market survey- so if you kenew against if you don’t know. See
example.
2.4. is less than £20 000, the firm of market consultants should be employed.
2.5. In the below illustration it was assumed that the additional information would give a 100 pa cent accurate
prediction of the expected demand. In practice, it is unlikely that perfect information is obtainable, but
imperfect information (for example, predictions of future demand ma be only 80 per cent reliable) may
still be worth obtaining. However, the value of imperfect information will always be less than the value of
perfect information except when both equal zero. This would occur where the additional information would
not change the decision. Note that the principles that are applied for calculating the value of imperfect
information are the same those we applied for calculating the value of perfect information, but the
calculations are more complex. For an illustration see Scapens (1991).
MINIMAX MAXIMIN AND REGRET

CRITERIA:
1. In some situations it might not be possible to assign meaningful estimates of probabilities topossible
outcomes. In this situation managers could use any of the following :
1.1. MAXIMIN CRITERION : YOU ASSUME automaticaly that the worst outcome will always happen. In the
above example (from buying perfect info.) you would say the worst outcomes are 100000 for machine A
and 10000 for B. so you would choose A under the supposition that if the worst happens.
1.2. MINIMAX CRITERION : You assume the best will happen. So the highest payoffs are 160000for A and
200000 for B. So you would choose B., assuming that the best would happen.
1.3. REGRET CRITERION : means that having selected an alternative that does not turn out to be the best,
the decision maker will regret not having chosen another alternative when he had the opportunity. So you
check every possibility individually and see if you chose that one , and some other one happened, what
will be your worst regret amount for that one – your worst ‘loss’. Now do this for every choice possible
and compare all your answers. The one where you loose the least is your answer. Say eg 100 for a , 10
for b and 30 for c. So you would choose B because it has the ‘Least Risk”
RISK REDUCTION AND DIVERSIFICATION

1. A firm should adopt a ‘diversification strategy’ so that if something goes wrong with one division, the other
divisions will at least still keep it afloat. ( not put all your eggs in 1 basket)
2. You consider the following characteristics:
2.1. Risk:
2.2. Expected Return:
3. The correlation co-efficient must be closer to -1 than to + 1for all your different risks – that means if it is a
perfect -1 that none of the risks correlate – they all go in exactly opposite directions(umbrellas and ice-cream)
4. So here it is not the risk of individual projects but the incremental risk to the company that count.
5. See example for how it works: you could also have a probability of 0.7 for rain & 0.3 for sun, then you just }
multiply 0.7 X {umbrella amount + ice-cream amount} for each sun and do the same for rain (o.3) and
compare the 2 to see if you will be in any sort of trouble if any of the 2 happen.
1-CHAPTER 8 :BUDGETS(ch8Viggio book)

Still add a raw materials needed per product budget- check all last years budgets for an example of this-
magato-
PRINCIPLES OF BUDGETING:
1. DEFINE BUDGETING:
1) Definition: Budgeting :are accounting plans that normally serve the purpose of quantifying the objectives
of the firm and provide a basis for control and performance evaluation. It is long & short term goals that are
quantified Financially OR Physically. Important is Comparison between goals & results.
3 CATEGORIES OF BUDGETS:
1) Operating Plans:
a) Operating plans are directed at the Production and Investment objectives of the firm.
2) Administrative Plans
a) These form the objectives of the development and maintenance of the Companies
structure.
3) Strategic Plans
a) Long term company objectives in relation to Competitors , Company growth, and
Philosophy.
REASONS FOR BUDGETING:
1) Periodic Planning : budgeting process’ creates a formal planning framework that provides specific
deadlines for each phase of the planning process:
2) Co-ordination of company activities and quantification of objectives. : exchange
ideas between various company segments +quantify costs of available alternatives + compare cost/revenue of
each product&dept.
3) Performance evaluation : compare actual to original or flexed budget.
4) Cost Awareness : promote cost awareness in managers who are normally concerned with other things
eg production or marketing strategy.
5) Goal Orientation. : makes depts. achieve com0pany goals, not their own goal. Often highlighted in the
the transfer and use of products intercompany- looks like nothing but it could be too much.
FINANCIAL & MANAGEMENT BUDGETING:
1) Define the objectives of the budgeting system to prevent: a battle of wills to by dept managers to get the
Max. expenditure and the Min. results.(to just keep fin. Managers happy)
2) Companies must realize there are 2 separate budgetry functions in the corporate objectives
a) Financial control: ie the Master Budget incorporating all the financial budgets.
b) Management Control : Line & production managers : system should allow greater freedom of action by line
managers varying from specific details to more general target specifications thereby improving attitude of
workers etc.
LONG TERM PLANNING:
1) Concerned with defining company objectives eg:
a) Profit maximization
b) Or Increase market share
c) Or Improve company image
d) Or Increase shareholder wealth
e) Or non-financial issues
i) Eg :environmental issues /
ii) Employee job satisfaction
iii) Improve company image ( where do we want to be in 10 years)
iv) Environmental issues.
v) Staff training
2) 5-10 years management to look at where it wants to be : as per asset base + labour force + market share. +
non-financial issue (as mentioned above)
3) Strategic Planning Requires :(it is a whole process to be read up about)
a) SWOT ananlysis : Strengths & Weaknesses + Opportunities & Threats evaluation.
b) Establish Data Banks to provide past & current information for planning.
c) Establish Preliminary Long Term Forecasts.
d) Review Expectations of internal + external company participants.
4)
5) See where resources are to be directed.
6) Most common Problems with Strategic Planning:
i) To make managers do Long term goals because they are vague and do not allways cause short term
profit (no-bonuses) etc.
ii) The assumption that historical data can be extrapolated to the future because unknown economic &
political changes make future strategies void within a short time.
POSITIVE FACTORS OF BUDGETING
BUDGETING & THE HUMAN FACTOR

1) Meeting goals means employees must 1- understand them and 2-act in certain manner to meet them
2) Coersion is often used eg : bonus or take action if budgets not met.
3) Lack of consultation as to employees reaction can lead to industrial disputes.
4) Dangers of Strict Performance Evaluation :Line managers could make sure budget is not bettered as future
budgets will be even more stringent.- ie deviousness. Also manipulate data and dysfunctional behavior to get
around tight budgets.
5) Defined, quantitative targets are more likely to motivate management to perform well, even if they are
difficult, as long as they are accepted by management.
6) Budgets will motivate workers if they represent a set of definite, quantitative goals, together with regular
feedback on the attainment of the standards. It is therefore essential that management is involved in setting
standards and budgets.
7) Companies should strive for a budgetary system that will achieve complete goal-congruence between the
workers and the company.
8) Positive aspects of budgeting
9) If the budgeting system creates a negative reaction in workers, who may see the system as unfair and
inequitable, you will create a subversive spirit leading to dysfunctional behaviour in conflict with corporate
goals.
The budgeting process should, where possible, be structured in such a

• El sets appropriate standards of performance:
• El defines good performance and provides a means of measuring such pertormance, anc
• U stipulates how rewards are to be linked to results.
• El Communication of corporate objectives and budgetary guidelines to all people responsible for budget
preparation.
• El Determination of the success factors of the company.
• El Full participation by all line management, with a commitment to meet corporate goals.
• II Preparation of the sales budget.
• El Preparation of budgets for all major operating activities.
• U Negotiation of budgets and standards.
• Co-ordination and review of budgets.
• El Acceptance and communication of all budgets by managers who will bear responsibility.
• El Frequent feedback of actual performance against budget targets.
• El Flexible budgeting capabilities.
• El Monetary and non-monetary incentives.
STAGES IN BUDGETING:
METHOD FOR BUDGETS:
1. MASTER BUDGET:
1) The master budget is the total budget package for a company; It is the end product of the budget preparation
process. The master budget consists of all the individual budgets for each part of the company aggregated
into one overall budget for the entire company. The development of the master budget is a sequential
process, in which information from one budget is carried forward to another budget. Some elements, such as
the capital expenditure budget, are independent.
2) Components of the master budget

• Operating budget
• Sales budget
• Budget of ending inventories

• Production budget:
— Materials budget
— Direct labour budget
— Manufacturing overhead budget.
• Budgeted cost of goods sold
• Administrative expense budget
• Marketing expense budget
• Budgeted net income from operations
• Budgeted non-operating items
• Budgeted net income
FINANCIAL BUDGET
Consists of the following parts:
• Capital expenditure budget
• Budgeted statement of financial position (balance sheet)
• Budgeted statement of changes in financial position
OPERATING BUDGET
• The operating budget is composed of the income statement elements. A manufacturing business budgets
for both manufacturing and non-manufacturing activities. We will discuss the various elements of the
operating budget of a manufacturing firm shortly.
CASH BUDGET: (OR CASH FLOW STATEMENT)

• Cash Budget is one of the most important budgets because it shows how liquid a company is.
• Normally prepared Weekly or Monthly as they are required for management (liquidity) information.
KEY PREPARATION OF CASH BUDGET STEPS

Notes :
1.Rem: wessels calls Gross Profit of 45% to meanit is gross profit on “sales” x 45% = profit so sales x
55%= cost of sales/inventory/purchases. Other lecturers seem to call the same thing as to mean it
is on “cost of sales” X 45 % = profit so always ask the lecturer what they means by “gross profit of
45%
2.Remember if they say bad debts = 5% of all credit sales, and they give you a figure for credit+cash sales
combined, and say credit=40% and cash = 60% ,you cannot say total X (40%-5%=35%) = credit sales after
bad debts , it will give you a wrong figure. You must say: first get credit sales ie 40% X total, then after that
deduct bad debts.
3.If they say company contributions:

3.1. are payable on 7th of following month, it means they ONLY pay then , not before ever.
3.2. Company contributions are not deducted from salary, it is paid by company separately.
3.3. Secondary tax on companies on DIVIDENDS is not ever deducted from the dividends declared. What is
declared is what will be paid, and any tax is worked out before this. So if they say dividends of 10000 and
secondary tax = 10% of dividend declared it does NOT mean deduct 10% from 10000, it means 10000
for dividends and 1000 for STC(secondary tax) =11000.
4.Rem: depreciation and other non-cash expenses always DO NOT appear, are removed from, the cash budget.
First you prepare the Debtors Collection Schedule, then the Creditors Payment Schedule, and then you can go
and prepare the final Cash Budget (or also called the Cash Flow ). Also , it is one of the last budgets one
prepares, because you must do all the sales,production, purchases etc budgets first to get all the figures you
need.
The cash budget is one of the most important budgets as it shows how liquid the company is at any point in time.
Cash budgets are normally prepared weekly or monthly, as they are required for management information.
Key factors in preparing a cash budget are
Establish opening cash balance
Estimate cash from operations, ie net income after adjusting for non-cash items such as depreciation
Estimate timing of debtor cash receipts taking into account customer payment behaviour
Include all non-operating cash items such as capital purchases, repayment or advances on loans, etc
Estimate the amount and timing of credit payments, salaries and wages
The difference between the net income figure and net cash flow is explained to a large extent by the
changes in working capital.
Note: The cash budget is normally the more complex budget to complete, because non-cash items appearing in
different budgets must be adjusted for (removed). Receipts &payments also usually lag behind periods incurred in
Note: Esp. in exam, it is recommended to first draw up a diagram to determine where cash flows take place.
STEP 1 DEBTORS
COLLECTION
SCHEDULE:
MONTH TOTAL JAN FEB MAR
December - 10000 (if8000
credit(cash in from it
previous credit sales) is
calculable
)
January-Cash 20000 20000
January-Credit 80000 16000 40000 20000
Feb-Cash 24000 24000
Feb-Credit 96000 19200 48000
Mar-Cash 32000 32000
Mar-Credit 128000 25500
Capital expenditure 1000 500 500
Loan repayments 5000 1000 2000 2000
Etc. 10000 5000 5000 0
TOTALS This total will 52500 98250 127500
include
april,may,etc
,so leave
out.
January-Cash 100% AS
PER
exercise
January-Credit(cash in 20% 50% 25%
from previous credit
sales)
Feb-Cash 100%
Feb-Credit 20 50%
Mar-Cash 100%
Mar-Credit 20%
Workings for Debtors Schedule: (rather write jan/feb with/ instead of %) : see all the calculations on
the left of this debtors schedule for how to do the calculations.
STEP 2: CREDITORS PAYMENTS SCHEDULE

• You can do the same type of creditors payment schedule as above
• or.
• Rem: wessels calls Gross Profit of 45% to meanit is gross profit on “sales” x
45% = profit so sales x 55%= cost of sales/inventory/purchases. Other
lecturers seem to call the same thing as to mean it is on “cost of sales” X 45
% = profit so always ask the lecturer what they means by “gross profit of 45%
MONTH TOTAL JAN FEB MAR

January-Cash 20000 20000
January-Credit(cash 80000 16000 40000
in from previous credit
sales)
Feb-Cash 24000 24000
Feb-Credit 96000 19200 xxxxxx
iTOTALS xxxx xxxx xxxx xxxxx
• Another type of payments/purchases budget.
Creditors’ payments schedule/Purchases

March April May
Sales 100 000 105 000 117 000
Cost of sales 66 667* 70 000* 78 000*
Opening Stock (15 625)* (60 000) (60 000)
100
Closing Stock (90 000 x /150) 60 000* 60 000* 60 000*
Increase Stock 44 375* - _ - _
Purchases 111 042 70 000 78 000
Discount @ 4% (4 442)* (2 800)* (3 120)*
106 600 67 200 74 880
Solution: CASH BUDGET or CASH FLOW

STATEMENT
Jan Feb Mar Apr Total
Open Bank (10000)(eg: from (142000) (from

Balance material being paid 1 below left)
Qtr in advance)
Sales 0(there were sales 60000(cash
but no receipts of received for previous
cash yet) sales etc.)
Total (10000) Etc Etc Etc Etc
Less:materials (80000) Etc Etc Etc Etc
Less:labour (10000) Etc etc Etc Etc
Less:other (20000) Etc Etc Etc Etc
Less:etc (22000) Etc Etc etc Etc
Closing Bank (142000) Etc Etc etc Etc
Balance
SALES BUDGET:
1) The sales budget is the first budget to be prepared, and it is usually considered the most important budget
because so many other budgets are directly related to sales and are therefore largely derived from the sales
budget.
2) Factors that are taken into account include
(a) Decisions taken by competitors
What the competitors are doing is important, as we need to consider whether we are likely to gain or lose
market share. Perhaps we should even consider diversifying.
(b) State of local and world economy
We need to consider our current markets as well as the potential for export. Local and world trends are
important, especially as the two begin to merge as lechnological advances improve. We need to consider
inflation rates, exchange rates and cost of debt.
(c) International markets
These must be considered from both the exporting side and the effect that imported goods will have on
our projected sales.
(d) Effectiveness of advertising and promotion policies
The effect that advertising will have on our product needs to be considered. Where necessary, surveys
should be carried out to ascertain consumer tastes. Demand elasticity should also be ascertained in setting
a pricing strategy.
(e) Effects of seasonal fluctuations
We need to ascertain if there are any seasonal or cyclical trends that should be considered in creating our
objective or subjective forecasts.
(I) Stability of supplies
Consideration of supply lines is important, as disruption will cause production bottlenecks that will affect
sales.
(g) Historical data
In preparing forecasts, it is always important to analyse historical data to ascertain trends and determine
whether future expectations are likely to mirror historical trends.
Key General Budgeting Factors
1) The key to budgeting lies in the recognition of the sales market as well as the production limitations.: These
are:
a) Expected Sales levels of products
b) Production capacity dictated by space, machine output, availability of labour and material.
c) Financial Resources, both short and long term
Sales Budget (EXAMPLE per

viggio)
JUNE Total JUL Total AUG Total

Value Value Value
Products Price Units Total Units Total Units Total
Value Value Value
June
Mondi 120 1000 120,000 Etc etc etc Etc
Hilton 150 2000 300,000 Etc etc etc Etc
420,000 Etc etc etc Etc
OR ALTERNATIVELY YOU CAN USE THIS LAYOUT, IF THERE are workings to be shown in the columns,
and not enough space etc.
Products Price Units Total Value

June
Mondi 120 1000 120,000
Hilton 150 2000 300,000
420,000
July
Mondi Etc etc
Hilton etc
etc
July
Mondi …total total …total
Hilton …total Etc …total
total
etc
Another Example Of Sales Budget “Workings”(vigio)

May June July Aug
Sales –Units 800 1000 1000 1200
Sales –Value 96000 120000 120000 144000
More “Sales” workings: (Vig) (for getting the % in weird questions with multiple % discounts etc to work out
first, before you do the answer)
May 45% 30% 15%
Jun 45% 30% 15%
Jul ` 45% 30%
Aug 45%
PURCHASES BUDGET : FOR RAW MATERIALS / OR RETAIL STOCK /OR ANY

1) One can do a purchases budget for Raw materials or Stock for a retail shop or anything else. One can do a
separate purchases budget for each of these things , then combine them in a master purchases budget, or
just add the figures from each to get the total purchases for the Budget Income Statement (SCI) or Cash
Budget(cash flow budget)
2) Before you do the purchases budget you must do the Sales Budget then the Production Budget then the Raw
Materials Opening Stock Budget etc. to get all the figures needed to do this budget. So it is one of the last
budgets you do.
PURCHASES BUDGET for: Raw Materials (MANUFACTURING)

(EXAMPLE per viggio)
1st half 2nd half Total
Material A
Required closing 13500kg Etc Etc
Stock
LESS:Opening 12500kg Etc Etc

stock
1000kg Etc Etc
ADD: materials 1250x20 Etc Etc
needed for ea=25000kg
current
production
Budget 26000 Etc Etc
Purchases
Material B.
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc
Another type of payments/purchases budget:
PURCHASES BUDGET for RETAIL SHOP STOCK.

March April May
Sales ( cosmetic ie: X 70% = 100 000 105 000 117 000
cost)
Cost of sales 70 000* 78 000* 66 667*
Opening Stock (60 000) (60 000) (15 625)*
Closing Stock (90 000 x 100/150) 60 000* 60 000* 60 000*
Increase Stock - _ - _ 44 375*
Purchases 111 042 70 000 78 000
Discount @ 4% (2 800)* (3 120)* (4 442)* OPENING STOCK
106 600 67 200 74 880 (finished goods OR raw
materials ETC) BUDGET:
1) This is a very specialized budget , actually just a calculation to work out the opening stock. The budget of this
type which would be more of a ‘budget’ is a ‘Stock’ or “stock-holding” budget –There can be many different
“stock ‘ budgets, eg 1-raw materials 2-finished goods etc.
2) A Raw Materials budget can be done in EXACTLY the same format and way- just different names&numbers.
3) This budget could be prepared in a format where the periods are in columns and materials on the left if it is
more convenient. Ie column 1=Material 2-Cost each 3- July: no.Units & Total Cost 4-Aug no.Units&Total
Cost 5-Sept. No.Units & Total Cost etc. etc. etc.
Given a policy to keep sufficient stock on hand to meet 50% of sales in following year:
1-First work out the cost of each finished goods.
Finished Goods Budget (EXAMPLE per viggio)
Products Units Cost Total Value
Opening stock Begin Year
Mondi 50%x1000=500 80 40,000
Hilton 50%x2000=1000 100 100,000
140,000
Stock Begin Second Half
Mondi Etc Etc
Hilton Etc
Year End Stock

Mondi Etc total …total …total
Hilton Etc total …total …total
PRODUCTION BUDGET:
• The production budget is dependent on the expected sales, together with required inventory levels of finished
goods. The production plan must take the opening stock levels into account, and specify the timing of
production.
• Remember: if the question says the policy of company is to keep 50% of the ‘estimated’ sales of finished
goods in stock then even if they DID NOT SAY there is any opening stock in the first year, THERE PROBABLY
IS so you must work it out as the OPENING STOCK for the first year of production ( this is a hidden figure-
not given or logical & plain)
• Production budget works on Units, not normally on Rands Value.
Given a policy to keep sufficient stock on hand to meet 50% of sales in following year:
1-First work out the cost of each finished goods.
Production Budget (EXAMPLE per viggio)
Mondi
Required closing 750 600 600
Stock
LESS:Opening 500 750 500
stock
250 (150) 100
ADD: Sales 1000 1500 2500
Budget 1250 1350 2600
Production:
Hilton
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc
OPENING STOCK -RAW / DIRECT MATERIALS- BUDGET:

Direct materials budget
• Purchases will be determined by opening stock levels, desired closing stock levels, and production
requirements. We need to consider:
○ Quantity discounts
○ Storage capacity
○ Stock and re-order levels
○ Delivery times from suppliers
○ Liquidity constraints
• So you first have to do the production budget in order to get the figures to be able to do this raw materials
budget next.
• This budget could be prepared in a format where the periods are in columns and materials on the left if it
is more convenient. Ie column 1=Material 2-Cost each 3- July: no.Units & Total Cost 4-Aug
no.Units&Total Cost 5-Sept. No.Units & Total Cost etc. etc. etc.
Given a policy to keep sufficient stock on hand to meet 50% of PRODUCTION(not sales) in next 6mnth period:
For unit calculation is was here: 50% x 1250(from previous budget) x20kg per unit= total material A needed
Raw Materials Stock Budget (EXAMPLE per viggio)

Materials Units Cost Total Value
Opening stock Begin Year
Material A 50%x1250x20=12500 2 25000
Material B 50%x1600x10=8000 5 40000
65000
Stock Begin Second Half
Material A 50%x1350x20=13500 Etc

Material B Etc
Year End Stock

Material A Etc total …total …total
Material B Etc total …total …total
LABOUR BUDGET:
1) The direct labour budget is useful for production planning as well as for personnel management. Consideration
must be given to any changes in the type of labour talent needed as a result of changes in the mix of products
manufactured and sold. Significant swings in production during the year cause much greater problems in
planning for labour than for materials and manufacturing overheads.
2) Factors requiring consideration
(a) Establish general requirements for skilled and unskilled labour
(b) Training needs
(c) Staff turnover
(d) Wage negotiating policies.
3) It is Taken from other budgets prepared for eg :Production Budget etc. above then carried on from there,
so:
LABOUR Budget (EXAMPLE per viggio)

Mondi type product.
Budget 1250 Etc Etc
Production
Direct Labour x4 Etc Etc
Hour
Total hours =5000 hrs Etc Etc
Hourly rate x10 Etc Etc
Direct Labour =R50000 Etc Etc
Cost
Hilton type product.
Budget Etc Etc Etc
Production
Direct Labour Etc Etc Etc
Hour
Total hours Etc Etc Etc
Hourly rate Etc Etc Etc
Direct Labour Etc Etc Etc
Cost
Total hours =50000 hrs Etc Etc
Hourly rate x10 Etc Etc
Direct Labour =R50000 Etc Etc
Cost
BUDGET INCOME STATEMENT/ STATEMENT OF INC&EXPENDITURE:

Taken from budgets above then carried on from there, so:
Sales 140000
Opening Stock: Finished product 65000
Opening stock: Materials 138250
Purchases: Materials 130000
LESS :Labour costs: (130 000)
473250
LESS Closing stock: Finished product (120000)
LESS Closing stock: Materials (73000)
COST of SALES: 280000 (280000)

Profit for the Year/half year/etc. 140000
Q1 Q2 Q3 Q4 Total
Sales (15000)(eg: even if (142000)
not paid for yet)
Costs
Less:materials (10000) Etc Etc etc etc
Less:labour (80000) Etc Etc etc etc
Less:other (10000) Etc Etc etc etc
Less:etc (20000) Etc Etc etc etc
Planning etc (22000) Etc Etc etc etc
Total costs ******** Etc Etc etc etc
Profit/loss (51)
NOT FINISHED YET : STILL TO DO: no

time
The following set of scans is what you could not finish due to no time:
still to study very well.as budgets are very common & important.
h
FLEXIBLE BUDGETING
1. Flexible budgeting is just taking the actual sales and making a new budget from the old one based on the
actual sales but using the old budgets costs and other figures. Then we can compare the flexible budget with
the actual budget and see all the variances that happened with costs etc. (see variable and absorbtion costing
and
2. A good example of a change in the actual sales compared to budget is the Cost-Volume-Profit (CVP) graph.
The CVP graph shows the cost structure for the company within the relevant range and the expected increase
or decrease in profits if the actual sales are different to budget. If we wish to cornpare the actual performance
to budgeted performance, we would construct a flexible budget in accorr dance with the company cost
structure and compare it to the actual results.
3. Note: The CVP chart and performance analysis are variable costing concepts and cannot be done on an
absorption costing basis. I-lowevcr, if we wish to analyse the actual results on an absorption costing basis we
can do so, hut the results will not he consistent with CVP assumptions and will not reflect a correct analysis of
performance.
4. lfwe compare the flexible budget to the actual results when analysing performance, does that mean that the
original budget is irrelewint? The original budget is very important, as it is based on the expected sales and if
the actual sales are different to the expected sales we would want to know why. A correct analysis of
performance must start with the original budget, reconcile to the flexible or standard budget followed by
analysis of variances to arrive at actual profit.
ZERO BASED BUDGETING

1. Also known as priority-based budgeting.
2. This is an extension of ABC (activity based costing budgeting) and one must first understand ABC budgeting to
be able to do this ( see ABC budgeting heading further below)
3. Decision Packages: are identified for each decision unit , each decision unit represent an operation or group
of activities that an organization undertakes. For example, managers might be asked to specify the base
package in terms of level of service that can be provided at 70% of the current cost level and incremental
packages identify higher actrivity or cost levels.
ABC BUDGETING (ACTIVTY BASED

COSTING) OR INCREMENTAL BUDGETING.
These are the only 2 pages out of the drury book on ABC budgeting.
COMPUTERISED BUDGETING
1. This new method of budgeting has reducted the workload of accountants a lot, allowing then to focus on the
important parts of the process instead of the figures . it allows easy and automatic comparison to actual and
flexible budgets and original budget.
2. It is easy for mngmnt to evaluate different possibilies eg 10% higher cost etc and do extensive what- is
analysis. So eg if credit terms are decreased to 30 days, or unit costs increase by 5% , can all be shown in
terms of a master budget instead of having to re-do all the product cost budgets or sales receipts budgets etc-
the computer does it all automaticly.
3. Control reports and revised budgets are easy in the middle of the year.
WEB- BASED BUDGETING:

1. This is an offshoot of computer budgeting allowing cost centres all over the world to update and access their
budgets and fill in all the needed info, instead of the accountant having to do costant input of info and recons.
2. Eg Clarus corporation’s Web deployed enterprise version of its budgeting tool – used by Toronto-Dominion
bank.
LINE ITEM BUDGETING

1. This is the original format of budgets esp. for non-profit organizations. Each type of expenditure has the figure
for last year,AS WELL AS this years budget, and revised budget and next years budget all in one line to be
able to compare them effectively.
2. These budgets fail to take ABC and cost centres/ wise usage of resources into consideration. See PPBS
(Planning ,Programming Budgeting Systems ) for a method suited to overcoming this (esp for non-profits eg
municipality.

Management Acc 301 Own Notes

Enviado por

Dados do documento

Descrição original:

Direitos autorais

Formatos disponíveis

Compartilhar este documento

Compartilhar ou incorporar documento

Opções de compartilhamento

Você considera este documento útil?

Este conteúdo é inapropriado?

Direitos autorais:

Formatos disponíveis

Management Acc 301 Own Notes

Enviado por

Direitos autorais:

Formatos disponíveis

MACN 301 Management Accounting: Notes Page |1

OWN Research to STILl:............................................................................................................................7

Fully Integrated Absorbtion costing System ( or “full” absorb. costing system).........................................23

assumptions of cvp analysis:.................................................................................................................35

6)relevant range and non-linear functions:..............................................................................................57

RELEVANT COSTS For Quantatative Models Under Conditions Of Uncertainty..................................................73

LINE ITEM BUDGETINGOWN RESEARCH TO

RECONCILLIATION OF ABSORBTION PROFIT TO ABSORBTION

Chapter 3 cost of capital and capital structure

1) Are the following definitions correct for DRURY book

LEARNING CURVE CHAPTER

CH 24 PLANNING CONTROL OF STOCKS

QUESTIONS CURRENT PLACE

TO SCAN IN/DO STILL:

REM: NOTES SPECIAL THINGS TO

I) (1)SEE PAGE 244 in Viggario book for Quest. + Answers.

1) How many decimals do we round off to?

DIRECT AND INDIRECT COSTS

i) In manufacturing organisations traditional product costs accumulated as follows – ( developed esp.

RELEVANT AND IRRELEVANT COSTS:

IRRELEVANT COSTS AND REVENUES:

AVOIDABLE OR UNAVOIDABLE COSTS:

-INCREMENTAL /OR DIFFERENTIAL- AND MARGINAL COSTS

JOB COSTING AND PROCESS COSTING SYSTEMS:

ABSORPTION COSTING AND VARIABLE COSTING:AND

FOR ABSORBTION COSTING THRE ARE 2 WAYS OF VALUING STOCK:1-BUDGET AND 2-

COST ABSORBTION RATE :

VARIABLE COSTING (OR MARGINAL OR DIRECT COSTING)

MAINTAINING A COST DATABASE:

FIXED AND VARIABLE PRODUCTION OVERHEADS : AND COST

UNITS vs VARIABLE COSTS GRAPH

VARIABLECOSTS: (a)TOTAL Variable Costs:(b)Per Unit (cost =R10per

PROFIT vs VARIABLE COSTS GRAPH.

FIXED PRODUCTION COSTS :

UNITS vs FIXED COSTS GRAPH

FIXEDCOSTS:(a) Total FIXED COSTS:(b) unit (supposed hyperbolic!)

Unit Fixed Cost

PROFIT vs FIXED COSTS GRAPH

SEMI-FIXED (OR STEP-FIXED COSTS) :

SEMI-VARIABLE (OR MIXED COSTS) :

“STANDARD PROFIT STATEMENT”:

(b) Cum-Dividend formula: Value = Dividend + (Do/(1+Ke)n X

2)Debt : Present value of debt:

2) Future Value FORMULA for ANNUITY DUE : FVa= I x [ {(1+i)n – 1 }/ i] (1+i)

b) FVa = future value of the annuity.

3) Present Value FORMULA for Regular ANNUITY : PVa= I x [ {1 – 1/ (1+i)n } / i]

4) Present Value FORMULA for ANNUITY DUE : PVa= I x [ ({1 – 1/ (1+i)n } / i) +

LOAN: PERIODIC PAYMENT OF A LOAN

MARKET VALUE OF A COMPANY:

2) The Market Value of a Company : there are 2 formulas :Formula 2 : V0 =

MARKET VALUE OF CONVERTIBLE DEBENTURES OR

CHAPTER 1: INFORMATION FOR DECISION

ECONOMIST VS ACCOUNTANTS VIEW

JUSTIFICATION FOR ACCOUNTANTS VIEW OVER ECON0MISTS:

ECONOMISTS VS ACCOUNTANTS COST-VOLUME-PROFIT

C.V.P. ANALYSIS. (COST-VOLUME-

ASSUMPTIONS OF CVP ANALYSIS:

STANDARD FORMULA FOR CVP (WRITE DOWN ONCE IN EXAM- MAKES

SR :Sales Revenue ( or use SP=selling price for

OR Total Sales revenue

Change in Variable Costs

COST –VOLUME –PROFIT CHART/DIAGRAM SHOWN IN A DIFFERENT WAY(VIGGARIO).

Cost-Volume Profit diagram