MA2 - Workbook1 (CHP 1 - 10) Jan19 (EO) PDF

MA2 MANAGING COST AND FINANCE
INTRODUCTION Sunway TES
MA2
MANAGING
COST & FINANCE
Sunway TES
WORKBOOK
Part 1
(Student Copy)
Version: Jan 2019
1
CONTENTS
CONTENTS ................................................................................................................................ 2
INTRODUCTION................................................................................................................................. 7
CHAPTER 1: FUNDAMENTALS OF COSTING ......................................................................................... 9
1a. Management Information Requirements ......................................................................................... 10
Topic Review (TLO 1a) ............................................................................................................ 13
1b. Cost Accounting Systems .................................................................................................................. 14
Topic Review (TLO 1b) ............................................................................................................ 16
1c. Cost classification .............................................................................................................................. 17
Topic Review (TLO A3a and b)................................................................................................ 18
1d. High-low Method .............................................................................................................................. 19
Topic Review (TLO 1d) ............................................................................................................ 21
1e. Cost Behaviour and Cost Analysis ..................................................................................................... 22
Topic Review (TLO 1e) ............................................................................................................ 23
Chapter 1 Summary ................................................................................................................................ 24
CHAPTER 2: INFORMATION FOR COMPARISION ............................................................................... 25
2a. The Purpose of Making Comparison ................................................................................................. 26
Topic Review (TLO A4a).......................................................................................................... 29
2b. Bases for Comparisons ..................................................................................................................... 30
Topic Review (TLO A4b) ......................................................................................................... 33
2c. The Forecasting/Budgeting Process and The Concept of Feed Forward and Feedback Control ...... 34
Topic Review (TLO A4c) .......................................................................................................... 37
2d. Concepts of Flexible Budgets ............................................................................................................ 38
Topic Review (TLO A4d) ......................................................................................................... 39
2e and f. Variance Calculation between Current Actual and Historical/Forecast data .......................... 40
Topic Review (TLO A4e and f) ................................................................................................ 43
2g. Identify Whether Variances Are Favourable or Adverse .................................................................. 44
Topic Review (TLO A4g).......................................................................................................... 45
2h. The Possible Causes of Variances ..................................................................................................... 46
Topic Review (TLO A4h) ......................................................................................................... 47
2i. The Concept of Exception Reporting ................................................................................................. 48
Topic Review (TLO A4i)........................................................................................................... 49
2j. Factors Affecting the Decision Whether to Investigate Variances .................................................... 50
Topic Review (TLO A4j)........................................................................................................... 51
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Chapter 2 Summary ................................................................................................................................ 52

CHAPTER 3: REPORTING MANAGEMENT INFORMATION ................................................................... 53
3a. Suitable Formats for the Presentation of Management Information According Purpose ............... 54
Topic Review (TLO A5a).......................................................................................................... 56
3b. Methods of Analysing, Presenting and Communicating Information .............................................. 57
Topic Review (TLO A5b) ......................................................................................................... 62
3c. Suitable Formats for Communicating Management Information .................................................... 63
Topic Review (TLO A5c) .......................................................................................................... 75
3d. The General Principle of Distributing Reports .................................................................................. 76
Topic Review (TLO A5d) ......................................................................................................... 77
3e. The Information Presented in Management Report ........................................................................ 78
Topic Review (TLO A5e) ......................................................................................................... 79
Chapter 3 Summary ................................................................................................................................ 80
CHAPTER 4: ACCOUNTING FOR MATERIALS ...................................................................................... 81
4a. Main Types of Material Classification ............................................................................................... 82
Topic Review (TLO B1a) .......................................................................................................... 83
4b. The Procedures and Documentation Required ................................................................................ 84
Topic Review (TLO B1b).......................................................................................................... 85
4c. Methods Used to Price Materials Issued from Inventory ................................................................. 86
Topic Review (TLO B1c) .......................................................................................................... 93
4d. The Accounting for Material Costs ................................................................................................... 94
Topic Review (TLO B1d).......................................................................................................... 95
4e. Material Input Requirements, and Control Measures, where Wastage Occurs............................... 96
Topic Review (TLO B1e).......................................................................................................... 97
4f. The Procedures Required to Monitor Inventory and Minimise Discrepancies and Losses ............... 98
Topic Review (TLO B1f) ........................................................................................................ 102
4g. The Costs of Holding Inventory and of Being Without Inventory ................................................... 103
Topic Review (TLO B1g) ........................................................................................................ 104
4h. Inventory Control Levels ................................................................................................................. 105
Topic Review (TLO B1h)........................................................................................................ 106
4i. Optimal Order Quantities ................................................................................................................ 107
Topic Review (TLO B1i) ......................................................................................................... 109
4j. The Relationship between Materials Costing System and Inventory Control System .................... 111
Topic Review (TLO B1j) ......................................................................................................... 112
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Chapter 4 Summary .............................................................................................................................. 113

CHAPTER 5: ACCOUNTING FOR LABOUR ......................................................................................... 114
5a. The Labour Remuneration Method ................................................................................................ 115
Topic Review (TLO B3a) ........................................................................................................ 118
5b. Payroll Accounting System ............................................................................................................. 119
Topic Review (TLO B3b)........................................................................................................ 120
5c. Direct and Indirect Labour Costs ..................................................................................................... 121
Topic Review (TLO B3c) ........................................................................................................ 124
5d. The Procedures and Documentation Required .............................................................................. 125
Topic Review (TLO B3d)........................................................................................................ 126
5e. The Accounting for Labour Costs .................................................................................................... 127
Topic Review (TLO B3e)........................................................................................................ 128
5f. Labour Costing and Payroll Accounting Systems ............................................................................. 129
Topic Review (TLO B3f) ........................................................................................................ 130
5g. The Causes and Costs of, and Calculate, Labour Turnover ............................................................. 131
Topic Review (TLO B3g) ........................................................................................................ 133
5h. Measures of Labour Efficiency and Utilisation ............................................................................... 134
Topic Review (TLO B3h)........................................................................................................ 135
Chapter 5 Summary .............................................................................................................................. 136
CHAPTER 6: ACCOUNTING FOR OTHER EXPENSES ........................................................................... 137
6a. Nature of Expenses by Function ..................................................................................................... 138
Topic Review (TLO B3a) ........................................................................................................ 139
6b. Procedures and Documentation Required ..................................................................................... 140
Topic Review (TLO B3b)........................................................................................................ 141
6c. Capital and Revenue Expenditure and the Relevant Accounting Treatment ................................. 142
Topic Review (TLO B3c) ........................................................................................................ 143
6d. Depreciation Charges ..................................................................................................................... 144
Topic Review (TLO B3d)........................................................................................................ 147
6e. Relationship between the Expenses Costing System and the Expense Accounting System .......... 148
Topic Review (TLO B3e)........................................................................................................ 149
Chapter 6 Summary .............................................................................................................................. 150
CHAPTER 7: ABSORPTION COSTING ............................................................................................... 151
7a. The rationale for absorption costing .............................................................................................. 152
Topic Review (TLO C1a) ........................................................................................................ 153
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7b. The Nature of Production and Service cost Centres....................................................................... 154

Topic Review (TLO C1b)........................................................................................................ 155
7c. Allocation, Apportionment and Re-apportionment of Production Overheads .............................. 156
Topic Review (TLO C1c, d, e) ................................................................................................ 163
7f. Production Cost Centre Overhead Absorption Rates ...................................................................... 165
Topic Review (TLO C1f) ........................................................................................................ 167
7g. The Relative Merits of Actual and Pre-Determined Absorption Rates. .......................................... 169
Topic Review (TLO C1g) ........................................................................................................ 170
7h. The Analysis and Interpretation of Over/Under Absorption .......................................................... 171
Topic Review (TLO C1h)........................................................................................................ 172
7i. Methods of Attributing Non-Production Overheads to Cost Units. ................................................ 173
Topic Review (TLO C1i) ......................................................................................................... 174
7j. Calculate product costs using the absorption costing method. ...................................................... 175
Topic Review (TLO C1j) ......................................................................................................... 176
Chapter 7 Summary .............................................................................................................................. 177
CHAPTER 8: PROFIT REPORTING .................................................................................................... 178
8a. Concept of Contribution ................................................................................................................. 179
8b. Marginal Costing Method ............................................................................................................... 181
8c. Absorption Costing Method ............................................................................................................ 184
Topic Review (TLO C2c) ........................................................................................................ 186
8d. Period Profit Reporting and Inventory Valuation ........................................................................... 187
Topic Review (TLO C2d)........................................................................................................ 188
8e. Profits Reported by Absorption and Marginal Costing ................................................................... 189
Topic Review (TLO C2e) ........................................................................................................ 191
8f. Usefulness of Profit and Contribution information ......................................................................... 192
Chapter 8 Summary .............................................................................................................................. 194
CHAPTER 9: JOB AND BATCH COSTING ........................................................................................... 195
9a. The Use of Job and Batch Costing ................................................................................................... 196
9b. Calculation in Job and Batch Costing .......................................................................................... 199
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9c. Control of Costs .............................................................................................................................. 201

9d. Application ..................................................................................................................................... 203
Chapter 9 Summary .............................................................................................................................. 205
CHAPTER 10: PROCESS COSTING .................................................................................................... 206
10a. Use of Process Costing ................................................................................................................ 207
10b. Normal and Abnormal Losses/Gains ........................................................................................... 209
10c. Unit Costs .................................................................................................................................... 211
10d. Process Accounts ......................................................................................................................... 213
10e. Scrap and Waste .......................................................................................................................... 217
Topic Review (TLO C4e) ........................................................................................................ 219
10f. By-products and Joint Products................................................................................................... 220
10g. Accounting for by-products and Joint Products .......................................................................... 222
Topic Review (TLO C4g) ........................................................................................................ 223
10h. Joint Process Costs ...................................................................................................................... 224
Topic Review (TLO C4h)........................................................................................................ 227
10i. Profit Cost/Profit Data ................................................................................................................. 228
Topic Review (TLO C4i) ......................................................................................................... 229
10j. Further Processing ....................................................................................................................... 230
Topic Review (TLO C4j) ......................................................................................................... 231
Chapter 10 Summary ............................................................................................................................ 232
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INTRODUCTION
Relational Diagram of MA2 and MA1 topics in this chapter

MA2 MA1
Chapter 1: Management Information Chapter 2: Management information
A1 Management Information Requirements A2 Management Information
Describe the purpose of management
A 1a information: planning, control and decision- A2a State the purpose of management information
making.
Describe the features of useful management Describe the features of useful management
A 1b A2d
Information Information
Describe the nature, source and importance of
Describe and identify sources and categories of
A 1c both financial and non-financial information A2e
information
for managers
a. Explain and illustrate the concept of
Describe management responsibilities for cost, cost centres.
profit and investment and their effect on b. Explain and illustrate the concept of
A1d C2
management information and performance profit centres.
measurement c. Explain and illustrate the concept of
investment centres.
Explain the role of information technology in Identify the key features, functions and benefits of
A 1e A1g
management information a computerised accounting system
Describe the role of a trainee accountant in a cost
A 1f Explain the role of the trainee accountant A2g
and management accounting system
A2 Cost Accounting systems

a.
Describe and illustrate the use of ledgers
Explain the relationship between the
A1f and prime entry records in both integrated
cost/management accounting system and the
and interlocking accounting systems.
A 2a financial accounting/management
b. Identify the key features, functions and
information systems (including interlocking
A2b benefits of a computerised accounting
and integrated bookkeeping systems)
system.
Describe the process of accounting for input a) Describe the procedures and documentation
A 2b B1b,c,d
costs and relating them to work done to ensure the correct authorisation, analysis
and recording of direct and indirect material
costs.
b) Describe the procedures and documentation

to ensure the correct authorisation, coding,
Identify the documentation required, and the
analysis and recording of direct and indirect
A 2c flow of documentation, for different cost B1b,c,d
labour and expenses.
accounting transaction
c) Describe the procedures and documentation
to ensure the correct analysis and recording
of sales.
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a) Explain and illustrate the use of codes in

categorising and processing transactions.
Explain and illustrate the use of codes in b) Explain and illustrate different methods of
categorising and processing coding data. (including sequential,
A 2d B2
transactions(including sequential, hierarchical, hierarchical, block, faceted and mnemonic).
block, faceted and mnemonic coding methods
c) Identify and correct errors in coding of
revenue and expenses.
Explain and illustrate the concept of cost

A 2e C2a Explain and illustrate the concept of cost units
units
a) Job costing
(i) Describe the characteristics of job
costing
(ii) Calculate unit costs using job costing.
b) Batch costing
(i) Describe the characteristics of batch
costing.
(ii) Calculate unit costs using batch costing.
c) Process costing
Describe the different methods of costing (i) Describe the characteristics of process
A 2f final outputs and their appropriateness to D4 costing.
different types of business organisation (ii) Calculate unit costs using process
costing. (note: split of losses into normal
and abnormal is excluded)
(iii) Describe and illustrate the concept of
equivalent units for closing work in
progress.
(iv) Calculate unit costs where there is
closing work-in-progress.
(v) Allocate process costs between finished
output and work-in-progress.
(vi) Prepare process accounts.
Describe methods of capturing, processing,

Identify the key features, functions and benefits of
A 2g storing and outputting cost and management A1g
a computerised accounting system.
accounting data by computer
A3 Cost Classification C1 Chapter 5: Cost Classification

Describe the variety of cost classifications Define cost classification and describe the variety
used for different purposes in a cost of cost classifications used for different purposes in
A 3a C1a
accounting system, including by responsibility, a cost accounting system, including by
function, direct/indirect, behaviour responsibility, function, behaviour, direct/ indirect
Explain and illustrate the nature of variable,
Describe and illustrate the nature of variable, fixed
A 3b fixed and mixed (semi-variable, stepped fixed) C1b
and mixed (semi-variable, stepped fixed) costs
costs
Use the high-low method to separate semi-
A 3c new
variable costs
Use variable, fixed and semi-variable costs in
A 3d new
cost analysis
Analyse the effect of changing activity levels
A 3e new
on unit costs
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CHAPTER 1: FUNDAMENTALS OF COSTING Sunway TES
CHAPTER 1: FUNDAMENTALS OF COSTING
Learning Outcomes
At the end of the chapter, you should be able to:
TLO 1a. Describe the management information requirements.
TLO 1b. Describe the cost accounting systems.
TLO 1c. Describe the variety of cost classifications for a cost accounting system.
TLO 1d. Apply the high-low method to separate semi-variable costs.
TLO 1e. Use variable, fixed and semi-variable costs in cost analysis.
TLO 1f. Analyse the effects of changing level of activity on costs.
The first three TLOs are purely re-visits of concepts and components already introduced and discussed at
length in MA1. These TLOs are separately but briefly discussed in sections 1a to 1c. Key terms and concepts
are re-visited just to ensure that you are ready to embark on the newer contents of cost accounting in this
MA2 syllabus.
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1a. Management Information Requirements

Learning Outcome (ACCA Study Guide Area A Topic A1):
Describe the management information requirements.
Purpose of Management Information
Management information refers to processed data that which are

more meaningful and understandable to design plans and
controls, and make appropriate and informed decisions, in order
to meet organisational goals.
The purpose of it lies in its definition – to make informed

decisions, and to meet organisational goals efficiently and
effectively!
Features of Useful Management Information
Useful management information is said to have the following

qualities:
 Sufficiently accurate
 Reliable
 Understandable
 Complete
 Timely
 Relevant
Further qualities include cost effectiveness and that it must be

communicated to the correct user(s).
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Nature, Source and Importance of Management Information
Where does data and information come from?
 Within the organisation (internal), or from outside (external).

 Routine data collection, or from an extraordinary task.
 A formal setting, or an informal one (like grapevine).
 Primary sources – questionnaires, observation, recordings, or
conversations.
 Secondary sources – readings from newspaper or magazines.
Wherever the data comes from, it is important that it serves the

intention for which the data is gathered.
Responsibility Centres
These are work units (such as departments or projects) with

managers who are held accountable for the decisions within their
areas of control. This concept is called responsibility accounting.
Managers are only assessed based on the controllable
performance.
There are four types of responsibility centres – cost, revenue,

profit and investment.
Cost centres are work units where only cost data are available.
The centre is not responsible for revenue generation, but more to
the creation of the product. Revenue centres are where revenue
data are way more significant than the costs incurred. Most often,
these centres are service providing units.
Profit centres are parts of the organisation that focuses on both

cost and revenue. However, the managers do not make decisions
on asset acquisition and related-investment matters. That would
be the investment centres’ function. Managers of investment
centres make decisions on costs, revenues and investments,
including purchase of non-current assets.
It is important to know to measure the performances of all these

responsibility centres, which has been fully covered in MA1.
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Role of Information Technology in Management Information
In this era of high-end technology, it is impossible and unwise to

run operations without computer intervention. Computer
systems are needed to capture, maintain, process and
communicate data and information as efficiently and effectively
as possible.
Common data capture methods these days are beyond keyboard

and mouse. Nowadays, it would be rare to see cashier counters
without bar code readers. Examination scripts are marked using
optical mark reader (OMR) and optical character reader (OCR)
systems. Both desktop and handheld computers can do many
tasks these days compared to 3 decades ago.
So computer or information systems are integral parts of any

industry, including accounting.
Trainee Accountant
The primary role of the trainee accountant would be to process data

(primarily accounting data) and report relevant information to users
that need that information. Findings need to be documented on
reports. They do not make major decisions just yet.
Their common responsibilities include:
 Inventory valuation.
 Preparation of budgeted statements.
 Computation of variances and preparation of suitable reports
for that.
 Financial data analysis.
 Answer a lot finance-related questions within the
organisation.
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Topic Review (TLO 1a)

Learning Outcome (ACCA Study Guide Area A, Topic A1):
Describe the management information requirements.
Get into a group of four. Select an organisation of your choice.
Discuss:
1. The sources of data and information for that organisation.
2. The responsibility centres in that organisations, including reference to specific departments.
3. Areas in which IT will be required, and for what purposes?
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1b. Cost Accounting Systems

Describe the cost accounting systems.
Relationship Between Accounting Systems
The financial and management accounting systems use the same

data but use and analyse differently. They are inseparable
because they both feed each other relevant data. Output of one
system becomes the input of the other.
The two accounting methods may be dealt with together in an

integrated accounting system, or separately in an interlocking
system. The features of these systems have their share of
advantages and disadvantages. In terms of cost, integrated
systems are cheaper because the contents are all placed together,
but can be extracted out as per users’ needs, and it requires only
one-time data entry. But to distinguish financial and management
accounting data easily, interlocking would be preferred.
Accounting for Input Costs and Documentation Involved
There are many ways to compute and account for input costs. As
such, all cannot be discussed here. The upcoming chapters will
address these MA1 repeat areas in depth and with more
elaboration.
The appropriate procedures and relating documentation of for all

these input or resources are important to ensure products are
properly cost and sold at profitable prices.
Codes
The aim of using codes is quite direct: To simplify data entry. They
not only expedite data collection but also the processing and
communication of information.
Different types of coding system are used to contain different

types of data. Codes are expected to be clear in meaning, and
uniform in structure.
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Cost Unit
Cost units have got costs attached to it. These are the elements or
items for which costs are estimated. They are also avenues of
income. Cost units can be said as the product (good or service)
that generates income. For a furniture factory, the furniture
produced would be its cost unit. For a credit control department,
each customer’s account is a cost unit.
Methods of Costing
This is the heart of management accounting! Different businesses

different products utilise different costing methods, according to
the appropriateness. This ranges from job to process costing,
marginal and absorption costing, and whether it is about costing
for materials, labour and expenses.
Further elaborations will be provided in upcoming chapters.
15
Topic Review (TLO 1b)

Describe the cost accounting systems.
1. Which statement is false?

A. Cost units are the same as unit costs.
B. Codes can comprise of alphanumeric characters.
C. Interlocking systems are more suitable for larger organisations.
D. Integrated systems can be bought off-the-shelf.
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1c. Cost classification

Learning Outcome (ACCA Study Guide Area A, Topic A3a and b):
Describe the variety of cost classification for a cost accounting system.
A summary of the cost classification is given in Figure 1.1.
COSTS
Production Selling, Distribution Finance

and Administration
(SDA)
Direct costs Indirect costs

(PRIME COSTS) (OVERHEADS)
Material Labour Expenses
Fixed Variable Mixed Stepped
Figure 1.1 Cost classification
As can be seen, costs can be classified by:
 Relevance to production – production and non-production (SDA

expenses and financing costs
 Traceability to end-product – direct and indirect
 Resource type – material, labour and expenses
 Behaviour towards changes in activity levels – fixed, variable,
semi-variable and stepped
Students are expected to carry forward this knowledge from MA1 in

order to proceed with the advance costing areas in this syllabus.
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Topic Review (TLO A3a and b)

Learning Outcome (ACCA Study Guide Area A, Topic A3a and b):
Describe the variety of cost classifications for a cost accounting system.
Tick the correct boxes.
No. Cost item Production SDA Direct Indirect Fixed Variable Mixed
1. Wood for
furniture
2. Truck driver
wages
3. Salesperson
commission
4. Supervisor in a
specific
department
5. Packaging
personnel
6. Machinery
used for
multiple
products
7. Hire of special
tool
8. Factory
manager salary
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1d. High-low Method

Learning Outcome (ACCA Study Guide Area A, Topic A3c):
Apply the high-low method to separate semi-variable costs.
High-low method is applied when it can be confirmed that a

certain value has got both the fixed and the variable component.
It is a simple and easy forecasting tool often used to quickly
predict costs for a given range of activity level.
What this method does it that it helps separate the two elements
– fixed and variable cost per unit.
There are four simple steps to applying it:
Step 1. Review past records of cost
 Select highest & lowest levels of activity
Step 2. Determine:
 Total cost at highest level of activity, HC*
 Total cost at lowest level of activity, LC*
 Highest level of activity, HU
 Lowest level of activity, LU
Step 3. VC per unit = HC*-LC*

HU-LU
Step 4. FC = HC* – (HU × VC per unit)
or
FC = LC* – (LU × VC per unit)
19
Let’s try applying this formula in Cindy Sews Ltd, which has the
following data:
Month Activity Total

Jan level
430 cost
2,215
Feb (units)
380 ($)
1,770
Mar 610 2,890
Apr 780 3,718
May 900 4,110
The highest activity is in the month of May, and the corresponding

total cost is $4,110. The lowest activity is in the month of Feb with
total cost $1,770.
Variable cost per unit =
Fixed costs = Total cost – Variable cost =
Limitations of High-Low Method
The problem with high-low method is that it assumes that past trend
will continue in future, and that is not true. On top of that, the
method uses only two values, which obviously does not contribute
to accuracy of results. It must be reminded that in reality, fixed costs
and variable costs pattern are consistent only within a relevant
range of production.
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Topic Review (TLO 1d)

Learning Outcome (ACCA Study Guide Area A, Topic A3c):
Apply the high-low method to separate semi-variable costs.
1. The following data are available for a manufacturing company:
Month Production units Total costs ($)

May 20x7 2,000 5,000
June 20x7 1,000 3,000
July 20x7 1,500 3,800
Calculate the variable cost per unit and fixed cost, and find the estimated total cost for 3,000 units.
2. A process operation in a factory resulted in the following total costs for various output levels:
Output Total cost

(units) ($)
11,500 102,476
12,000 104,730
12,500 106,263
13,000 108,021
13,500 110,727
14,000 113,201
Using high-low method, analyse the costs of the process operation into fixed and variable
components.
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1e. Cost Behaviour and Cost Analysis

Learning Outcome (ACCA Study Guide Area A, Topic A3d and e):
Use variable, fixed and semi-variable costs in cost analysis.
Analyse the effects of changing level of activity on costs.
Variable, Fixed or Semi-Variable?
How does one know whether a cost is variable, fixed or semi-

variable?
Case 1: If full or total costs are the same for two different
activity level, then the cost is fixed in nature.
Case 2: If they are not the same, then the unit cost should be
computed. If the unit cost for the two activity levels are
the same, then the cost is variable in nature.
Case 3: If the above two cases do not apply, then the cost is
semi-variable in nature.
Effects of Changing Activity Levels On Unit Cost
If it is the fixed cost, naturally when activity levels increase, the unit
cost decreases. This is because:
Fixed cost per unit = Fixed cost

Activity level
The unit fixed cost is adversely affected by the increase in the

denominator in the formula, the activity level.
But if is the variable cost, then the total variable costs will change
proportionately with the change in activity levels, as per its
definition. The unit variable cost stays constant for a given range of
activity level.
The impact on semi-variable cost is uncertain as it is made up of both

the fixed and variable components. Computations are necessary to
see the impact.
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Topic Review (TLO 1e)

Learning Outcome (ACCA Study Guide Area A, Topic A3d):
Use variable, fixed and semi-variable costs in cost analysis.
Analyse the effects of changing level of activity on costs.
1. A particular cost is fixed in total. What is the effect on cost per unit of a reduction in activity of 50%?
A. Cost per unit increases by 100%.
B. Cost per unit reduces by 50%.
C. Cost per unit increases by 50%.
D. Cost per unit is unchanged.
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Chapter 1 Summary
1. Management accounting involves gathering data from internal and external sources of an
organisation, analysing them, interpreting the results obtained, and reporting the results to the
relevant users within an organisation.
2. Responsibility accounting is a system of accounting that places revenue and costs into areas of
personal responsibility of the managers of specific parts of the organisation.
3. Responsibility centres are work areas or divisions in an organisation. There are four types of
responsibility centre – cost centre, profit centre, revenue centre and investment centre.
4. Cost centres are departments or divisions of the organisation where only cost details are available.
Two types of cost centres are:
a. Production cost centres, where the actual production takes place.
b. Service cost centres, which exist simply to support production cost centres.
5. Profit centres are departments or divisions in an organisation where both cost and revenue related
data and information can be gathered.
6. Revenue centres are departments or divisions that are responsible for generating revenues, and
where only revenue data and information can be obtained.
7. Investment centres are departments or divisions where data and information regarding investment
activities (primarily capital investments) can be obtained.
8. A cost unit is a quantitative unit of product or service in relation to which costs are ascertained.
9. Direct costs are costs which are easily traceable to the product. Indirect costs are difficult or are
impossible to be traced to the product.
10. Fixed costs are costs which remain the same with regard to changing levels of activity. Variable costs
vary proportionately with levels of activity.
11. High-low method is used to separate the fixed and variable cost elements.
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CHAPTER 2: INFORMATION FOR COMPARISION Sunway TES
CHAPTER 2: INFORMATION FOR COMPARISION
Learning Outcomes
TLO A4a. Explain the purpose of making comparisons.
TLO A4b. Identify the bases used for comparison of actual data: previous period data
corresponding period data, forecast/ budget data.
TLO A4c. Explain the forecasting/ budgeting process and the concept of feed forward and
feedback control.
TLO A4d. Explain and illustrate the concept of flexible budget.
TLO A4e and f. Use the appropriate income and expenditure data for comparison and Calculate
the variances between current actual and historical/ forecast data which may or
may not be adjusted for volume change. (note: standard costing is excluded)
TLO A4g. Identify whether variances are favourable or adverse.
TLO A4h. Identify the possible causes of variances.
TLO A4i Explain the concept of exception reporting.
TLO A4j. Explain factors affecting the decision whether to investigate variances.
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2a. The Purpose of Making Comparison

Learning Outcome (ACCA Study Guide Area E, Topic A4a):
Explain the purpose of making comparisons.
Comparisons are important performance measures. They are

essential to gauge how near or far the organisation or the business
or a certain task is from its targets or objectives. Comparisons tell of
how much more work needs to be done before targets can be
effectively achieved. They tell of the necessary actions that must be
undertaken in order to accomplish tasks efficiently and effectively.
Corrective actions can range from improving processes to even
changing the objectives itself.
However, it is crucial to make only valid comparisons. These are the

differences that matter and are relatively significant in determining
whether the organisation is going in the favoured direction. This
involves making “like with like” comparisons.
For example, pizza take-out sales on a weekday should be compared

with another week-day (excluding Friday) and not weekends. School
days’ sales should be compared with only school days, and not
holidays.
Why so?
Weekday routines for pizza fans are usually different from weekend
routines. One can expect more take-outs on weekdays when people
are tired and just want to get home to some food and cosy couch.
But on weekends, generally people prefer to cook-in or eat out with
friends and family. So, sales on these two times (weekdays and
weekend) are not fair comparisons.
Comparisons in management accounting directly refers to the term

variances, which means comparisons between actual and expected
values or results. As the emphasis is on valid comparisons, it is
important to compute the expected values appropriately.
Where do comparisons fit in, in a process?
To answer this question, one needs to refer to the control cycle.
26
The control cycle is shown below:
Goal/Target/Objective
Plan
1. Strategy
2. Action plan
Set standards
Start operations
Actual results
Compare results
VARIANCES
Take corrective action
Figure 2.1 Simplified control cycle
27
The control cycle is one that helps managers design plans, exert
appropriate controls and make suitable decisions to run the business
processes effectively and efficiently.
As Figure 2.1 suggests, the flow is quite a straightforward one. A few

things to note here:
 There are 2 types of plans. A strategy is a general outline of what

the process intends to do, whereas an action plan is crafted with
details on exactly what should be done, using which resources,
and the methods to be used.
 Common errors include forgetting or ignoring the “Set standards”

before executing operations. If standards are not known first
hand, then the operations could be carried out without proper
directions.
 It should not be assumed that it is always the operations methods

that need improvement when variances are significant.
Corrective actions need not focus on operations, but can range
from changing ways of comparisons right up to changing the
targets.
 As mentioned earlier, computing variances should be done with

care. Only valid and sensible comparisons will explain
discrepancies and help make favourable differences in
accomplishing goals.
28
Topic Review (TLO A4a)

State the purpose of making comparisons.
1. What does “like with like” mean?
2. Why is it important to use only valid comparisons?
3. Write short notes on control cycle.
29
2b. Bases for Comparisons

Learning Outcome (ACCA Study Guide Area E, Topic A4b):
Identify the bases used for comparison of actual data: previous period data, corresponding period data,
forecast/budget data.
Comparison of Data
Figure 2.2 Comparison of data
Comparing current period results with other data makes the

information more meaningful to managers. Comparisons also
help to identify mistakes or errors in the information reported.
The following are the common bases for comparisons:
i. Previous period
ii. Forecast
iii. Budget
30
Comparison with Previous Period Data
Statutory financial accounts require comparison to be made to the Some companies’ financial accounts
previous financial year. For management accounting purposes, include data for the last five years to
comparisons are made on a quarter by quarter or month-on- month show trends in certain data.
basis in order to identify short term trends or problems.
Where there are seasonal fluctuations, month by month or quarter

by quarter comparisons are not very useful. A more meaningful
comparison would be to compare the month or quarter in question
with the corresponding period (month or quarter) in the previous
years, such as comparing June 2012 with June 2013.
Comparison with Forecasts

a. Cash Flow Forecast
The purpose of preparing a cash flow forecast is to enable the
business to predict its cash requirements in the upcoming
period or year. This is to ensure that the business does not
experience cash flow problems during the year. To maintain a
positive cash balance, the business has to ensure that
additional funds are available when a cash deficit is predicted.
Comparison with actual figures and assessing differences helps
management to produce more accurate future forecasts.
b. Sales Forecast
Sales forecasting is an important part of planning and
budgeting. It is often the starting point for the preparation of
operating budgets. Comparison with sales targets allows
management to evaluate organizational as well as managerial
performance.
Comparison with Budget
A budget is a financial plan. On a general note, there are two types

of budget: fixed and flexed.
Fixed budgets use original data, which means the original plan
with initial expected activity levels. Flexed budgets use actual
levels of activity. Although flexed seems more appropriate, but
fixed budget comparisons are useful sometimes as well.
31
Non-Financial Comparisons
Where qualitative measures are used to assess managerial

performance, the results may be compared in the same ways as
financial measures as listed above. Non-financial measures include
measures of quality and customer satisfaction, output reject volume
and product return rates.
32
Topic Review (TLO A4b)

Identify the bases used for comparison of actual data: previous period data, corresponding period data,
forecast/budget data.
1. Which of the following comparisons are not encouraged for a seasonal product?
A. Forecasts and budgets.
B. Different time periods.
C. Different industries.
D. Different regions.
E. Rivals.
33
2c. The Forecasting/Budgeting Process and The Concept of Feed Forward and Feedback
Control
Learning Outcome (ACCA Study Guide Area E, Topic A4c):
Explain the forecasting/ budgeting process and the concept of feed forward and feedback control.
Objectives of A Budgeting System:
1. Force managers to plan ahead and work out detailed plans for
achieving targets.
2. Coordinate the activities of various parts of the organization to

achieve goal congruence.
3. As a formal communication tool to communicate the

organisation' goals to all levels of staff.
4. Motivate staff to achieve or exceed the targets by providing a

system of performance feedback. A reporting system which
identifies controllable reasons for departures from budget will
enable managers to improve future performance.
5. Control operations by investigating variances from budget and

taking corrective action where necessary.
6. Evaluates managerial performance by comparing against actual

performance and relating the results to a reward system.
Budgets
There are two types of budgets that must be prepared:
1. Functional budgets
These are budgets for individual working units of the
organisation, such as the sales, production and purchasing
departments.
2. Master budget
This comprises of budgeted:
 Statement of profit and loss (SOPL)
 Statement of financial position (SOFP)
 Cash flow statement
Budgets are prepared individually by the budget officers and

integrated in a budget committee.
34
The budgeting process and its related elements are illustrated below:
The Budgeting Process
Steps Activities
Determine the principal budget factor (PBF), which is the

starting point for budgeting.
A PBF is usually the sales demand. However, it can also be
a limiting factor.
1
(A limiting factor is a production constraint; a resource
found to be in shortage, therefore adversely affecting the
production process. Typical limiting factors include
material, and machine and labour hours.)
2 Prepare the sales budget according to the PBF.
3 Prepare the production budget.
4 Prepare the raw materials usage and purchases budget.
5 Prepare the labour and production overhead budgets.
Prepare the rest of the necessary budgets, including SDA

6
expenses.
7 Prepare the Master Budget.
People Involved
1. Budget holder
Usually the responsibility centre manager accountable for
controllable operations.
2. Budget committee
This consists of Chairman (or an extremely senior manager),
accountant, and budget officers who are representatives of each
working unit. They sit together to effectively integrate the
functional budgets to finally derive the Master Budget. It must be
noted that budgets must be in congruence with the
organisational goals.
3. Budget officer
These representatives for the organisation’s work units (namely
departments) ensure that budget preparation deadlines are met.
35
Budget Manual
This serves as a guide to preparing a workable budget, complying to
organisational policies and addressing all relevant constraints.
Individuals preparing budgets should be well aware of its contents.
Variances and Controls

Variances are indications that for some reasons, budgets were not
or cannot be met. Corrective actions come in two main forms:
1. Feedback control
Corrective actions are taken only AFTER the variance incurs,
which is why variance reporting is a good example of feedback
control measure. If a variance is controllable, the manager will
have to take steps to investigate and correct any problems.
2. Feedforward control
This applies when managers take a pro-active measure when
they foresee the variance coming. When variances can be
anticipated, the impacts, especially the adverse ones, can be
avoided or minimised.
36
Topic Review (TLO A4c)

Explain the forecasting/ budgeting process and the concept of feed forward and feedback control.
1. Which statement is false with regard to budgets?

A. They are prepared to ease operations.
B. Only senior managers prepare them.
C. Budget officers may be budget holders too.
D. Rigid budgets can lower the motivation level of budget holders.
2. The budgeting process does not include:

A. Preparation of budget manual.
B. Communication between budget officer and holder.
C. Preparation of departmental budgets.
D. Identifying principal budget factors.
37
2d. Concepts of Flexible Budgets

Learning Outcome (ACCA Study Guide Area E, Topic A4d):
Explain and illustrate the concept of flexible budget.
The purpose of flexible budget is to ensure comparison between

actual and budget is meaningful, by comparing like with like.
If actual production differs from budgeted production, obviously the

costs and revenue will be different. For example, the amount of
resources required for an output of 10,000 units would be different
from that required for 8,000 units. Variances from budget are bound
to occur.
To make a meaningful comparison between actual and budgeted

results, the budget needs to be adjusted or flexed to the same
production level. The revised budget is known as flexible or flexed
budget.
When preparing a flexible budget, only variable costs and/or sales

are adjusted to reflect the new output level. Fixed costs are not
adjusted.
For example:
Actual Budget
Production (units) 3,000 2,500
$ $
Direct Material 1,677 1,600
Direct Labour 881 800
Fixed Overheads 375 400
Total Costs 2,933 2,800
Prepare a Flexible budget and variance report.
38
Topic Review (TLO A4d)

Explain and illustrate the concept of flexible budget.
1. Which one of the following is not adjusted or flexed when preparing a flexed budget?
A. Fixed costs.
B. Fixed cost per unit.
C. Variable costs.
D. Variable production overhead.
39
2e and f. Variance Calculation between Current Actual and Historical/Forecast data

Learning Outcome (ACCA Study Guide Area E, Topic A4e and f):
Use the appropriate income and expenditure data for comparison.
Calculate the variances between current actual and historical/ forecast data, which may be adjusted for
volume change. (note: standard costing is excluded).
Calculating Variances:
Revenue variances occur for one or both of the following main

reasons:
a. A change in the level of activity (quantity sold).
b. A change in the selling price.
Cost variances occur for one or more of three main reasons:

a. A change in the level of activity (quantity sold/produced).
b. A change in the price paid for resources.
c. A change in the efficiency with which resources are used.
Total variances can be divided into activity variances and

price/efficiency variances. A flexed budget is a budget adjusted
from the original fixed budget (set before a period commences) to
reflect what budgeted revenues and costs would have been if set at
the actual level of activity.
This enables:
a. Activity variances to be calculated through the comparison of
the original fixed budget and the flexed budget.
b. Price/efficiency variances to be calculated through the
comparison of the flexed budget and the actual financial results.
Formulae for Sales Variances
i. Total Sales Revenue Variance

= Actual Sales Revenue – Original Budgeted Sales Revenue
ii. Sales Price Variance
= Actual Sales – (Actual units sold x Budgeted selling price)
iii. Sales Volume Variance
= (Actual units sold x Budgeted selling price) – Original
Budgeted Sales Revenue
40
Formulae for Cost Variances
i. Total cost variance

= Actual Cost – Original Budgeted Cost
ii. Price Variance
= Actual Cost – (Actual produced x Budgeted unit cost)
iii. Volume Variance
= (Actual units produced x Budgeted unit cost) – Original
Budgeted Cost
Planning and Control
 Planning is the setting of realistic and achievable targets.

 Control involves variance reporting for income and cost
elements, the investigation of variances and the resulting
managerial action taken.
41
Variance Reporting
The budgets prepared by managers will be compared with actual
results. Any deviation of actual results from budgets is known as
variance. The comparison is known as variance reporting.
For example:
Actual Budgeted Variance Variance**
$ $ $ %
Sales 22,100 18,000 4,100 (F) 22.78
Heat & Light 1,435 1,500 65 (F) 4.33
Rental 735 600 135 (A) 22.5
Wages 6,730 5,000 1,730 (A) 34.6
**Variance (%) = Actual amount – Budgeted amount

Budgeted amount
42
Topic Review (TLO A4e and f)

Learning Outcome (ACCA Study Guide Area E, Topic A4e and f):
Use the appropriate income and expenditure data for comparison.
Calculate the variances between current actual and historical/ forecast data which may or may not be
adjusted for volume change (note: standard costing is excluded).
1. A certain product is sold at a standard price of $5 per unit. Budgeted sales volume is 10,000 units,
but actual sales volume was 10,200 units, sold at $49,700.
(a) What is the sales price variance?
(b) What is the total sales revenue variance?
2. The same product is produced at a standard cost of $3 per unit. Budgeted production volume is
10,000 units, but actual production was 9,600 units, which incurred a cost of sold at $30,000.
What is the total cost variance?
43
2g. Identify Whether Variances Are Favourable or Adverse

Learning Outcome (ACCA Study Guide Area E, Topic A4g):
Identify whether variances are favourable or adverse.
Variances are said to be favourable when the:

 Actual cost is lower than expected cost.
 Actual revenue is higher than expected revenue.
The same way, variances are adverse when the:

 Actual cost is higher than expected cost.
 Actual revenue is lower than expected revenue.
It must be noted that favourable variances are not always good for
the organisation. Sometimes, in the course of trying to save money,
organisations may end up sacrificing quality, effectiveness and
efficiency. Just the same, adverse variances are not always bad.
44
Topic Review (TLO A4g)

Learning Outcome (ACCA Study Guide Area E, Topic A4g):
Identify whether variances are favourable or adverse.
1. Actual costs of manufacture were $5,360 while the budgeted cost was $4,270. Is the cost variance
adverse or favourable?
2. The actual revenue from a certain product line is $123,789 while the budgeted revenue was
$122,900. Is the revenue variance adverse or favourable?
45
2h. The Possible Causes of Variances

Learning Outcome (ACCA Study Guide Area E, Topic A4h):
Identify the possible causes of variances.
Variances can incur for many reasons, namely:
1. Change in material standard

When standards change, usage or consumption rates can
change. This usually directly impacts the purchase price. If
standards are not revised before the actual purchase, then there
are bound to be foreseen variances.
2. Material price increase

As mentioned above, it is only logical to say that price variances
are going to incur if the market prices’ change is not
incorporated into the standards in use.
3. More effective use of material

Better use of material naturally affects the usage variance. It can
also affect the labour variances.
4. Wage rate increase

Naturally labour rate variances will be affected if standards do
not accommodate the changes in time.
5. Labour skill level

This affects the efficiency, material consumption, wastage and
defect rates. So, variances can be expected here.
6. Unexpected changes in sales demand

This definitely affects sales volume and activity variances.
Depending on the market and price elasticity, price variances
can happen too.
46
Topic Review (TLO A4h)

Learning Outcome (ACCA Study Guide Area E, Topic A4h):
Identify the possible causes of variances.
1. Which one of the following can cause favourable variances?

A. Poorer quality material.
B. Higher skilled workers.
C. Increase in national wage rate.
D. New maintenance technician.
47
2i. The Concept of Exception Reporting

Learning Outcome (ACCA Study Guide Area E, Topic A4i):
Explain the concept of exception reporting.
Exception reporting is the concept of reporting variances that

exceed tolerance levels, to senior management and entities alike.
These variances are communicated to the respective personnel

and work units so that corrective actions can be taken, after
necessary investigations on the deviations are properly carried
out.
Things can get serious if the variances have a worrying adverse

trend.
48
Topic Review (TLO A4i)

Explain the concept of exception reporting.
1. When is exception reporting applied?
2. What is the reason for exception reporting?
49
2j. Factors Affecting the Decision Whether to Investigate Variances

Explain factors affecting the decision whether to investigate variance.
There are a few key determinants on whether variances should be

investigated or not:
1. Materiality
Small variations are bound to occur and unlikely to be significant.
It will be time consuming to investigate all variances. The size of
the variance is often an indication of the size of the problem.
Variances that exceed tolerance level are usually investigated.
2. Controllability
Only controllable variances should be investigated. If a variance
is controllable, managers can take action to rectify the problem.
Non-controllable variances arise due to factors beyond the
manager’s control. External events are like a worldwide increase
in raw material price, acts of nature, idle time due to power
outage and changes in employment law are examples of
uncontrollable factors.
3. Variance trend
Small variances in a single period are unlikely to initiate further
investigation than small variations that occur consistently. If a
variance continues to be adverse or favourable consistently, this
definitely calls for a query.
4. Adverse or Favourable
It is very common that adverse variances are selected for
investigation compared to favourable ones.
5. Interdependence between variances

Variances should not be looked in isolation. Sometimes a
favourable variance for one item will lead to an adverse variance
for another item, such as purchase of low quality raw material
may save material costs but this will result in company losing
customers who are concerned about quality.
6. Cost of investigation
The potential benefits or savings from investigating and
resolving variance must outweigh costs of investigation.
50
Topic Review (TLO A4j)

Explain factors affecting the decision whether to investigate variances.
1. Which of the following is a reason to investigate favourable variances?

A. The same variance is always reported as favourable.
B. Investigation costs exceed benefits.
C. Variances are caused by global trends.
D. The variance does not affect most of the other variances.
51
Chapter 2 Summary
1. Comparison of data makes information more meaningful to managers and help to identify mistakes
in the information reported.
2. Budgetary control compares actual results to budgeted figures and investigating significant variances.
3. Flexible budgets are prepared to ensure meaningful comparisons are made as they are adjusted to
the same level of production.
4. Types of variances calculations:

a. Revenue variances
b. Cost variances
c. Total variances
5. Variances can be classified as:

a. Favourable variance
b. Adverse variance
52
CHAPTER 3: REPORTING MANAGEMENT INFORMATION Sunway TES
CHAPTER 3: REPORTING MANAGEMENT INFORMATION
Learning Outcomes
TLO A5a. Identify suitable formats for the presentation of management information according
purpose.
TLO A5b. Describe methods of analysing, presenting and communicating information.
TLO A5c. Identify suitable formats for communicating management information according to purpose
and organisational guideline including: informal business report, letter and email or memo.
TLO A5d. Identify the general principle of distributing reports (e.g. procedures, timing, recipients)
including the reporting of confidential information.
TLO A5e. Interpret information presented in management report.
53
3a. Suitable Formats for the Presentation of Management Information According Purpose
Identify suitable formats for the presentation of management information according purpose.
Presenting or reporting management information refers to

conveying of information that has been generated in the course of
running the business, to the necessary entities. These refer to both
individuals and departments alike.
Reporting any form of information is a responsible activity and must

be done with care. This is because management information are
crucial data about running the organisation and therefore should not
be passed around without consideration of its importance and the
issues of confidentiality. Such information cannot land in the hands
of anyone or everyone.
It is also important to communicate effectively. Effective

communication means the recipient understand the message or
information in exactly the same meaning as intended by the source
or sender.
Communication Methods
There are 3 common methods of communication in any

environment:
1. Oral or spoken
2. Written
3. Non-verbal or body gestures
As far as MA2 syllabus is concerned, the focus is on written forms of

communication, which is divided into two broad categories:
1. Textual
2. Graphical
Written textual form includes report, formal letter, memorandum

and email. Graphical forms include table, bar chart, line graph and
pie chart. Each of these forms has its importance and functions. So
it is essential to know when to use which form and format,
depending of various factors.
54
Factors to Consider When Choosing a Method of Communication
FACTOR EXPLANATION
Time The communication mode chosen depends of

the travelling time and the urgency of sending
and feedback of the information.
If the message of information is very elaborate,

then a more organised format of delivery
Complexity would be required. The more complex and
complicated the information are, the higher
the need for preparing a neatly organised,
written format.
Money or time spent. Must be cost-effective –
Cost
benefits exceed costs.
The travelling distance of the information

Distance determines whether one can walk into the
receiving manager’s room, or needs to email it.
The “tone” and format of the message (and
even the paper used) must be fit to the person
Competence
receiving it. Is the message going to the
level of
production worker, or to a senior manager?
recipient
What would be the appropriate language and
tone?
Naturally, if the number of recipients is
relatively high, the information needs more
Number of organisation and probably needs to be
recipients duplicated or emailed out. It would be
uncommon to pass to individual recipients by
hand, unless deemed necessary.
This is a very critical element of concern when

choosing the communication method. Private
and confidential information, typically marked
Confidentiality
as “P & C”, cannot fall into the wrong hands.
Necessary care and control must be taken when
disseminating confidential information.
It must be noted that sometimes, it is the

Recipient recipient that decides the communication
preference method, especially if senior management is
involved.
55
Topic Review (TLO A5a)

Identify suitable formats for the presentation of management information according purpose.
1. In which circumstances would oral communication be preferred?
2. Let’s say there is a confidential report prepared today, in your office in Malaysia that needs to reach
a senior manager in the Indian office, within 5 days. There is a manager from your office travelling
to India tomorrow.
Discuss feasible ways sending that piece of information across on time.
56
3b. Methods of Analysing, Presenting and Communicating Information

Describe methods of analysing, presenting and communicating information.
The focus here is on the graphical presentation, which usually does

not stand alone. The continuing section shows how this information
are embedded into suitable presentation formats.
Let’s take a look at four common methods:

1. Table
2. Bar chart
3. Line graph
4. Pie chart
1. Tables
Tabulation is the systematic arrangement of numerical data.
General Rules:
i. Title – comprehensive and self-explanatory title.

Indicate relationships between variables.
ii. Source – source of material used must be stated.
iii. Units – units of measurement used must be stated

as well. E.g. 000s means figures in thousands.
iv. Headings – all column and row headings should be

concise and unambiguous.
v. Totals – subtotal and total should be shown where

appropriate to assist comparisons.
57
2. Bar chart:
It is a chart where data is shown on the form of a bar. It is often

used when information is of quantitative form. Bar charts are
also used to demonstrate and compare amounts or numbers
of things.
4 Types of Bar Chart:
i. Simple bar chart
ii. Component (or stacked) bar chart
iii. Percentage component bar chart
iv. Compound (multiple) bar chart
Types of Bar charts
a. Simple Bar Chart
A simple bar chart shows the actual amount of data (from

vertical axis) and relationship between data.
Bar chart: Grain Production in UK, 19X1 to 19X3
58
ii. Component Bar Chart (or Stacked Bar Chart)

It is often used to show relative values or percentages. For
example, the bar chart below can be used to show sales
for 3 regions. It is obvious that the region represented by
the black component area contributed the most revenue
in 2003 and 2004 but has been taken over by the region
represented by the light grey component in 2005.
500
450
400
350
300
250
200
150
100
2003 2004 2005
iii. Percentage Component Bar Chart

Actual values of each component are not shown but % of
total for each component is shown. All bars are at same
height (=100%) and divided according to proportions of
each element.
iv. Compound Multiple Bar Chart

 There will be more than 1 bar for each sub-division of
the chart.
 Separate bar to represent each product every year.
 It is a suitable chart if total of each component is not
important.
Each component has its own bar. For example, each block
may represent a different item such as production cost for
three products, with each bar representing one product.
59
3. Line Graphs
 Useful for demonstrating trends. The reader can see the
movement of the variables clearly over a period of time.
 The dependent variable is represented by the y axis and the

independent variable is represented by the x axis.
 The value of the independent variable helps to determine the

value of y. Examples of independent variables would be time,
date, year and interest rates.
60
4. Pie Charts
A pie chart is a good way of showing the constituent parts of
a variable. It consists of a circle split into segments. The
segments represent individual parts which; taken together,
make up the total.
The 360° circle is divided in proportion to the parts that make

up the total. Therefore, 360° represents 100%.
In order to calculate the size of each segment of a pie chart, you

need the following:
 The number value of each component part of the whole.
 The total of all the component parts.
Shading each segment with a different colour allows

one to quickly distinguish one segment from another.
Advantages of Pie Charts:

 Displays the relative sizes of elements under comparison.
 Easy to read and understand.
Disadvantages of Pie Charts:

Only the relative proportions and not the actual values are
shown. It is difficult to make comparisons when the segments
are roughly the same size. However, this problem can be
overcome by typing the value into each segment in the pie chart
or next to it.
61
Topic Review (TLO A5b)

Describe methods of analysing, presenting and communicating information.
True or false?
1. Tables show comparisons easily.
2. Bar charts and line graphs can show data trends.
3. Multiple line graphs have similar functions as multiple bar charts.
4. A simple bar chart’s function is the same as a pie chart’s.
5. Uniformity of data representation is important in graphs and charts

but not in tabular formats.
6. Pie charts show the distribution of a certain category of information.
62
3c. Suitable Formats for Communicating Management Information

Identify suitable formats for communicating management information according to purpose and
organisational guideline including informal business report, letter and email or memo.
Improving Communications
A well-written management document eliminates the possibility of

misunderstanding and misinterpretation. In writing messages, it is
necessary to be precise, making the meaning as clear as possible so
that it accomplishes the desired purpose. The language used should
be simple, clear and straightforward, where possible. Complex or
ambiguous words destroy accuracy, leading to misunderstanding of
the meaning or intent of the message. So, be specific and to the
point.
The communication of management information should be timely

so that the decisions and actions taken in time and when necessary.
The timing of the message and the environment setting in which the
message is delivered and received is equally important. An
important message delivered at the wrong time or in a non-
conducive environment may lose its effectiveness.
Business communication must pass through the proper channels to

reach the intended receiver. The communication flow and its spread
must avoid bypassing levels or people. When these concerned levels
are omitted or by-passed, it creates confusion and conflict.
Accordingly, the established channels must be used as required.
Management information can be communicated verbally but verbal

communication may need to be followed up by written
confirmation.
Management reports should be complete so as not only to meet the

demands of today but should be based on future needs of the
organisation. A reasonable projection and assessment of future
environment would need to be considered in order to provide
information for decision-making.
63
The ability for one to understand the content of information can

be improved in the following ways:
1. Use simple words

Where possible, avoid jargon (technical term), which can
create unnecessary anxiety and unrest due to the sound of
the complicated term.
2. Avoid information overload

Keep the information straightforward. Do not say too much
nor add irrelevant data, as the recipient might miss the main
point and start focusing on the unimportant sections.
3. Include pictures, charts and/or graphs

“Pictures are worth a thousand words.” Supplementing the
management report or the like with graphical representation
usually helps the recipient understand faster and in a clearer
manner, added on with the reading of the interpretations.
4. Follow recipient competence level and preference

It is always a good idea to be sensitive to who the recipient is
and what format he/she prefers. This simplifies and eases a
lot of comprehension issues for the recipient.
The continuing part provides an in-depth look at the various

communication formats.
64
65
Memorandum Format
To : (name and title of target audience)
From : (name and title of writer: remember to sign or

initial)
Date :
RE :
CC : (distribution list when necessary)
Introduction [no heading necessary]
Discussion sections [varies with purpose of report]
Conclusion
Heading Information: The material at the top of the memo always

includes the date, the names of the writer and the receiver of the
memo, and the subject of the memo. Different organizations may
use other formats for this information than the one that appears
here.
i. Use a courtesy title (Mr., Miss, Mrs., Ms., Dr) before the
recipient's name and a job title after it.
ii. Use a job title after your name, and hand write your initials by
your name. This confirms that you take responsibility for the
contents of the memo.
iii. The subject heading should be as specific as possible.
Formatting Memos: use all the same formatting devices as other

documents, including the following:
 Headings to help the reader skim for sections of the

document.
 Numbered and bulleted lists to make information easily
accessible.
 Typographical devices such as underlining, boldfacing, italics,
etc. to make headings and important information stand out.
Paragraphing: As in all technical and business communications, long

paragraphs of dense text make reading more difficult. Keep your
paragraphs.
66
Sample of A Memorandum
67
Letter Format
Business letters usually contain the following information (in this

order):
i. Letterhead or sender's address
ii. Date of writing
iii. Recipient's address
iv. Salutation or Greeting
If you don't know whether the recipient is a man or woman, the

traditional practice has been to write "Dear Sir" or "Dear Sirs".
When you do have the names of individuals, remember to
address them appropriately: Mrs., Ms., Mr., Dr, and so on.
i. Subject or reference line (a heading announcing the main

business of the letter.
ii. Message (body of the letter).
iii. Complimentary Close.
(The "Yours sincerely" part of the business letter. Only the
first letter is capitalized, and it is always followed by a
comma.)
 Signature, printed name, and position of sender
Use 'Yours sincerely' when you have addressed someone
by their name. Use 'Yours faithfully' if you don't know the
name of the person you're writing to.
 In some situations, a business letter may also include the

following optional information:
a. Enclosures (Encl:)
b. Courtesy copy Recipients (cc:)
c. Reference Initials (of the typist)
68
Sample of Business Letter
15th February 2016

Mr. Clark Kent, ACME Printing Co.
180 Dally Planet Building, Superman Drive,
78555 NY.
Dear Mr. Kent,
RE: Rejected shipment (Order # 234A5)
I am returning with this letter a recent shipment of 300 imprinted “Crime does pay!”
t-shirts (order # 234A5) along with a copy of our original purchase order.
As stated, the logo should be reproduced in our corporate logo in colour. The logos on
the t-shirts you sent are in black, which is unacceptable.
Please make the necessary corrections and send another shipment of 300 t-shirts (with
the correct logo colours) by the 10th of March. We need them for the upcoming
Criminal Masterminds convention that starts on the 20th of March.
Thank you for your prompt attention on this matter.
Yours sincerely
Ms. Loius Lane

Head - Purchasing
69
House Style for Written Communications
 A house style or style guide is a set of standards for the design

and writing of documents, either for general use or for a specific
publication or organisation.
 Many organisations use standard forms or electronically stored

templates which contain the company logo and other relevant
information to guide and make sure that employees adhere to an
approved format for communication, internally and externally.
 The house style may specify the type of fonts and font sizes to be
used, rules for paragraphing, abbreviations, use of bold and
italics and even how numbers are to be presented.
 Many style guides are revised periodically to accommodate

changes in conventions and usage.
Note:
MS Word comes with many templates for letters, reports, memos,

faxes and other documents, which can be easily modified to create
a house style for a small business.
70
Business Reports
71
72
Principles of Effective Report Writing

ELEMENTS DESCRIPTION
 Brief and explicit.
Title
 Clear and as short as possible.
 This information should be placed before the
Identification title.
of report  The list of recipients.
writer, report  The name of writer.
user and date  The date the report was completed.
 The sentence “Private and confidential” should
Confidentiality be printed on top of report and every page,
where necessary.
 Listing the contents of the report by topic and
Table of page numbers will assist users in searching
Contents through the report.
 It explains the purpose of the report and any
restrictions on its scope.
 For example: The terms of reference of a
management accounting report may be
limited to comments and recommendations on
a short term solution to a problem (for
example, over the next 12 months) and specify
that data used in the report covers only a
Terms of
certain period in question.
reference/
 The introductory section should include 3 parts:
Introduction
i. A statement of the problem or situation.
ii. The task assigned to the writer and the scope
of the project.
iii. Purpose of the report and forecasts for the
reader the topics of the report.
 The various sources of the data should be

stated in appendix of report.
 It may be a list of descriptions and
Source of identifications of the editions, dates of issue,
reference data authorship, and typography of books or other
written material (bibliography) used in the
report or simply a list of historical records used
or surveys conducted.
73
ELEMENTS DESCRIPTION
 The main body of report should be divided
into sections.
 These sections must be logically sequenced
with clear headings.
 Paragraphs should be numbered with each
Sections paragraph explaining one point.
 If each section of a long or short report
contains a headings, a reader will be able to
skim the report and read important sections
without having to refer back to the
introduction for its context or read through
the entire report in detail.
 The main body of the report should be
concise.
 Detailed explanations, calculations, charts
Appendices and tables should be attached as
appendices. Cross-referencing should be
done where appropriate.
 The summary describes the purpose of the
report, the conclusions and how they were
reached.
 The conclusions are the main points or
Summary and findings of the report and what can be
Conclusions/ learned from what has happened before or
Recommendations what progress has been achieved.
 If recommendations are required, then list
the options or actions you consider to be the
best.
 In long reports, this section is often placed
before the discussion or main body of the
report.
 Sometimes, the summary and conclusions
and recommendations are included in a
Executive separate document and circulated. This is
Summary called the executive summary because
people can get the information without
having to read the whole report.
 Leave a space for your signature.
Sign Off  Type your name.
 Type your title or position.
 Read for meaning.
 Read for accuracy.
Proof Read  Get someone else to proof read once more
as the writer sometimes cannot see the
his/her own mistakes.
74
Topic Review (TLO A5c)

Identify suitable formats for communicating management information according to purpose and
organisational guideline including informal business report, letter and email or memo.
True or false?
1. Memoranda are internal communications only.
2. Letters are external communications only.
3. Politeness is a key feature in preparing business letters, but not for

memoranda.
4. Whatever the format, information delivered should be unambiguous

and as straightforward as possible.
5. Terms of reference is found in reports and formal letters.
6. Memoranda and reports do not require signatures.
75
3d. The General Principle of Distributing Reports

Identify the general principle of distributing reports (e.g. procedures, timing, recipients) including the
reporting of confidential information.
Distribution of reports, or dissemination of information per say, is

relatively a simple task. However, there is a certain amount of care
to be considered. If the report is for public knowledge, it is
acceptable to make is accessible easily by leaving it physically visible
for anyone. But if it is one that is for restricted view and use, then
more controls must be in place to ensure that the information is not
disclosed irresponsibly.
When dealing with confidential information, it is critical that only the

people who are authorised to view this information, can access it.
Certain cautious measures can be taken. For instance, if the person
is within reachable physical distance, pass it to the persons directly
via a face-to-face encounter. Avoid leaving the P & C document with
the secretary or on the person’s desk. Do not email it if it can be read
by another, such as the secretary who should not have that
information. Confidentiality must be respected and protected at all
times.
One more concern is the timing of the report distribution. Reports

will only be useful when delivered on time to make informed
decisions. Timeliness is, nevertheless, a quality of good and useful
information.
76
Topic Review (TLO A5d)

Identify the general principle of distributing reports (e.g. procedures, timing, recipients) including the
reporting of confidential information.
Suggest specific gestures of conveying confidential information in a manufacturing organisation.
77
3e. The Information Presented in Management Report

Learning Outcome (ACCA Study Guide Area E, Topic A5e):
Interpret information presented in management report.
A management report is generally investigative in nature. So, the

typical data and information found in it include:
 The problem
This would be the very reason for starting an investigation and
subsequently documenting all matters pertaining it.
 Research method
A report should outline the method of collecting the necessary
data in line with the stated problem. The reader of the report
must understand why such a data collection and research
methods were chosen.
 Findings and analysis

The reader must be able to understand the data and information
churned out by the computations and analyses. If they are
technical data, supporting explanations should be available so
that the reader understands in the right meaning.
 Conclusion or deduction
If the report is interpreted correctly, the reader’s conclusion
should more or less be in line with the conclusion provided in
the report. Otherwise, either the reader is incompetent to reach
the same conclusion, or the wrong conclusion had been
documented in the report.
 Solution or recommendation
The reader should be able to understand the solutions provided.

Whether he/she agrees with the recommendations or not, is a
separate concern. But the solutions cannot be entirely wrong or
misinterpreted so.
78
Topic Review (TLO A5e)

Learning Outcome (ACCA Study Guide Area E, Topic A5e):
Describe the tools and techniques that can be used to build the team and improve team effectiveness.
1. Correct interpretation of a management report is important. Which of the following statements is

not a reason for that?
A. Wrong interpretation will lead to wrongful decisions.
B. The reader needs to pass on this conclusion to the next phase of investigation.
C. There will be no use for the report after distributing it,
D. Correct interpretation can detect inaccuracies in the report.
79
Chapter 3 Summary
1. Methods of communicating management information should be according to:

a. Urgency/Complexity
b. Confidentiality
c. Cost
d. Distance
e. Recipient
f. Internal/External to organisation
80
CHAPTER 4: ACCOUNTING FOR MATERIALS Sunway TES
CHAPTER 4: ACCOUNTING FOR MATERIALS
Learning Outcomes
TLO B1a. Describe the main types of material classification.
TLO B1b. Describe the procedures and documentation required to ensure the correct authorisation,
coding, analysis and recording of direct and indirect material costs.
TLO B1c. Explain, illustrate and evaluate the FIFO, LIFO and periodic and cumulative weighted average
methods used to price materials issued from inventory.
TLO B1d. Describe and illustrate the accounting for material costs.
TLO B1e. Calculate material input requirements, and control measures, where wastage occurs.
TLO B1f. Describe the procedures required to monitor inventory and minimise discrepancies and
losses.
TLO B1g. Explain and illustrate the costs of holding inventory and of being without inventory.
TLO B1h. Explain, illustrate and evaluate inventory control levels (minimum, maximum, re-order).
TLO B1i. Calculate and interpret optimal order quantities.
TLO B1j. Explain the relationship between the materials costing system and the inventory control
system.
81
4a. Main Types of Material Classification

Learning Outcome (ACCA Study Guide Area B, Topic B1a):
Describe the main types of material classification.
Introduction
Materials are a primary resource in an organisation, in an activity,

especially when it is a manufacturing organisation. They are
substances with various measurement units, with various physical
properties. Metals, non-metals, in units, in kg, in litres, and in
various colours and shapes.
As far as cost accounting is concerned, there are two types of

materials – direct and indirect. Direct material costs are cost of
materials that can be directly traced back to the product with
minimal difficulty and indirect material costs refer to cost of
materials which cannot be identified for individual products.
Raw materials are good examples of direct materials. They are

purchased specifically to be converted into finished products.
Machinery lubricant, varnish and glue are examples of indirect
materials because it is difficult to identify the volume used per
unit of finished product. Usually, manufacturing organisations use
more direct materials than indirect ones, whereas in service
organisations, use of indirect materials are usually more than the
use of direct materials.
Another way to look at materials is by the degree of completion.

For a manufacturing company, inventory can be made up of:
 Raw material – as primary input to product manufacture

 Work in progress – incomplete units which are still going
through the production process
 Finished goods – completed units which are ready for sale
For a trading company, material costing may refer to only

valuation of finished goods, which are bought to be sold off with
no further processing.
Basically, it is common for most businesses to hold some form of

material.
82
Topic Review (TLO B1a)

Describe the main types of material classification
Answer true or false?
Answer
1. Raw materials are purchased specifically to be converted into finished
products.
2. Manufacturing organisations use more direct materials than indirect

ones, when compared to service organisations.
3. Different degrees of completion cause costing complications.
4. Materials can be direct, indirect and semi-direct.
83
4b. The Procedures and Documentation Required

Learning Outcome (ACCA Study Guide Area B, Topic B1b):
Describe the procedures and documentation required to ensure the correct authorisation, coding,
analysis and recording of direct and indirect material costs.
This section has been fully covered in MA1 (ACCA Study Guide Area
B, Topic B1b). It is important to carry forward the acquired
knowledge on all the procedures and documents from MA1.
To review quickly, where materials are concerned, the following

activities can be observed:
 Purchasing, which involves purchase requisition, purchase order,

letter of enquiry, quotation, advice note and invoice.
 Delivery of goods, which involves delivery note, consignment
note and goods received note.
 Payment, which involves invoice, debit note and credit note.
 Requisition from departments, which involves material
requisition note and material returned note.
 Updates of the inventory via goods received note, bin card and
stores ledger.
84
Topic Review (TLO B1b)

analysis and recording of direct and indirect material costs.
Name and explain any three activities with regard to materials in a fast food business. Include in your
explanations, the documents involved as well.
Answers:
Choose any three of the following:
 Purchasing, which involves purchase requisition, purchase order, letter of enquiry, quotation, advice
note and invoice.
 Delivery of goods, which involves delivery note, consignment note and goods received note.
 Payment, which involves invoice, debit note and credit note.
 Requisition from departments, which involves material requisition note and material returned note.
 Updates of the inventory via goods received note, bin card and stores ledger.
85
4c. Methods Used to Price Materials Issued from Inventory

Learning Outcome (ACCA Study Guide Area B, Topic B1c):
Explain, illustrate and evaluate the FIFO, LIFO and periodic and cumulative weighted average methods
used to price materials issued from inventory.
Stock Valuation
It is common for material prices to vary according to market

demand and supply. The same material can be purchased at
different times at different prices. So, one of the cost accounting
concerns is the stock valuation when it comes to costing of
materials and assessment of closing inventory.
This is a repeat coverage from MA1 (ACCA Study Guide Area D,

Topic D1d).
There are basically four valuation methods:
1. First in first out (FIFO);
2. Last in first out (LIFO);
3. Cumulative weighted average (CWA); and
4. Periodic weighted average (PWA).
86
First-In-First-Out (LIFO)
Issues are valued at the price of the oldest batch in stock until all
units of that batch are issued out, after which the price of the next
oldest batch would be used. That means, the remaining stock –
closing inventory – will be valued at the prices of the more recent
purchases. The assumption is that materials are issued out in the
order they were delivered in.
Basically, issues to production are charged oldest prices and the

closing inventory are valued at the most recent price.
The best way to understand this valuation method is via an example.

Let’s look at the following transactions in Teelo Ltd’s stores
department during October 20X6.
Date Details Units Unit cost ($)

Oct 1 Opening inventory 100 2.00
2 Purchases 400 2.10
5 Issues 200
12 Issues 400
22 Issues 100
The recommended way to present the values of the inventory

movement and balances in the stores is to use the stores ledger
format.
PURCHASES ISSUES BALANCE

Date
$ per Total $ per Total $ per Total
(Oct) Units Units Units
unit ($) unit ($) unit ($)
1 100 2.00 200
2 400 2.10 840 100* 2.00 200
400 2.10 840
5 100* 2.00 200 300 2.10 630
100 2.10 210
10 300 2.12 636 300** 2.10 630
300 2.12 636
12 300** 2.10 630 200 2.12 424
100 2.12 212
15 100 2.40 240 200*** 2.12 424
100 2.40 240
22 100*** 2.12 212 100 2.12 212
100 2.40 240
87
Each time there is an issue, the stock issued out is valued at the price
of the oldest stock. The total cost of all issues would be $1,464 – all
values concerned are bolded in the ledger above.
The closing inventory volume is determined by adding all purchases

to opening inventory, and then deducting the issues – 100 + (400 +
300 + 100) – (200 + 400 + 100) = 200 units. The value of the closing
inventory is (100 × $2.12) + (100 × $2.40) = $452.
Note:
1. The total volume of closing inventory and issues must equal to

the total volume of opening inventory and purchases. Otherwise,
there is reason to investigate the discrepancy, as there is always
room for fraud.
Closing inventory + Issues = Opening inventory + Purchases
2. Similarly, the total value of closing inventory and issues must

equal to the total value of opening inventory and purchases.
Value of closing inventory + Value of issues
= Value of opening inventory + Value of purchases
88
Last-In-First-Out (LIFO)
The value of the issues are the prices of the most recent purchases.
This means, issues are valued at the price of the most recent batch
until a new batch is received. The remaining stock will be valued at
the prices of the oldest batches. This method assumes that materials
are issued out of stock in the reverse order to which they were
delivered – the most recent deliveries are issued prior to the earlier
ones.
Product costs are based on current prices and remaining inventory

valued at oldest prices.
The stores ledger for Teelo Ltd using LIFO method should look like
this:
PURCHASES ISSUES BALANCE

Date
$ per Total $ per Total $ per Total
(Oct) Units Units Units
unit ($) unit ($) unit ($)
1 100 2.00 200
2 400 2.10 840 100 2.00 200
400* 2.10 840
5 200* 2.10 420 100 2.00 200
200 2.10 420
10 300 2.12 636 100 2.00 200
200 2.10 420
300** 2.12 636
12 300** 2.12 636 100 2.00 200
100 2.10 210 100 2.10 210
15 100 2.40 240 100 2.00 200
100 2.10 210
100*** 2.40 240
22 100*** 2.40 240 100 2.00 200
100 2.10 210
Each time there is an issue, the stock issued out is valued at the
price of the most recent stock. The total cost of all issues would
be $1,506. The value of the closing inventory is (100 × $2.00) +
(100 × $2.10) = $410.
89
Cumulative Weighted Average (CWA)
The issue price is based on the average stock price calculated

each time new stock is purchased. The product costs and value of
closing inventory would lie between the values computed using
FIFO and LIFO.
At Teelo Ltd, when CWA method is used, the stores ledger should
look like this:
Date PURCHASES ISSUES BALANCE

(Oct) $ per $ per $ per
Units Total ($) Units Total ($) Units Total ($)
unit unit unit
1 100 2.00 200
2 400 2.10 840 500 2.08 1,040
5 200 2.08 416 300 2.08 624
10 300 2.12 636 600 2.10 1,260
12 400 2.10 840 200 2.10 420
15 100 2.40 240 300 2.20 660
22 100 2.20 220 200 2.20 440
Each issue is valued at the average price computed every time

there is a purchase. For instance, on Oct 2nd, the total value of the
new balance is $1,040. To find the material price per unit, take
the value of the new balance and divide it by the new volume,
which gives $1,040 ÷ 500 units = $2.08. That exercise has to be
done after each purchase, until the end of the period.
For the example above, the total cost of all issues would be
$1,476. The value of the closing inventory is 200 × $2.20 = $440.
Value of issues Value of closing inventory

FIFO $ 1,464 $ 452
LIFO $ 1,506 $ 410
CWA $ 1,476 $ 440
Table 4.1 Valuations using FIFO, LIFO and CWA
90
Periodic Weighted Average (PWA)
The stock price per unit is not calculated until the end of a given
period. This method is very easy as it goes by the following
formula:
Average issue price = Value of all receipts or purchases + Value of opening inventory
Total volume of purchases + Volume of opening inventory
For Teelo Ltd’s October 20X6 store’s transactions, the PWA stock
price would be:
($840 + $636 + $240) + $200 = $2.129 (correct to 3 decimal places)

(400 + 300 + 100) + 100
When the unit costs of an organisation’s purchases change over

time, the different inventory methods can result in significant
differences in cost of sales, and in values of closing inventory. These
differences are important because they affect the organisation’s
financial statements.
A note to remember is that the cost of sales is usually the largest

expense on a business organisation’s income statements and the
closing inventory is usually one of the large assets on their balance
sheets. Furthermore, the differences between the valuation
methods can have a significant effect on the amount of cash the
organisation has for use.
91
FIFO, LIFO and CWA
Pricing During inflation

FIFO Issue oldest  Materials may be valued at a lower
items first! cost than current market value.
 Closing stock is valued at a cost similar
to current market value.
LIFO Issue most  Materials may be valued at a cost
recent items similar to current market value.
first!  Closing stocks may be under-valued.
CWA Unit cost  Value of materials will rise gradually,

recalculated BUT lags a little behind the current
for each market value at the date of issue.
purchase or  Closing stocks also a little below
receipt current market value.
Table 4.2 Change in inventory values during inflation
Advantages Disadvantages
FIFO  Reasonable pricing  Difficult to apply – each
method – normally the batch needs to
oldest items are used identified separately.
first.  Difficulty in cost
 Easy to understand. comparison – varying
prices for the same
materials.
LIFO  Decision makers are  Not reasonable – LIFO is

kept updated on the opposite to what is
latest material prices. actually happening.
 Difficult to apply – each
batch needs to
identified separately.
 Difficulty in cost
comparison – varying
prices for the same
materials.
CWA  Easy to use – price  Calculated issue price is
fluctuations smoothed usually not the actual
out. price paid, especially
 Easy to administer – no when there are
need to identify each numerous decimal
batch separately. places.
Table 4.3 Advantages and disadvantages of FIFO, LIFO, CWA
92
Topic Review (TLO B1c)

Explain, illustrate and evaluate the FIFO, LIFO and periodic and cumulative weighted average methods
used to price materials issued from inventory.
On June 1st 20x8, Messlo Ltd had an opening inventory of 200 units valued at $10.50 each. The
following purchases and issues were recorded in the same month:
Date Details Units Unit price ($)

June 9th Purchases 300 10.00
June 17th Purchases 500 11.00
June 28th Issues 700
What was the value of issues on June 28th, using these methods?
(a) FIFO (b) LIFO (c) CWA (d) PWA
93
4d. The Accounting for Material Costs

Learning Outcome (ACCA Study Guide Area B, Topic B1d):
Describe and illustrate the accounting for material costs.
This has already been addressed at length in MA1. A quick review

provided here.
All movements of material costs are noted in the materials (or

stores) control account. Movement of direct and indirect materials
are recorded in the work in progress (WIP) and production overhead
control (POHC) accounts respectively.
94
Topic Review (TLO B1d)

Describe and illustrate the accounting for material costs.
1. Materials control a/c is credited when:

(Choose 2 answers.)
A. Materials are issued to production.
B. Materials are returned from the stores.
C. Materials are returned to suppliers.
D. Materials are bought in from suppliers.
2. True or false?
a) All materials are eventually recorded in the work in progress a/c.

b) Movements are recorded in the bin card and stores ledgers, must tally with the data recorded in
the materials control account.
95
4e. Material Input Requirements, and Control Measures, where Wastage Occurs
Learning Outcome (ACCA Study Guide Area B, Topic B1e):
Calculate material input requirements, and control measures, where wastage occurs.
This concept has been thoroughly discussed in MA1. As such, this

content is more of a review concern.
Generally, the input requirement would go in line with this equation:
Opening inventory + Shortage = Demand + Closing inventory
A more precise equation would be:
(1) For end-products:

Opening inventory + Production = Sales + Closing inventory
(2) For materials:

Opening inventory + Purchases = Usage + Closing inventory
Production processes must take into consideration of potential (and

actual) losses or wastages. For instance, if there will be a 5% loss of
materials, then extra material must be allocated accordingly for the
process. Similarly, if there is going to be a 10% defect rate on the
final product, then more units must be produced.
Losses are controllable sometimes, and sometimes not. Where

possible, wastages can be minimised by:
 Improving workforce effectiveness.
– so that the production quality targets are met
– training helps improve skills as well
 Use better quality material.
 Maintain efficiency and effectiveness of machinery and
equipment used in the production processes.
 Continually improve production processes to decrease defects
and costs whilst improving quality as well.
96
Topic Review (TLO B1e)

Calculate material input requirements, and control measures, where wastage occur.
A particular household product Q contains a raw material called Teq. Each Q has 2.7 kg of Teq after a 10%
loss in the production process. Current sales demand for Q is 2,000 units. Free inventory level for Q is set
420 units and available inventory is only half of that.
1. How much of Q needs to be produced?

Upon an inventory check, it is discovered that current inventory level of Teq is 560 kg which is 200
kg more than the set safety stock level.
2. How much of Teq needs to be purchased to meet the production demand?
97
4f. The Procedures Required to Monitor Inventory and Minimise Discrepancies and Losses
Learning Outcome (ACCA Study Guide Area B, Topic B1f):
Describe the procedures required to monitor inventory and minimise discrepancies and losses.
Stock Control
Stock control refers to regulating stock levels so that costs are
minimised, and at the same time, materials are available as and
when necessary.
This includes purchasing, holding, and issuing of materials.
Determine optimal stock levels
Compare actual stocks with re-order level
Actual inventory at or below re-order level?
Yes
No Replenish inventory – place re-order quantity
Issue materials for production
Figure 4.1 Summarised stock control mechanism
Ordering Cost
Typically, when are inventories ordered?
 When materials reach the re-order level (the level at which a
fresh replenish order is placed)
 When materials are completely finished, as in just-in-time
purchasing systems)
 When there is a special need for them (materials)
Ordering inventories cost money too. The elements of ordering

cost include:
 Transportation costs
 Administration costs
 Taxes
It must be noted that at all times, unwanted stock-out (which means

no stock) risk be eliminated.
(Stock-out will be discussed in section 4g.)
98
Just-in-time (JIT) policy
JIT is a production and purchase policy adapted and proven

successful in inventory management, in Japan. This is a concept
where materials are purchased only when needed and/or products
are manufactured only when there is a sales demand. This directly
cuts holding cost in a favourable manner whilst sustaining material
and/or product freshness, enhancing the input and output quality.
With JIT in place, inventory is favourably kept at near-zero levels.
 Smaller and more frequent purchase orders.

 Fewer suppliers for each item.
Effects of JIT
 Long term contracts with suppliers.
 Less paperwork.
 Reduced ordering costs per purchase order
 Lower investment in stock.

 Space savings due to reduction in inventory.
Benefits of JIT
 Companies can respond more quickly to
market changes.
 Elimination of waste and inefficiency.
 High quality of product, and as such, better
customer goodwill.
Table 4.4 Effects and benefits of JIT policy
Safety Inventory (or Free Or Buffer Stock)
Although JIT policy recommends minimum level of storage and

costs, it is important to keep safety stock in case of emergencies.
Safety inventory is especially useful in the following situations:

 There is a sudden customer demand
 Fluctuating or changing customer demands
 Unstable lead time (duration between placing an order until
the goods are delivered)
 Unreliable supply of materials – can be due to seasonal
fluctuations and other variations in usage and demand of the
materials
 Unreliable suppliers- especially where a new supplier is
involved
Basically, the primary purpose of safety stock is to avoid stock-out

costs. Stock-out refers to a situation of running out of stock.
99
Stocktaking
This is a process of counting physical stock on hand and checking if

the value tallies with balances in the bin card & stores ledger
account.
There are two types of stocktaking – periodic and continuous.
 Periodic Stocktaking
This is done at periodic intervals in a year. It can be once or twice

a year on a specific date or time. Although it is less troublesome,
and only a day’s (or a few days’ time), this is not a good way to
detect fraud.
 Continuous Stocktaking
This refers to regular counting and checking. This is a system

whereby stocktaking is carried out on an ongoing rota basis
throughout the year, so that every stock item is checked at once.
It serves as a better fraud control method, thereby improving

management decision making and even reduces losses by
obsolescence. Items of greater value or importance may be
counted several times during the year.
As a result, stocktaking effort can be directed to minimise

control and minimise costs. In contrast to periodic stocktaking,
it also avoids disruption to production.
Perpetual Inventory System
Perpetual inventory is a system of entering details of all stock

receipts and issues for each individual raw material and/or finished
product onto a record card, thus enabling the stock quantity on hand
to be known at any time.
The inventory quantity provides the necessary information for stock

re-order, verification and reconciliation with physical inventory
counts.
Any discrepancies (non-tallying data) must be investigated and

corrected for the benefit of management activities, including profit
reporting.
100
Inventory Discrepancies
This means there is a difference in numbers or data recorded in the

bin card, stores ledgers and in the storage area.
Common reasons include:
 Fraud
 Misplacement in stores or warehouses – stock placed in wrong
racks
 Inventory returned from production not documented
 Spoilt or wasted goods not recorded or accounted for
 Quantity issued to production is different from quantity
requested via material requisition note – probably due to
carelessness of issuing clerk or officer
 Quantity accounted for in the goods received note is different
from actual quantity delivered by supplier
101
Topic Review (TLO B1f)

Describe the procedures required to monitor inventory and minimise discrepancies and losses.
1. (Choose 2 answers.)
Just-in-time purchasing and production lower:
A. Product and material quality.
B. Wastage and spoilage.
C. Customer goodwill.
D. Storage space and costs.
2. Which statement is true?

A. The stocktaking methods include periodic, continues and perpetual.
B. Periodic stocktaking is a good method of preventing fraud.
C. Continuous stocktaking is done a few times a year, to detect fraud.
D. Perpetual inventory system records all inventory movements as and when they occur.
3. Reasons for inventory discrepancies do not include 2 of the following:

A. Inventory stored in the wrong cupboard.
B. Thrown out spoilt inventory not recorded in the bin card.
C. Materials bought have been fully used up.
D. Values in the stores ledger use FIFO, but in the bin card, LIFO.
102
4g. The Costs of Holding Inventory and of Being Without Inventory

Learning Outcome (ACCA Study Guide Area B, Topic B1g):
Explain and illustrate the costs of holding inventory and of being without inventory.
Holding Cost
Holding cost refers to costs involved in storing or keeping materials

which have been purchased for production. This includes:
 Rental of the store/warehouse

 Store requisitions costs
 Interest charges on funds used to buy the materials being stored,
and not used yet
 Theft
 Insurance costs on materials being stored
 Risk of obsolescence = materials kept too long become “out of
trend” and are no longer preferred nor used
 Deterioration – spoilage due to long term storage beyond the
lasting time
Material inventories exist because:
 There should be enough materials for use when needed

 Materials may be needed in between processes – as buffer stock;
 Companies do take advantage of promotions and trade
discounts, hence stoking up
If inventory is not needed, or only bought when needed for

production (JIT), then stock-out issues do not exist.
But if inventories are supposed to be replenished and available at all

times, then stock-out costs can be damaging to the business.
Stock-out costs include:
 Cost of production halts or stoppages;

 Cost of labour frustration over stoppages;
 Loss of contribution due to loss of sales – because finished goods
cannot be produced in absence of materials;
 Loss of future sales due to dissatisfactions of customers who
have been delayed before due to lack of materials
 Loss of customer goodwill
103
Topic Review (TLO B1g)

Explain and illustrate the costs of holding inventory and of being without inventory.
1. How will the holding cost for a manufacturing company differ from the same for a service
organisation?
2. What are the short term consequences of suffering a stock-out during a production process?
104
4h. Inventory Control Levels

Learning Outcome (ACCA Study Guide Area B, Topic B1h):
Explain, illustrate and evaluate inventory control levels (minimum, maximum, re-order).
There are certain terms related to stock levels:
1. Re-order level
The re-order level is the minimum level of inventory that is

reached after which inventory must be ordered. It is the lowest
stock level before re-ordering. For example, if the re- order level
of a product is 100 units, the moment the actual level hits 100
units, or lower, after an issue, the product must be re-ordered –
at EOQ. This is a stock-out preventive measure. It is computed as:
Re-order level = maximum usage × maximum lead time
Lead time refers to duration between order and delivery of

goods.
If the maximum usage and maximum lead time are not provided,
then the re-order level is computed as:
Re-order level = safety stock + (average usage × average lead

time)
2. Minimum stock control level
If actual stock is lower than this level, then it has just hit a
dangerously low level. Stock level should not be any lower than
the minimum stock control level. The risk of stock- outs will be
very high.
Minimum stock control level is computed as follows:
Minimum stock control level

= Reorder level – (average usage × average lead time)
3. Maximum stock control level
This is the maximum quantity that can be held. Any level higher
than this will possibly result in wastage or increase risk of
obsolescence.
Maximum stock control level is computed as follows:
Maximum stock control level

= Reorder + reorder – (minimum × minimum)
level quantity usage lead time
105
Topic Review (TLO B1h)

Explain, illustrate and evaluate inventory control levels (minimum, maximum, re-order).
The following data are available on a certain raw material, Y.

Maximum usage 50 units per week
Average usage 40 units per week
Minimum usage 30 units per week
Maximum lead time 5 weeks
Average lead time 4 weeks
Minimum lead time 3 weeks
Annual demand 15,000 units
Safety stock 100 units
EOQ 300 units (c = $3; h = $1)
Calculate for Y, the:
(a) Re-order level;
(b) Minimum stock control level;
(c) Maximum stock control level.
106
4i. Optimal Order Quantities

Learning Outcome (ACCA Study Guide Area B, Topic B1i):
Calculate and interpret optimal order quantities.
Optimal order quantity is better known as economic order quantity

(EOQ). It refers to the re-order quantity which minimises total
annual costs of holding and ordering stock.

Economic order quantity (EOQ) = 2cD
h
where
c = cost per order
h = holding cost per unit per year
D = demand per year
The bigger the order size, the fewer orders a year. But that would
mean more stock will be held after each order, thus increasing
holding cost. On the other hand, the smaller the order size, the
more frequent the order, which increases ordering cost. So, a
balance between these costs has to be determined to ensure
lowest total annual costs of ordering and holding inventory.
Annual ordering costs are computed this way:
Annual ordering costs = Annual Demand × cost per order

Re-order quantity
Annual holding costs are computed as:

Annual holding costs = average stock × holding cost per unit per
year
where Average stock = Reorder quantity + Safety stock
2
Let’s say the cost of an order of a material X is $50 and the holding
cost per unit per year is $4. The annual demand is given as 1,600
units. So, the EOQ would be computed as follows:

Economic order quantity (EOQ) = 2 × $50 × 1,600 units = 200 units
$4
This means, only if 200 units are ordered each time, the annual
holding costs PLUS the annual ordering costs, will be the lowest, in
this case $800. Any other re-order quantity will result in a higher
total annual cost.
Annual ordering costs = 1600 units × $50 = $400

200 units
107
Annual holding costs = 200 units × $4 = $400

2
Total annual ordering and holding = $800
108
Topic Review (TLO B1i)

Learning Outcome (ACCA Study Guide Area B, Topic B1i):
Calculate and interpret optimal order quantities.
1. Solomon Ltd has been buying Product Z in lots of 1,200 units, a four-months’ supply. The cost per
unit is $100, the ordering costs are $200 per purchase order and the annual inventory holding costs
for one unit are $25. Assume that the units will be required evenly throughout the year. What is the
EOQ?
2. ACB Ltd has determined the following for a given year:
EOQ in units 5,000

Total annual ordering costs $10,000
Ordering costs per purchase order $50
Costs of holding 1unit for 1 year $4
What is ACB Ltd’s estimated annual demand in units?
3. A company plans to purchase 90,800 units of a particular item in the next year. The item is purchased
in boxes, each containing 10 units of the item, priced at $200 per box. A safety stock of 250 boxes is
kept.
The cost of holding an item in stock for a year (including insurance, interest and space costs) is 15%
of the purchase price. The cost of placing and receiving orders is to be estimated from cost data
collected relating to similar orders, where costs of $5,910 were incurred on 30 orders. It should be
assumed that ordering costs change in proportion to the number of orders placed.
a. Calculate the economic order quantity.

b. Determine the required frequency of placing orders, assuming that usage of the item will be
even over the year (1 year = 52 weeks).
4. Product costs include ordering costs of $30 per order and stockholding costs of $1.60 per unit
per annum for a particular component. Annual usage of the component is 4,000 units and a
buffer (safety) stock of 100 units is held on average.
Construct a table showing the total annual ordering cost, the total annual stockholding cost and
the total annual inventory cost of the component for order sized between 50 to 4,000 units.
Determine the EOQ based on the table constructed.
109
Answers:
110
4j. The Relationship between Materials Costing System and Inventory Control System
Learning Outcome (ACCA Study Guide Area B, Topic B1j):
Explain the relationship between the materials costing system and the inventory control system.
The materials costing system helps one compute the value of

materials injected into the production process, thus directly helping
ascertain product cost and product selling price.
The inventory control system focuses on managing inventories –

from purchasing, to maintaining, to release to production.
The material cost itself comprises more than just the purchase price.
Where possible, inventory control costs namely ordering and
holding charges are included. This reduces ambiguities and
irresponsibly grouping stock control costs as indirect, whilst being
transparent about exact elements of material costs involved.
The inventory control and material costing systems are not

separable systems – one focuses on volume, and one on value. If
managed well together, they form an efficient and effective
inventory management system.
111
Topic Review (TLO B1j)

Learning Outcome (ACCA Study Guide Area B, Topic B1j):
Explain the relationship between the materials costing system and the inventory control system.
True or false?
1. Materials costing help set selling prices.
2. Inventory control system ensures materials are recorded at the most

appropriate costs.
3. Material costing system includes both volume and value of inventory

movement.
4. Material costing and inventory control systems are parts of an efficient

inventory management system.
112
Chapter 4 Summary
1. Three valuation methods:

a. FIFO – Issues are valued at the price of the oldest batch in stock until all units of that batch
are issued out, after which the price of the next oldest batch would be used.
b. LIFO – Issues are valued at the price of the most recent batch until a new batch is received.
c. CWA and PWA:
i. CWA – The issue price is based on the average stock price calculated each time new
stock is purchased. The product costs and value of closing inventory would lie
between the values computed using FIFO and LIFO.
ii. PWA – The stock price per unit equals to value of total inventory (opening and
purchased) divided by volume of total inventory.
2. Safety stock refers to inventory which are kept as back-up for emergency reasons.
3. Ordering costs are costs incurred when making an order.
4. Holding cost refers to costs involved in storing or keeping materials which have been purchased for
production.
5. Stocktaking is a process of counting physical stock on hand and checking if the value tallies with
balances in the bin card & stores ledger account:
a. The periodic stocktaking is done once or twice a year on a specific date.
b. The continuous stocktaking refers to regular counting and checking.
6. Economic order quantity (EOQ) is the re-order quantity which minimises total annual costs of holding
and ordering stock.
7. Re-order level is the minimum level of stock that is reached after which stock must be ordered. It is
the lowest stock level before re-ordering.
8. Actual stock should not be lower than the minimum stock control level; otherwise, the risk of stock-
outs will be very high.
9. The maximum stock control level refers to the maximum quantity that can be held, exceeding which
would lead to wastage or increased risk of obsolescence.
113
CHAPTER 5: ACCOUNTING FOR LABOUR Sunway TES
CHAPTER 5: ACCOUNTING FOR LABOUR
Learning Outcomes
TLO B2a. Explain, illustrate and evaluate labour remuneration methods.
TLO B2b. Describe the operation of a payroll accounting system.
TLO B2c. Distinguish between direct and indirect labour costs.
TLO B2d. Describe the procedures and documentation required to ensure the correct coding, analysis
and recording of direct and indirect labour.
TLO B2e. Describe and illustrate the accounting for labour costs.
TLO B2f. Explain the relationship between the labour costing system and the payroll accounting
system.
TLO B2g. Explain the causes and costs of, and calculate, labour turnover.
TLO B2h. Describe and illustrate measures of labour efficiency and utilisation (efficiency, capacity
utilisation, production volume and idle time ratios).
114
5a. The Labour Remuneration Method

Explain, illustrate and evaluate labour remuneration methods.
There are two broad categories of remuneration methods:

 Time-related
Wages paid according to hours worked.
 Output-related (piecework)
Wages paid by the level of activity or output volume.
Both these categories have been fully addressed and illustrated in

MA1. However, for revision purposes, here are some of the
important terms that should be remembered:
 Basic pay
This is calculated based on total hours worked and basic rate of

pay.
Basic pay = Total hours worked x Basic rate of pay
 Normal pay
This is calculated based on the normal or usual hours of work.
Normal pay = Normal hours of work x Basic rate of pay
 Overtime pay
This refers to wages paid on the extra hours of work with a

premium amount. Overtime rate are supposed to be
significantly higher than basic rates. Otherwise, logically, it
would not be reasonable for individuals to clock in the extra
hours.
Overtime pay = Overtime hours x Overtime rate
In reality, not all overtime hours are paid. A lot of executives and
managers are not usually rewarded with overtime pay for the
needful extra working hours. But, they are usually rewarded in
other ways, which includes replacement leaves, performance
bonuses and similar incentives.
 Overtime premium
This is the additional wages on the overtime hours, above the

basic rate. The premium rate would be the difference between
basic rate and overtime rate.
Overtime premium = Overtime hours’ x Overtime premium rate
115
 Gross pay
This is the total earnings of an individual. It will include wages

payable for all hours worked or units produced, along with
allowances, bonuses and incentives. It can be computed as a
total of:
 Basic pay and overtime premium, or
 Normal pay and overtime pay.
 Net pay
This would be the take-home pay after all deductions –Pay As

You Earn (PAYE) tax and employee’s National Insurance
Contribution (NIC).
Net pay = Gross pay – PAYE Tax – Employee’s NIC
 Labour cost to employer
This will be the cost an employer bears for each employee in the
payroll. It must include the employer’s share of National
Insurance Contribution.
Labour cost to employer = Gross pay + Employer’s NIC
 Idle time pay
This is the amount paid for work time, but in fact, no productive
work is done. Idle time can be caused by various reasons, from
breakdown in the production line to delays in materials’ arrival.
Idle time pay = Idle time hours’ x Basic rate of pay
Idle time may be avoidable or unavoidable.
It is avoidable when production disruptions due to inefficient

scheduling and machine breakdown can be prevented by more
efficient management and regular maintenance services
respectively. Avoidable costs should not be treated as product
costs and as such, be written off to profit or loss account.
Idle time may be unavoidable due to normal working conditions

or external factors. This includes shortage of material supplies
and/or machine hours. In such cases, the idle time pay will be
treated as part of production costs.
116
 Straight piecework and differential piecework
Straight piecework is where a standard rate is agreed for the

production of each unit. This will be based upon an expected
time to produce one unit and the normal rate per hour. The
guaranteed minimum wage provides some security of wages
when production is below a certain level. Beyond that, wages
are based upon the level of output multiplied by a piecework
rate per unit and thus the higher the level of output, the higher
the wages paid.
When differential piecework scheme is employed, wages are

based upon level of output multiplied by a piecework rate per
unit. The rate per unit increases on additional units produced
when certain output levels are reached. Three different
piecework rates apply in this case depending upon output levels
reached.
Differential piecework scheme does not provide the security of

a guaranteed wage but has the enhanced incentive of increased
rates for higher production.
In general, in the short run, wages may vary with level of activity or
remain fixed; may be controllable or non-controllable. However, in
the long run, wages can be completely variable and controllable.
117

Explain, illustrate and evaluate labour remuneration methods.
1. Kelly works as a production worker in the Assembly department of a manufacturing company. She
works on a 40-hour work week. She is paid $9 per hour, but overtime is paid at a time and a third.
On a particular week, she works 48 hours. Her wages deductions are 23% of gross wages. Her
employer’s NIC amounts to 15% of her gross wages.
Calculate her:
a. Basic pay
b. Normal pay
c. Overtime premium
d. Overtime pay
e. Gross wages
f. Net wages
g. Labour cost to employer
118
5b. Payroll Accounting System

Describe the operation of a payroll accounting system.
The payroll accounting system has been adequately addressed in

MA1. Figure 5.1 summarises the operations of the system.
Figure 5.1 Payroll processing cycle
119

Describe the operation of a payroll accounting system.
1. Where do the inputs for the payroll processing system come from?
2. Where do the outputs of the payroll processing system go to?
120
5c. Direct and Indirect Labour Costs

Distinguish between direct and indirect labour costs.
Direct Labour Cost

Direct labour cost relates to all cost that can be easily identified with
a product. It is usually calculated for direct workers, by deducting
their idle time pay from their basic pay. Where relevant, overtime
premium is treated as part of the direct labour cost.
Direct labour cost = Basic pay of direct workers
– Idle time pay of direct workers
+ Overtime premium (if necessary)
Direct labour costs are credited from the Wages Control account
and debited into the Work in Progress (WIP) account.
Indirect Labour Cost

Every other costs related to workforce basically come under indirect
labour cost. Usually, the elements of indirect labour cost include:
 Gross wages of indirect workers
 Idle time pay of indirect workers
 Overtime premium of direct workers
 Bonuses, allowances and incentives
Indirect labour cost = Gross wages of indirect workers
+ Idle time pay of direct workers
+ Overtime premium of direct workers (if

necessary)
+ Bonuses, allowances and incentives, if any
Indirect labour costs are credited from the Wages Control account
and debited into the Production Overhead Control account.
121
Overtime Premium
Overtime premium of a direct worker is usually treated as indirect
cost, except in two situations, where:
1. Overtime is clocked regularly

When working overtime becomes a regular event, and the
worker seems to work a constant number of hours after the
normal hours, the overtime premium may be treated as a direct
cost of production and spread over all units of output.
2. Overtime is worked at a specific request of a customer

Basically, the overtime performed is simply to meet a specific
production demand. That means, all the extra hours of work are
for a specific production demand only, and for no other reason.
Hence, the overtime pay can be directly traced to the products
being made (or service being provided). As such, here, the
overtime premium is treated as direct cost of production.
For direct workers, the overtime wages basic wages for overtime
hours should be charged directly to jobs or tasks in the same way
as the normal hours of direct workers. The charging of the
overtime premium will depend upon circumstances.
If overtime working is normal, or the result of general short-term

peaks in activity, it would be unfair to charge the additional
premium costs to the jobs that happen to be scheduled during
the overtime hours.
There are two alternatives in such circumstances:
1) Share the overtime premium over all the jobs worked in a

period by including the cost of overtime premium in the direct
labour rate applied to all jobs.
2) Treat overtime premiums as an indirect cost and include

within the overhead absorption rate to be applied to all jobs.
However, if overtime working is a consequence of an urgent

customer order, then, the total cost of overtime working (basic
and premium) should be charged as a direct cost of the work
undertaken in overtime hours.
122
How is overtime processed in a manufacturing business’ cost

accounts?
Overtime is time that is paid for, generally at a premium, over and

above the basic hours for a period. As with idle time, there are a
number of possible causes which will influence cost accounting
treatment. Overtime hours at the basic rate should be allocated to
products as a direct cost. The overtime premium will generally be
treated as an indirect cost and thus apportioned to all products.
However, when overtime is worked at the request of a particular

customer, the premium cost may be allocated directly to the work
done in overtime hours. If avoidable, the premium cost may be
excluded from product costs entirely and charged direct to Profit
and loss a/c.
How is idle time pay processed in a manufacturing business’ cost

accounts?
Idle time is time paid for that is non-productive. It is important that

the amount of idle time and the reasons for it are monitored, acted
upon and treated appropriately in terms of cost
allocation/apportionment. Time booking procedures should be in
place.
There are a number of possible causes of idle time (i.e. machine

breakdown, lack of sales demand and poor scheduling) which will
influence cost accounting treatment. If unavoidable, the cost of the
idle time will generally be treated as an indirect cost and will be
apportioned to all products as part of production overhead. If
avoidable, the cost may be excluded from product costs and charged
direct to Profit and loss a/c.
123

Distinguish between direct and indirect labour costs.
1. A company operates a factory that employed 40 direct workers throughout a four-week period that
has just ended. Direct workers were paid $4.00 per hour for a 38-hour week. Total hours of the direct
workers in the four weeks were 6,528. Overtime, which is paid at a premium of 35%, is worked in
order to meet general production requirements. Employee deductions total 30% of gross wages.
188 hours of the direct workers‟ time were registered as idle.
a. What are the gross wages and the net wages of the direct workers?
b. How much of the labour costs would be recorded in the work in progress and production
overhead control accounts?
2. A company employs 10 direct production workers and 5 indirect staff in manufacturing department.
The normal operating hours for all employees is 35 hours per week and all staff are paid $6 per hour.
Overtime hours are paid at the basic rate plus 50%. During a week, all employees worked for 48
hours.
What amount would be charged to production overheads?
124
5d. The Procedures and Documentation Required

Describe the procedures and documentation required to ensure the correct coding, analysis and recording
of direct and indirect labour.
Yet another content that has been fully elaborated in MA1.
Some documents that must be remembered:
1) Clock card
It records working time or time at workplace, namely time-in
and time-out.
2) Pay advice
Also known as pay slip, this document states gross income and
net pay alongside all deductions.
3) Time sheet
This is a data collection document. It is a tool that records
specific working time on specific tasks and also overtime.
4) Job card
Contains labour-related details such as hours worked on the
specific job. It also hints on the skills employed to complete the
job, that should be paid accordingly.
Timesheet and job cards are very useful to trace specific working
hours and effort to specific work or tasks, which helps compute
direct labour costs.
125

Describe the procedures and documentation required to ensure the correct coding, analysis and recording
of direct and indirect labour.
1. Which two of the following are not elements in labour cost documentation?
A. Clock card.
B. Bin card.
C. Timesheet.
D. Job sheet.
E. Stores card.
F. Pay advice.
126
5e. The Accounting for Labour Costs

Describe and illustrate the accounting for labour cost.
This has already been addressed at length in MA1. A quick review

provided here.
All labour costs are noted in the wages (or salaries) control account.
Direct and indirect labour costs are recorded in the work in progress
(WIP) and production overhead control (POHC) accounts
respectively.
127

Describe and illustrate the accounting for labour.
1. (Choose 2 answers.)
Wages control account accepts data from:
A. Production department.
B. Payroll accounting system.
C. Labour costing system.
D. Senior managers.
128
5f. Labour Costing and Payroll Accounting Systems

Explain the relationship between the labour costing system and the payroll accounting system.
Data collected for labour costing system directly feeds into the
payroll accounting system. Output from the costing system directly
decides the amount of salaries to be paid and the relevant
deductions.
The two systems are no separable, unless it is a very small

organisation and everyone (all employees) are on fixed salaries.
The moment there is overtime and allowances or a more enhanced

remuneration system, the labour costing system becomes essential.
129
Topic Review (TLO B3f)

Explain the relationship between the labour costing system and the payroll accounting system.
1. Which one of the following statements is false?

A. Payroll is part of financial accounting.
B. Labour costing is part of management accounting.
C. Both payroll and labour costing systems co-exist in a manufacturing company.
D. Service industries do not need labour costing systems because there is relatively no production
involved.
130
5g. The Causes and Costs of, and Calculate, Labour Turnover
Explain the causes and costs of, and calculate, labour turnover.
Labour turnover is a measure of the speed at which employees leave

an organization or are replaced. High labour turnover means many
people come and then leave, resulting in a high cost to the
organisation.
Labour turnover can be measured this way:
Labour turnover rate = number of replacements × 100%

average number of employees
where average number of employees =
number of employees at number of employees

the beginning of the year + at the end of the year
2
Costs of Labour Turnover – Replacement Costs
Replacement costs are incurred when employees or positions are

replaced.
1) Leaving costs
These are costs relating to administering necessary
documentation and possible disruption at work, especially when
replacements are not yet available.
2) Recruitment costs
These are costs of advertising, selection and bringing new
recruits aboard. Examples include agency fees and relocation
fees.
3) Learning costs
These are costs of training and learning curve effect, which
refers to possible reduced productivity and poor quality work
during the learning period.
4) Non-financial costs of low morale

The motivation level of remaining staff can be low due to greater
absenteeism and poorer productivity due to shortage of
manpower.
131
Reasons for Leaving
Common reasons for leaving include:

 Job dissatisfaction
 Poor relationship between management and staff
 Wage rate below market rate
 Lack of development opportunities
 Unsafe working conditions
 Stressful working conditions
 Demanding bosses
 Inadequate training
 Retirement, death or illness
 Moving homes or emigration
Stopping People from Leaving
Most of these can be managed skilfully. It is good to keep labour

turnover rates at minimum levels.
Preventive costs are costs involved in ensuring employees do not

leave, and they are retained with satisfaction. These comprise of cost
of medical services, cost of welfare services (such as sports facilities,
house, and vehicles), administration costs in maintaining good
relations with employees, an also pension schemes providing
security to employees.
Labour turnover can also be minimised by paying satisfactory wages

(preferably at market rate), offering sufficient opportunities up the
promotional ladder, and at the same time, improving jobs – using job
enrichment, enlargement or rotation policies. Management can
ensure satisfactory working conditions and also encourage good
relations among all staff.
132
Topic Review (TLO B3g)

Explain the causes and costs of, and calculate, labour turnover.
1. Why do people leave a well-paying job?
2. How to stop employees from leaving a low skill job?
3. How does a high labour turnover affect the growth of an organisation?
Answers:
133
5h. Measures of Labour Efficiency and Utilisation

Describe and illustrate measures of labour efficiency and utilisation (efficiency, capacity utilisation,
production volume and idle time ratio.
The labour utilisation ratios have been addressed in MA1 and merely
areas of revision here:
Activity ratio = Standard hours × 100%

Budgeted hours
Capacity ratio = Actual hours × 100%

Budgeted hours
Efficiency ratio = Standard hours × 100%

Actual hours
Other ratios used in the cost accounting function include:
Idle time ratio = Idle hours x 100%

Total hours
Number of hours/days absent (in a

Absenteeism rate = given period) x 100%
Total hours/days paid/worked (in a
given period)
Number of days off work due to

Sickness rate = sickness (in a given period) x 100%
Total no. of days paid/worked (in a
given period)
Overtime rate = Overtime hours worked x 100%

Total hours worked
134
Topic Review (TLO B3h)

Describe and illustrate measures of labour efficiency and utilisation (efficiency, capacity utilisation,
production volume and idle time ratios).
1. In a particular production line, normal production volume of 25,000 units require 100,000 hours.
But the actual production was only 24,300 units in a total of 96,500 hours. 97200
What are the utilization ratios?
2. In a particular month, there were 10 sick leaves for a group of 25 persons paid for 26 days that
month. Other leaves were 5 days. What is the sickness ratio? Absenteeism ratio?
135
Chapter 5 Summary
1. Basic pay of a worker is calculated based on total hours worked and basic rate of pay.
2. Normal pay is calculated based on the normal or usual hours of work.
3. The overtime pay is calculated based on extra hours worked and the overtime rate. It is made up of
two main parts – basic pay of the overtime hours., and the overtime premium. Overtime premium of
a direct worker is usually treated as indirect cost, except in two situations, where:
a. Overtime is clocked regularly.
b. Overtime is worked at a specific request of a customer.
4. Idle time pay is the amount paid for time not used for production and is paid at basic rate.
5. Direct labour cost is usually calculated for direct workers, by deducting their idle time pay from their
basic pay. Overtime premium is included where relevant.
6. Every other cost related to workforce come under indirect labour cost.
7. Gross wages are total wages paid out to all employees, which is a total of either:
a. Direct labour cost and indirect labour cost, or
b. Basic pay of all workers and overtime premium of all workers, and bonuses, allowances and
incentives, if any, or
c. Normal pay of all workers and overtime pay of all workers, and bonuses, allowances and
incentives, if any.
8. Net wages refer to all amounts payable to employees after deducting employees' National Insurance
Contribution (NIC) and Pay As You Earn (PAYE) tax.
9. Labour cost to employer is made up of employer's NIC and total gross wages.
10. Time-related pay refers to wages being calculated based on hours worked, regardless of productivity
levels.
11. Piecework pay refers wages paid based on workers' productivity levels. It may work in these three
ways:
a. Pay is solely based on productivity.
b. There is a guaranteed minimum wage.
c. There is a basic wage that is paid with the piecework pay.
12. Straight piecework is one where a standard rate is agreed for the production of each unit.
13. When differential piecework scheme is employed, wages are based upon level of output multiplied
by a piecework rate per unit.
14. Labour turnover is a measure of the speed at which employees leave an organization or are replaced.
15. Preventive costs are costs involved in ensuring employees do not leave, and replacement costs are
costs involved in replacing the employees who have left the organisation.
136
CHAPTER 6: ACCOUNTING FOR OTHER EXPENSES Sunway TES
CHAPTER 6: ACCOUNTING FOR OTHER EXPENSES
Learning Outcomes
TLO B3a. Describe the nature of expenses by function.
TLO B3b. Describe the procedures and documentation required to ensure the correct authorisation,
coding, analysis and recording of direct and indirect expenses.
TLO B3c. Describe and calculate capital and revenue expenditure and the relevant accounting
treatment.
TLO B3d. Calculate and explain depreciation charges using straight-line, reducing balance, machine
hour and product units methods.
TLO B3e. Explain the relationship between the expenses costing system and the expense accounting
system.
137
6a. Nature of Expenses by Function

Describe the nature of expenses by functions.
Introduction
Expenses refer to all costs, which cannot be categorised as materials

or labour. Most expenses are indirect in nature, except for a few,
such as royalty, franchise fee and hire of special equipment or tool.
Direct Expenses
Direct expenses can be easily traced to a specific product or cost

unit, and as such, are part of prime costs. The incurrence of direct
expenses is recorded into the Work in Progress (WIP) account. This
includes hire of specific equipment, royalty payments and packaging
costs.
Indirect Expenses
When an expense cannot be attributed or is difficult to be traced to

a particular product or cost unit, it is an indirect expense, and its
incurrence will be recorded into the Production Overhead Control
account. Building rental and machinery, depreciation and insurance,
and utility bills are common examples of indirect expenses.
138

Describe the nature of expenses by functions.
True or false?
1. There are more direct expenses in manufacturing organisations than

in service organisations.
2. Individual packaging can be considered direct expense.
3. The same packaging tapes used in wrapping multiple products are

treated as indirect expense.
4. Power used by a particular machinery that makes only one product

can be considered as direct expense.
139
6b. Procedures and Documentation Required

analysis and recording of direct and indirect expenses.
There is no specific document to collect solely direct or indirect

expenses. However, direct expenses can be obtained from a
product’s unit cost card, job cost card and any relevant documents
which show clearly, specific expenses or costs incurred on an
expense item.
Item such as packaging is noted on the product’s unit cost card.

Hire of special tool can be seen on a job cost card.
As for indirect expenses such as utilities’ consumption, only the

monthly bills will reflect on usage volumes and values. Factory
rental data are depicted on tenancy contracts. Depreciation
information are obtained from the financial accounting division.
In short, indirect expenses are gathered from various sources as

per arising requirements.
Coding of expenses have been elaborately discussed in MA1.
140

Describe the procedures and documentaries required to ensure the correct authorities, coding analysis
and recording of direct and indirect expenses.
What are the sources of the following information?

1. Electricity charges.
2. Telephone charges.
3. Building depreciation.
4. Machinery lease.
141
6c. Capital and Revenue Expenditure and the Relevant Accounting Treatment
Describe and calculate the revenue expenditure and relevant accounting treatment.
Types of Expenses
The types of expenses can be also being categorised as capital and

revenue expenditure, based on the purpose of the expenses
Capital Expenditure
It refers to money spent to acquire fixed assets such as vehicles,

machinery and equipment. Such expenses are recorded in balance
sheet as fixed assets.
Revenue Expenditure
It refers to basically all other expenses. That would include fixed

salaries, utility bills, and building insurance and rental. Revenue
expenditure is treated as expense in profit and loss account in the
period incurred.
Major discussions are available in FA2.
142

Describe and calculate capital and revenue expenditure and the relevant accounting treatment.
Select the false statements:

1. Buying a new vehicle is a capital expenditure.
2. Painting an existing van is a capital expenditure.
3. Renovating the showroom to give it a new look is revenue expenditure.
4. Depreciation of fixed assets is recorded in the profit and loss account.
143
6d. Depreciation Charges

Calculate and explain depreciation charges using straight- line, reducing balance, machine hour and
product units methods.
Depreciation
Depreciation is the measure of wearing out, consumption or other
reduction in the useful economic life of a fixed asset. It can be seen
as a way to spread out the capital cost of an asset. Although total
depreciation in accounting is considered an overhead, the
depreciation of a specific item used for exclusive reasons (such as
using special equipment in a specific batch of production) can be
considered as a direct expense.
In a way, depreciation is a method of writing off capital expenditure.

Cost of fixed assets is recorded in balance sheet while depreciation
of fixed assets is written off to P&L account.
Reason for calculating depreciation is due to compliance with

matching concept. Fixed assets are being used to make goods or
generate income; therefore, a proportion of asset’s cost should be
charged to the business as an expense to match with revenue.
Methods of Depreciation
The common methods of depreciating an asset are:
1. Straight line
2. Reducing balance
3. Machine hour
4. Production volume
144
1. Straight Line Method

The depreciation amount in the asset’s useful life is the same
for each period. The total depreciating amount is computed as
the asset’s purchase cost less its estimated disposal value,
which is then divided by the economic useful life.
Depreciation = Purchase cost – Estimated disposal value

Economic useful life
For example, if an asset is purchased at a cost of $50,000 with a

useful life of 6 years, and after that, be disposed at $8,000, then
the depreciation amount for each year would be = ($50,000 -
$8,000) ÷ 6 years = $7,000.
2. Reducing Balance Method

In this method, the most amount of depreciation is charged at
the beginning of the asset’s useful life, and then the amount
decreases each year. The first year’s depreciation would be a
certain percentage of the purchase cost. The subsequent years’
depreciation would then depend on the net book value (NBV) of
the asset for that year.
First year’s depreciation = depreciation percentage × purchase

cost
Subsequent years’ depreciation = depreciation percentage × NBV

of the asset
For an asset that is purchased at $8,000 and depreciates at 20%

each year:
Year Depreciation amount($) NBV ($)

1 8,000 × 20% = 1,600 8,000 – 1,600 = 6,400
2 6,400 × 20% = 1,280 6,400 – 1,280 = 5,120
3 5,120 × 20% =1,024 5,120 – 1,024 = 4,096
4 4,096 × 20% = 819.20 4,096 – 819.20 = 3,276.80
So, the value of the asset at the end of year 4 is $3,276.80.
145
3. Machine Hour Method

Depreciation is charged based on the number of machine hours
used.
Depreciation per hour = Purchase cost - Estimated disposal value

Estimated total hours of useful life
Let’s say a machine is purchased for $30,000 and it has nil

residual value at the end of its 6 useful years.
During those six years, it is estimated that the machine will be

operational for 12,000 hours. In the first year of operations, the
machine was used for 2,000 hours.
Using the machine hours method of calculating depreciation

what is the depreciation charge for the first year?
The depreciation charge would be:

= $30,000/12,000 hours
= $2.50 per hour Depreciation charge in yr1
= 2,000 hours’ x $2.50
= $5,000
4. Production Volume Method

Depreciation is calculated per unit of output, but this is only
possible when the total production volume of the assets is
known.
Depreciation per unit = Purchase cost - Estimated disposal value

Estimated total output during useful life
For instance, a machine costs $80,000 to buy. It can produce

a total of 20,000 units during the useful life, after which it will
be sold off for $5,000.
The machine is expected to produce 6,000 units this year.

What would be the depreciation charge for the year?
Depreciation would be:

($80,000 - $5,000) ÷ 20,000 units = $3.75 per unit.
Charge for the year with 6,000 units = $3.75 x 6,000 = $22,500
146

Calculate and explain depreciation charges using straight-line, reducing balance, machine hour and
product units methods.
1. Kool Plc purchases an asset for $450,000 which is depreciated over 6 years using straight line
method.
What is the net book value (NBV) of asset after 4 years?
2. Gummy Ltd purchases an asset for $450,000, which is depreciated at 25% using reducing balance
(4 years).
What is the net book value of asset after 3 years?
147
6e. Relationship between the Expenses Costing System and the Expense Accounting System
Explain the relationship between the expenses costing system and the expense accounting system.
Basically, the expenses costing system relates to management
accounting, and the expenses accounting system related to financial

accounting.
The expenses costing system provides certain inputs for the

expenses accounting system. This includes items like depreciation,
which is used to cost a product and determine long term
profitability of the production line and plant.
What the expenses accounting system does, is that it takes these

estimations and values and projects them in the financial
statements, whilst updating the relevant T accounts.
The relationship between the two systems is unavoidable as the

accounting system cannot function without feeds from the costing
system.
148

Explain the relationship between the expenses costing system and the expense accounting system.
1. Which two of the following statements are true?

A. Expenses recording in the cost and financial accounting is the same.
B. Expense costing and expense accounting are not related.
C. The relationship between expenses costing and financial accounting is very complicated.
D. The relationship between expenses costing and financial accounting cannot be avoided.
E. Expenses accounting system feeds primary data to expenses costing system.
F. Expenses costing system feeds calculated data to expenses accounting system.
149
Chapter 6 Summary
1. Expenses are costs which cannot be categorised as materials or labour. Most expenses are indirect in
nature.
2. Two types of expenses are:

a. Capital expenditure – Money spent to acquire fixed assets such as vehicles, machinery and
equipment.
b. Revenue expenditure – All other expenses.
3. Depreciation is the measure of wearing out, consumption or other reduction in the useful economic
life of a fixed asset.
4. Common methods of depreciation are:

a. Straight line method where the depreciation amount in the asset's useful life is the same for
each period.
b. Reducing balance method where the most amount of depreciation is charged at the
beginning of the asset's useful life, and then the amount decreases each year.
150
CHAPTER 7: ABSORPTION COSTING Sunway TES
CHAPTER 7: ABSORPTION COSTING
Learning Outcomes
TLO C1a. Explain the rationale for absorption costing.
TLO C1b. Describe the nature of production and service cost centres and their significance for
production overhead allocation, apportionment and absorption.
TLO C1c. Describe the process of allocating, apportioning and absorbing production overheads to
establish product costs.
TLO C1d. Apportion overheads to cost centres using appropriate bases.
TLO C1e. Re-apportion service cost centre overheads to production cost centres using direct and step
down methods.
TLO C1f. Justify, calculate and apply production cost centre overhead absorption rates using
labour hour and machine hour methods.
TLO C1g. Explain the relative merits of actual and pre-determined absorption rates.
TLO C1h. Describe and illustrate the accounting for production overhead costs, including the analysis
and interpretation of over/under absorption.
TLO C1i. Describe and apply methods of attributing non-production overheads to cost units.
TLO C1j. Calculate product costs using the absorption costing method.
151
7a. The rationale for absorption costing

Learning Outcome (ACCA Study Guide Area C, Topic C1a):
Explain the rationale for absorption costing.
Production overheads refer to the all the indirect costs involved in

the production process. This comprises of material and labour costs,
and expenses which cannot be easily nor economically identified
with the cost unit. Common examples are:
 Costs of indirect materials - screws, glue and machinery

lubricant
 Salaries of indirect workers – production line supervisor, factory

manager and administrative staff working at the factory
 Indirect expenses – factory rental, building and machinery

depreciation and insurances
Production overheads may be fixed, variable, semi-variable and

even stepped, and they are all part of product or inventory valuation
under absorption costing method.
In absorption costing (AC), fixed production overhead is certainly

included in product costing. This means, unit fixed production
overhead is part of unit product cost.
As far as non-production overheads are concerned, they do exist.

Just that, they do not have direct relevance to absorption costing
estimations. Besides, valuation of inventory does not include non-
productions costs anyway.
152
Topic Review (TLO C1a)
Explain the rationale for absorption costing.
1. AC product cost includes all the following except these four:

A. Machinery lubricant
B. Accounting clerk in the factory
C. Equipment maintenance cost
D. Insurance of head office building
E. Salesmen commission
F. Production workers’ salaries
G. Truck driver salary
H. Board of director’s Chairman’s salary
2. Give 2 examples of indirect costs (not stated in the main text) in the following categories:
a. Material
b. Labour
c. Expenses
153
7b. The Nature of Production and Service cost Centres

Learning Outcome (ACCA Study Guide Area C, Topic C1b):
Describe the nature of production and service cost centres and their significance for
production overhead allocation, apportionment and absorption.
The responsibility centre which dwells with costs are typically the
cost centres. Only at cost centres, are cost data available for
collection and analysis.
Again, as already addressed in MA1, there are two types of cost

centres:
(1) Production Cost Centres

These are work units where the product is actually made (a
service is actually rendered). In a manufacturing company, the
production department and its divisions are the production cost
centres. In a service organisation, where the service is provided
– such as the classroom in a local college. Production cost
centres are the fundamental reasons for existence of a business
entity, and is, in fact, the heart of the organisation.
(2) Service Cost Centres

These are the supporting units. They exist solely to provide all
the necessary help, facilities and services alike to the production
cost centres – so that the products can be properly made or
delivered. It is for these definitions and reasons that the
products’ costs (fixed production overheads included) are
absorbed only in the production cost centres.
In short:
 A product is produced (only) in the production cost centres.

Therefore, all costs should be absorbed in these locations and
nowhere else.
 Service cost centres are merely supporting units. Therefore,
they should not be bearing any overheads on their own. All
overheads should be channelled to the very reasons of their
existence, which are the production costs centres.
Hence, absorption of fixed production overheads happens only in

production cost centres.
154
Topic Review (TLO C1b)

Describe the nature of production and service cost centres and their significance for production overhead
allocation, apportionment and absorption.
1. Production overheads are absorbed into the product through pre-determined OARs computed only
in production cost centres.
Why is that so? Why aren’t the overheads absorbed from the service cost centres?
155
7c. Allocation, Apportionment and Re-apportionment of Production Overheads

Learning Outcome (ACCA Study Guide Area C, Topic C1c, d, e):
Describe the process of allocating, apportioning and absorbing production overheads to establish product
costs.
Apportion overheads to cost centres using appropriate bases.
Re-apportion service cost centre overheads to production cost centres using direct and step down
methods.
The Overhead Absorption Process
As addressed in MA1, the overhead absorption process summarised

in Figure 7.1 below.
Step 1
Allocation and apportionment of overheads to all cost

centres
Step 2
Re-apportionment of service cost centre overheads to
production cost centres
Step 3
Absorption of overheads
(Computing OAR)
Figure 7.1 Overhead absorption process
There is hardly any new information on allocation, apportionment

and absorption in the MA2 syllabus. So all knowledge acquired in
MA1 are directly applicable here. But there is a little addition to the
re-apportionment section.
It must be acknowledged that there are three types of re-

apportionment methods:
(1) Direct
(2) Step-down
(3) Reciprocal
156
Re-apportionment refers to sharing out the overheads of the service

cost centres to the production cost centres. This is done according
to production cost centres‟ utilization percentage of the service cost
centres. Re-apportionment depends on the extent of services
provided. Questions like “How often does Assembly make
requisitions from the Stores?” and “How many employees are there
in assembly who eat at the canteen?” have to be asked and
answered in order to determine the utilisation rate.
In the direct re-apportionment method, as learnt in MA1, the

overheads are re-apportioned from the service cost centres to only
production cost centres, based on the utilisation levels.
But when there is at least a situation where one service cost centre
helps another service cost centre without the former being helped
by the latter, then step-down re-apportionment method applies.
This can be seen as a “one-way traffic” where the service cost centre
that helps is not helped the same.
However, if there is a mutual support system among at least two

service cost centres, then the reciprocal method applies. MA2
syllabus requires the learners to only know the theoretical concept
of this method, and not the calculations (which will be addressed in
FMA/F2).
Let’s take an in-depth look at the first two methods.
(1) Direct Method
When this re-apportionment method is employed, overheads

of each service cost centre are re-apportioned to only the
production cost centres. The direct method of re-
apportionment is only applicable in situations where (it is
assumed that) the service cost centres in question are not
utilised by other service cost centres. As such, the service cost
centres overheads are conveniently shared among only the
production cost centres.
Let’s take a look at the following example.
A manufacturing business has two production cost centres,

Alpha and Beta, and two service cost centres, Gamma and
Lamda. The service cost centres are only utilised by the
production cost centres. The expenses expected to incur in
the forthcoming year are as follows:
157
Expense Items $
Indirect materials Alpha 25,000
Beta 10,000
Lamda 5,000
Indirect labour Alpha 20,000
Beta 15,000
Gamma 25,000
Lamda 35,000
Machinery depreciation 15,000
Rent and rates 80,000
Heat and light 18,000
Power 25,000
Insurance of machinery 12,000
Extra information required to compute overhead absorption rate

are:
Item Alpha Beta Gamma Lamda Total

Floor Area (sq. m) 2,000 1,500 800 700 5,000
Power usage (%) 50 35 10 5 100 %
Net Book value of 55,000 30,000 10,000 5,000 $100,000
machinery
The following information reflects on usage of Gamma and Lamda

by Alpha and Beta
Alpha Beta
Gamma 55% 45%
Lamda 30% 70%
Applying the direct re-apportionment method would require an

overhead analysis sheet to be prepared. This sheet would show the
allocated, apportioned, re-apportioned and the final amounts of
overhead in each cost centre.
158
Overhead analysis sheet
Basis of
apportionment Alpha ($) Beta ($) Gamma ($) Lamda ($) Total ($)
Allocation:
Indirect
25,000 10,000 5,000 40,000
materials
Indirect labour 20,000 15,000 25,000 35,000 95,000
Apportionment:
Machinery NBV of
8,250 4,500 1,500 750 15,000
depreciation machinery
Rent & rates Floor area 32,000 24,000 12,800 11,200 80,000
Heat & light Floor area 7,200 5,400 2,880 2,520 18,000
Power Power usage 12,500 8,750 2,500 1,250 25,000
Insurance of NBV of
6,600 3,600 1,200 600 12,000
machinery machinery
TOTAL 111,550 71,250 45,880 56,320 285,000
Re-apportionment:
Re-apportion Lamda to: (56,320)

Alpha 16,896
Beta 39,424
Re-apportion Gamma to: (45,880)
Alpha 25,234
Beta 20,646
TOTAL 153,680 131,320 285,000
(2) Step-Down Method
This re-apportionment method requires overheads of the

each service cost centre to be re-apportioned to all other cost
centres – production and service – which utilises the service
cost centre’s facilities. The service cost centre which still has
overheads attached to it, will continue re-apportioning its
overheads to other cost centres, except to the previously re-
apportioned service cost centre.
Gradually, all the service cost centre would have transferred

their overheads to the production cost centres, and as such,
will have no overheads left (to re-apportion out) in any of the
service cost centres.
159
The step-down method of re-apportioning service cost centre

overheads is applicable in situations where the service cost
centres in question are utilised by other service cost centres.
However, the utilisation behaviour will not be reciprocal.
For example, a company has two service cost centres (P and

Q) and several production costs centres. P utilises the services
of Q, but Q does not utilise P at all. In such a case, the step-
down re-apportionment method may be applied to, first, re-
apportion Q‟s overheads to P and the relevant production
cost centres, and then re-apportion P‟s updated overheads‟
amount to the production cost centres concerned. It must be
observed that P does not share out its overheads to Q, which
does not utilise P‟s services.
Let’s take a look at how step-down re-apportionment method

is applied in Saphi Ltd. The company specialises in motorcar
spare parts‟ manufacturing.
Saphi Ltd has just completed the initial allocation and

apportionment of its budgeted overheads for the next year,
to its production and service cost centres, as shown in the
following table.
Department Overhead Production Service

Machining Finishing Stores Maintenance Canteen
Allocated & apportioned $56,000 $32,000 $8,000 $16,000 $12,000
No. of employees 80 20 10 10 8
Maintenance hours 1,000 600 100
Material requisitions 600 400
Machine hours 40,000
Labour hours 8,000
From the given data, it appears that Maintenance provides its

services to Stores. It must also be acknowledged that every
employee must be using the Canteen services. So, it is logical to re-
apportion Canteen to all other cost centres first. For that, the total
employees used in the computation of the re-apportioned amount
for each cost centre, would exclude the number of employees in
Canteen – which is 120 employees.
160
The re-apportioned amount for the cost centres are as follows:
Cost centre Working Re-apportioned

Machining (80 employees ÷ 120 employees) × $12,000 8,000 ($)
amount
Finishing (20 employees ÷ 120 employees) × $12,000 2,000
Stores (10 employees ÷ 120 employees) × $12,000 1,000
Maintenance (10 employees ÷ 120 employees) × $12,000 1,000
Canteen – nil – 0
TOTAL (equates to overheads of Canteen prior to re- 12,000
apportionment)
After that, the overheads of Maintenance have to be re-apportioned.

The re- apportionment basis will the maintenance hours spent in
each cost centre. The total maintenance hours are 1,700. The
overheads of this cost centre will not be re-apportioned to Canteen
simply because (according to the data given) Canteen has not used
Maintenance’s service at all. The overheads of maintenance are now
$16,000 + $1,000 =$17,000. This is due to the acceptance of $1,000
re-apportionment amount from Canteen. The re-apportioned
amount from Maintenance to the cost centres will be:

Machining (1,000 hours ÷ 1,700 hours) × $17,000 amount
10,000($)
Finishing (600 hours ÷ 1,700 hours) × $17,000 6,000
Stores (100 hours ÷ 1,700 hours) × $17,000 1,000
Maintenance – nil – 0
TOTAL (equates to overheads of Maintenance prior 17,000
to re-apportionment)
Lastly, the overheads of Stores will be re-apportioned to the

relevant cost centres, which are Machining and Finishing. The total
overheads in stores are now $8,000 + $1,000 + $1,000 = $10,000
because of the added overheads from Canteen and Maintenance.
The re-apportionment basis will be the material requisitions from
each cost centre. The total requisitions received by Stores are
1,000. The data given clearly shows that there were no material
requisitions from Maintenance or Canteen.
161
Hence, the following re-apportionment schedule for Stores:

amount ($)
Machining (600 ÷ 1,000) × $10,000 6,000
Finishing (400 ÷ 1,000) × $10,000 4,000
Stores – nil – 0
Maintenance – nil – 0
TOTAL (equates to overheads of Stores prior 10,000
to re-apportionment)
With the completion of the step-down re-apportionment exercise,

the total overheads in Machining $56,000 + $8,000 + $10,000 +
$6,000 = $80,000 and in Finishing $32,000 + $2,000 + $6,000 +
$4,000 = $44,000. The totals of these overheads are the same as the
total overheads prior to re-apportionment exercise, which were
$124,000.
The next step is the absorption exercise.
162
Topic Review (TLO C1c, d, e)

Learning Outcome (ACCA Study Guide Area C, Topic C1c, d, e):
Describe the process of allocating, apportioning and absorbing production overheads to establish product
costs.
Apportion overheads to cost centres using appropriate bases.
Re-apportion service cost centre overheads to production cost centres using direct and step down methods
1. There are two production cost centres (PCC X and PCC Y), and two service cost centres (SCC A and
SCC B) in a factory. Production overheads have been allocated and apportioned to cost centres and
now require re-apportionment from service cost centres to production cost centres. Relevant details
are:
SCC X SCC Y
Total overheads $42,000 $57,600
% to PCC X 40 55
% to PCC Y 60 45
What is the total re-apportionment to PCC Y?
2. Bell Designs has two production departments A and B and two service departments X and Y. some
of the budgeted overheads for the year ending 30 June 20X3 have already been allocated to the
departments as shown below:
Total Dept.A Dept.B Dept.X Dept.Y

Allocated overheads ($) 280,000 141,345 82,655 32,000 24,000
However, the remaining overheads have to be apportioned to each of the departments
Electricity $24,000 (on the basis of machine operating hours)

Indirect labour $36,000
Rent $64,000
Machine maintenance $12,000
The following information is also available:
Dept. A Dept. B Dept. X Dept. Y

Machine operating hours 12,000 10,000 1,500 500
Number of indirect workers 2 2 1 1
Floor area (square m) 21,000 19,500 4,500 3,000
163
The Service departments are expected to spend their time as follows:
Dept. A Dept. B Dept. X

Department X 40% 60%
Department Y 50% 30% 20%
What are the total amounts of overheads in A and B after the re-apportionment exercise?
164
7f. Production Cost Centre Overhead Absorption Rates

Learning Outcome (ACCA Study Guide Area C, Topic C1f):
Justify, calculate and apply production cost centre overhead absorption rates using labour hour and
machine hour methods.
Overhead Absorption Rate (OAR)
The overhead absorption rate is computed to absorb the overheads into

the products – to ensure all costs are included in total costs, so that an
appropriate selling price can be set.
Production overheads can be absorbed on the basis of:
 Volume or percentage of machine hour or direct labour hour

 Percentage of machine hour or direct labour hour
 Percentage of prime costs factory costs
 Percentage of prime costs
In order to compute the OAR, overheads need to be allocated,

apportioned and re- apportioned first. Once all that are done, it is time
to absorb the overheads into the products.
Typically, the OAR has to be determined by dividing the adjusted

overheads in each production cost centre by either the machine
hours or the labour hours, according to the absorption criteria set.
If a production cost centre is a machine intensive one, usually, the

OAR is adjusted overheads divided by machine hours. If the
production cost centre is a labour intensive department, then the
OAR equals to adjusted overheads divided by labour hours.
Overhead absorption rate (OAR) = Overheads after re-apportionment

Total machine hours or labour hours
The decision to use total machine hours or total labour hours

depends on:
 Whether the department is more machine intensive or labour

intensive
 The preference of the cost accountant or managers
It must be noted that the OAR being calculated in the absorption

process is, in fact, the pre-determined overhead absorption rate
(also known as the pre-determined recovery rate) because the
overheads and the bases in use are all budgeted figures, and not the
actual data or values.
165
Going back to Saphi Ltd, if Machining’s machine hours were 40,000,

the pre-determined overhead absorption rate would be:
$80,000 ÷ 40,000 machine hours = $2 per machine hour
So, if a finished product had spent 4 hours in the Machining

department, then the overhead absorbed into each product would
be $2 × 4 hours = $8.
The overheads for actual production volume based on the pre-

determined overhead absorption rate is called absorbed overhead.
Absorbed overhead = Actual production × Pre-determined OAR
If, let’s say, the pre-determined overhead absorption rate per unit is
$12, and 500 units are produced, the absorbed overhead is $12 ×
500 = $6,000.
But in reality, the actual overheads are seldom the same as the
absorbed overheads, due to many reasons.
166
Topic Review (TLO C1f)

Justify, calculate and apply production cost centre overhead absorption rates using labour hour and machine
hour methods.
1. A company employs an overhead absorption rate based on machine hours. Budgeted factory
overheads for last year were $720,000, but the actual factory overheads incurred were $738,000.
Last year, the company absorbed $714,000 of factory overheads on 119,000 actual machine hours.
What was the company’s budgeted annual level of machine hours?
2. A company makes a range of products with total budgeted manufacturing overheads of $973,560
incurred in three production departments (A, B and C) and one service department. Department A
has ten direct operatives who each work 37 hours per week. Department B has five machines with
each machine operating 24 hours a week. Department C is expected to produce 148,000 units of
final product in the budget period. The company will operate for 48 weeks in the budget period.
Budgeted overheads incurred directly by each department are as follows:
$
Department A 261,745
Department B 226,120
Department C 93,890
Service department 53,305
The balance of budgeted overheads is apportioned to departments as follows:
%
Department A 40
Department B 35
Department C 20
Service department 5
Service department overheads are apportioned equally to each production department.
a. Calculate an appropriate predetermined OAR in each production department.
b. Calculate the manufacturing overhead cost per unit of finished product in a batch of 100 units
which take nine direct labour hours in Department A and three machine hours in Department B
to produce.
167
Answers:
168
7g. The Relative Merits of Actual and Pre-Determined Absorption Rates.

Learning Outcome (ACCA Study Guide Area C, Topic C1g):
Explain the relative merits of actual and pre-determined absorption rates.
Almost always, businesses are geared to use pre-determined rates.

The primary reason for this is the absence of actual data on costs, or
overheads and rates. If the business is determined to use on actual
values, then it will not be able to generate quotations for customers
and prepare projections in time for use. Then there will be no
customers, no revenue, and definitely no more business
transactions!
Naturally, it is quite an automatic mechanism to use estimations and

pre-determined rates to complete these quotations and tasks alike.
In fact, it is for this reason that absorption costing is able to
smoothen out profit fluctuations when sales fluctuates while
production is constant.
Then again, using pre-determined rates has its share of drawbacks.

Pre-determined OARs directly cause over- and under-absorption of
overheads, which can be quite troublesome sometimes. It makes
this costing technique look complicated, and as such, less usable.
All said, absorption costing application has its place and time in the
profit-oriented businesses.
169
Topic Review (TLO C1g)

Explain the relative merits of actual and pre-determined absorption rates.
1. State the advantages and disadvantages of using pre-determined rates instead of actual rates.
170
7h. The Analysis and Interpretation of Over/Under Absorption

Learning Outcome (ACCA Study Guide Area C, Topic C1h):
Describe and illustrate the accounting for production overhead costs, including the analysis and
interpretation of over/under absorption.
Over- and Under-Absorbed Overhead
Over- and under-absorbed overheads are results of differences

between actual overheads and absorbed overheads.
Over/(under) absorbed overheads = Difference between
Actual overheads and Absorbed overheads
Over-absorbed overheads are obtained when the actual overheads

are lesser than absorbed overheads. There is unexpected savings of
money here.
On the other hand, under-absorbed overheads are obtained when

the actual overheads are greater than absorbed overheads. So, there
is unexpected extra cost here.
The over -absorbed overhead is written off as a credit in the P/L

Account, and the under- absorbed overhead is written off as a debit.
To understand the over- and under-absorption better, let’s look at

QT Ltd’s production budget and actual results for quarter 2 of year
20x7:
QT Ltd budgeted to make 200units of Product L. Its unit costs are as

follows:
Direct material $4
Direct labour $5
L will be sold at $16 per unit. The budgeted production overheads
were $420. The actual results were as follows
Units of production 220 units

Direct material cost $380
Direct labour $400
Overheads incurred $450
Now, the predetermined overhead absorption rate is $420 ÷ 200

units = $2.10 per unit.
The absorbed overheads were $2.10 × 220 units = $462. The actual
overheads are lesser than absorbed overheads by $462 - $450 = $12.
That means, there is an over-absorption of $12.
171
Topic Review (TLO C1h)

Describe and illustrate the accounting for production overhead costs, including the analysis and
interpretation of over/under absorption.
1. Over-absorbed overheads are obtained when budgeted overheads are lesser/greater than actual
overheads and when budgeted production volume is lesser/greater than actual production volume
2. Data used to compute over/(under)-absorbed overhead excludes:

A. Budgeted level of activity
B. Actual overheads
C. Budgeted OAR
D. Production costs
172
7i. Methods of Attributing Non-Production Overheads to Cost Units.

Learning Outcome (ACCA Study Guide Area C, Topic C1i):
Describe and apply methods of attributing non-production overheads to cost units.
Non-production overheads, namely the selling, distribution and

administration expenses, cannot be ignored when computing total
estimated cost.
Sometimes, the unit overhead can be traced directly to the

individual cost units, which make it easy to compute the final cost.
But sometimes the overheads need to be grouped together then be
incorporated into the cost unit on the bases of:
 Units – production or sales volume

 Sales orders or batches
 Percentage of prime or production costs
 Any other basis deemed fit
In this syllabus, it is important to acknowledge the non-production

costs but no major technical computations are expected of the
learner.
173
Topic Review (TLO C1i)

Describe and apply methods of attributing non-production overheads to cost units.
1. Which one of the following statements is false?

A. Product costs excludes non-production expenses.
B. Non-production costs are costs which do not incur in the factory ground.
C. Production and non-production costs are part of total unit cost under AC.
D. Non-production costs are equally significant as production costs where price setting is
concerned.
174
7j. Calculate product costs using the absorption costing method.

Learning Outcome (ACCA Study Guide Area C, Topic C1j):
Calculate product costs using the absorption costing method.
As mentioned early in this chapter, absorption costing incorporates

all production costs into the end-product.
Let’s take a product with prime costs of $30, variable production

overheads of $6, SDA expenses of $8, and fixed production overhead
of $10,000 absorbed on the basis of normal production volume of
2,500 units.
This means unit fixed production overhead would be $10,000 ÷

2,500 units = $4.
The AC product cost or unit inventory valuation would be:
Prime costs $30

+ Variable production overhead $ 6
+ Fixed production overhead $ 4
AC product cost $40
But the total cost would include SDA expenses of $8, making AC total
cost $48.
175
Topic Review (TLO C1j)

Calculate product costs using the absorption costing method.
1. A product Z has the following unit costs:
Direct material $8
Direct labour 6
Packaging 2
Variable overhead 3
Fixed production overheads amounts to $50,000 for a standard production volume of 25,000 units.
What is the full production costs of one unit of product Z?
176
Chapter 7 Summary
1. Overheads refer to the cost of material, labour and expenses which cannot be economically
identified with a product.
2. Production overheads relate to only production related activities, and non-production

overheads relate to financing and SDA activities. Non-production costs are not included
in the valuation of inventory.
3. OAR is computed to absorb the overheads into the products. In the traditional absorption
costing method, production overheads are absorbed on the basis of:
a. volume or percentage of machine hour or direct labour hour
b. percentage of machine hour or direct labour hour
c. percentage of prime costs factory costs
d. percentage of prime costs
4. Four steps of the overhead absorption process:

a. Allocation – charging an entire expense to a single cost centre.
b. Apportionment – sharing out total overheads to all cost centres according to a certain basis
of apportionment and rate of utilisation by the cost centre.
c. Re-apportionment – sharing out the overheads of the service cost centres to the production
cost centres according to production cost centres' utilization percentage of the service cost
centres.
d. Absorption – total overheads in prod cost centres are absorbed into individual
units of production.
5. Overheads of service cost centres are re-apportioned to production cost centres because:
a. Service cost centres exist to provide support to production cost centres.
b. Revenue is generated by production cost centres' efforts. So, all overheads are borne by
production cost centres for convenience of costing and pricing.
6. Three methods of reapportionment:

a. Direct – overheads of each service cost centre are re-apportioned to only the production
cost centres.
b. Step-down – overheads of each service cost centre to be re-apportioned to all other cost
centres, where mutual utilisation of services does not exist among service cost centres.
c. Reciprocal – there is mutual utilisation of services among service cost centres.
7. Over/(under)-absorbed overheads are results of differences between actual overheads and absorbed
overheads.
a. Over-absorbed overheads are obtained when the actual overheads are lesser than absorbed
overheads.
b. Under-absorbed overheads are obtained when the actual overheads are greater than
absorbed overheads.
177
CHAPTER 8: PROFIT REPORTING Sunway TES
CHAPTER 8: PROFIT REPORTING
Learning Outcomes
TLO B3f. Explain and illustrate the concept of contribution.
TLO B3g. Prepare profit statements using the marginal costing method.
TLO B3h. Prepare profit statements using the absorption costing method.
TLO B3i. Compare and contrast the use of absorption and marginal costing for period profit reporting
and inventory valuation.
TLO B3j. Reconcile the profits reported by absorption and marginal costing.
TLO B3k. Explain the usefulness of profit and contribution information respectively.
178
8a. Concept of Contribution

Learning Outcome (ACCA Study Guide Area C, Topic C2a)
Explain and illustrate the concept of contribution.
The method treats fixed cost as period cost, which means that the
fixed cost is applied in full for the accounting period. The cost is
not carried forward to the next accounting period. That means the
fixed cost is not attached to the units of production. As such, the
product cost comprises only of variable production costs; closing
stock is valued at variable production costs.
The marginal costing product cost is equivalent to only the

variable production cost per unit.
Marginal costing product cost = variable production cost per unit
Its variable cost of sales would be:
𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐜𝐨𝐬𝐭 𝐨𝐟 𝐬𝐚𝐥𝐞𝐬

= 𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐩𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐨𝐧 𝐜𝐨𝐬𝐭 𝐨𝐟 𝐬𝐚𝐥𝐞𝐬 + 𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞 𝐧𝐨𝐧
− 𝐩𝐫𝐨𝐝𝐮𝐜𝐭𝐢𝐨𝐧 𝐜𝐨𝐬𝐭 𝐨𝐟 𝐬𝐚𝐥𝐞𝐬
𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝒄𝒐𝒔𝒕 𝒐𝒇 𝒔𝒂𝒍𝒆𝒔

= (𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏 𝒄𝒐𝒔𝒕 𝒑𝒆𝒓 𝒖𝒏𝒊𝒕 𝒙 𝑺𝒂𝒍𝒆𝒔 𝒗𝒐𝒍𝒖𝒎𝒆)
+ 𝑽𝒂𝒓𝒊𝒂𝒃𝒍𝒆 𝒏𝒐𝒏 − 𝒑𝒓𝒐𝒅𝒖𝒄𝒕𝒊𝒐𝒏 𝒄𝒐𝒔𝒕 𝒐𝒇 𝒔𝒂𝒍𝒆𝒔
Variable cost of sales (VCOS) can be referred to as marginal cost

of sales, because this cost directly reflects the increase in sales
volume. Unit marginal cost of sales is the extra cost that incurs
when an extra unit is sold.
In order to compute the marginal costing profit, contribution

must be calculated. Contribution reflects on how much of sales
revenue can cover fixed cost after deduction of all variable costs.
Contribution = Sales revenue – ALL Variable costs
The marginal costing profit is then computed by deducting all

fixed cost from contribution.
Marginal costing profit = Contribution – Fixed costs
179

Explain and illustrate the concept of contribution.
1. A company produces and sells two products X and Y, and uses an absorption costing system. Fixed
production overheads are absorbed at a rate of $9.00 per machine hour based upon normal levels
of production.
Estimates for the following month are as follows:
Product X Product Y
Sales (unit) 15,800 26,300
Selling price ($) 1.15 2.40
Variable cost of production ($) 7,650 32,472
Machine hours 1,020 2,200
Opening stock (units) 1,940 1,870
Fixed production overheads are estimated at $28,350 for the following month, and selling and
administration overheads at $9,580.
Calculate the total contribution from both products.
180
8b. Marginal Costing Method

Prepare profit statements using the marginal costing method.
There are four principles.
(1) Fixed cost is the same

throughout the entire
accounting period. Selling an
extra unit increases:
 Revenue by selling price

 Costs by variable cost per unit;
 Profit by contribution per unit.
Note:
Fixed cost is not affected by increase in sales volume.
(2) Profit is directly affected by contribution per unit. Increase

and decrease in sales volume reduces profit according to
contribution earned. A decline in sales volume results in a
decline in profit, which equals to the amount of
contribution lost.
(3) Profit should be measured only by analysing total
contribution.
(4) Extra cost of production is variable costs of production.
The principles are summarised in Table 8.1.
FC is constant within the relevant

range of activity. ONE extra item
Principle 1
sold → revenue + selling price
→ cost + variable cost per unit
→ profit + contribution per unit.
Principle 2 Sales volume drops → Profit drops by contribution lost.
Principle 3 Profit adjusted according to total contribution. (FC same).
Principle 4 Extra costs of production = variable production costs.

Table 8.1 Summary of Marginal costing principles
181
A detailed marginal costing profit statement looks like this:
$ $
Sales revenue x
Less: Variable cost of sales
Opening inventory x
Add: Production x
Less: Closing inventory (x)
Add: Non-production variable costs x
Total variable cost of sales (x)
CONTRIBUTION x
Less: Fixed costs
Production x
Non-production x
Total fixed costs (x)
NET PROFIT xx
Figure 8.1 Format of Statement of Profit and Loss using Marginal
costing
182

Prepare profit statements using the marginal costing method.
of production. Estimates for the following month are as follows:
Product X Product Y
Sales (units) 15,800 26,300
Calculate the marginal costing profit.
183
8c. Absorption Costing Method

Learning Outcome (ACCA Study Guide Area C, Topic C2c):
Prepare profit statements using the absorption costing method.
A detailed absorption costing profit statement looks like this:
$ $
Sales x
Less: Cost of sales
Opening inventory x
Add: Production x
Less: Closing inventory
Total cost of sales (x) (x)
GROSS PROFIT x
Less: Under-absorbed overhead (x)
OR
Add: Over-absorbed overhead x
ADJUSTED GROSS PROFIT x
Less: Non-production costs
Fixed x
Variable
Total non-production costs x (x)
NET PROFIT xx
Figure 8.2 Format of Statement of Profit and Loss using
Absorption costing
Let’s look at Nilu Ltd that makes and sells a household product,
Superbrush, which is sold for $20 per unit. Its variable cost per
unit is $12 and the fixed production overhead was $40,000 for a
normal production volume of 10,000 units.
The production and sales data for January and February 20x7 are as
follows:
January 20x7 February 20x7

Sales (units) 8,000 10,000
Based on the given data, the fixed production overhead per unit is
$40,000 ÷ 10,000 units = $4.
The product cost is $12 under the marginal costing method, and
$12 + $4 = $16 under the absorption costing method.
184
The Statement of Profit and Loss prepared using marginal costing

would be:
January 20x7 February 20x7

$ $ $ $
Sales 160,000 200,0
Less: Variable cost of sales 00
Opening inventory 0 24,000
Add: Production 120,000 108,00
Less: Closing inventory 012,000
Total variable cost of 24,0 (96,000)
sales 00 (120,0
Contribution 64,000 80,000
00)
Fixed production overhead (40,000)
Profit 24,000 (40,000)
40,0
00
Take note that the fixed production overhead is the same for
both months, regardless of the production volume.
The Statement of Profit and Loss prepared using absorption costing

would be:
In January 20x7, the production volume was the same as the

normal production volume. So, there were no over/under-
absorbed overheads. However, in February 20x7, the actual
production volume was lower than the normal production
volume. The difference was 10,000 normal volumes – 9,000
actual volume = 1,000 units. As such, there was an under-
absorbed overhead of $4 × 1,000 units = $4,000.
185
Topic Review (TLO C2c)

Prepare profit statements using the absorption costing method.
of production.
Product X Product Y
Sales (units) 15,800 26,300
Calculate the adjusted gross profit and the absorption costing net profit.
186
8d. Period Profit Reporting and Inventory Valuation

Learning Outcome (ACCA Study Guide Area C, Topic C2d):
Compare and contrast the use of absorption and marginal costing for period profit reporting and inventory
valuation.
Although both methods, absorption costing and marginal costing,

often show differences in profits, there are cases where the
profits can be the same – when the volume of sales equals volume
of production, at which point opening inventory equals closing
inventory.
However, in the long run, the total profits computed under the
absorption costing method and the marginal costing method
would be almost the same. This is because the fixed costs would
eventually be recorded and accounted for anyway over a long
period of time.
A summary of the differences is provided in Table 8.2.
Absorption Costing (AC) Marginal Costing (MC)

Fixed cost is part of product cost, is charged according to FC is treated as period cost, and is charged in full in the
units sold and retained in the profit statement. profit statement.
Product cost = VC unit + FC unit* (production costs only) Product cost = VC unit
(production costs only)
*unit FC = Total FC Normal production

volume
Total costs of product Total costs of product

= fixed costs + variable costs; TC = FC + VC = only variable costs; TC = VC
New terms: New terms:
Over/(under) absorbed overhead CONTRIBUTION
Actual overhead > Absorbed overhead  Sales – ALL Variable cost of sales
 Under-absorbed overhead
Actual overhead < Absorbed overhead Shows how much of sales revenue contributes to the
 Over-absorbed overhead
paying of the fixed cost after deducting the variable costs
Format of Profit statement
Sales x Sales x
(Production cost of sales) (x) (Variable cost of sales) VC unit x sales (x)
(VC unit + FC unit) × sales volume volume
Gross Profit x Contribution x
(Under-absorbed overheads) (x) Fixed costs (x)
Over-absorbed profits x Operating profit xx
Adjusted gross profit x
(Non-production costs) (x)
Operating profit xx
Table 8.2 Summary of difference between Absorption costing and Marginal costing
187
Topic Review (TLO C2d)

Compare and contrast the use of absorption and marginal costing for period profit reporting and inventory
valuation.
1. Circle the correct word/phrases with regard to the key differences between AC and MC methods:
AC MC
Treatment of fixed costs Period costs Period costs
Production costs Production costs
Product cost component Variable production Variable production

costs costs
Both fixed and variable Both fixed and variable
2. The following terms are applicable in which costing method?
AC or MC
Variable cost of sales
Over/(under)-absorbed
overheads
Gross profit
Contribution
188
8e. Profits Reported by Absorption and Marginal Costing

Learning Outcome (ACCA Study Guide Area C, Topic C2e):
Reconcile the profits reported by absorption and marginal costing.
The values of units sold and closing inventory greatly depend on

the profit reporting method used.
With marginal costing, it has been made clear that the cost of
production comprises of only variable costs, and that fixed costs
of sales are applied in full for the accounting period. As such, the
value of closing inventory will comprise only of variable costs too.
However, it is not the same with absorption costing. The value of

all goods produced and sold comprise of both the variable and the
fixed cost elements. So, there is a portion of fixed costs in every
sold product, in every unsold product – closing inventory
comprises of both variable and fixed costs.
When an accounting period records no opening inventory, but has

closing inventory, the absorption costing profit will be greater
than that of marginal costing. This is because, with absorption
costing, the fixed costs of sales applied for that term is only the
fixed costs of the goods sold. The fixed costs attached to the
closing inventory are not charged in the current term, instead are
charged in the term where the closing inventory is sold off. As
such, the total costs recorded for the accounting term is lower
than the total costs recorded using the marginal costing method.
When total costs are lower, naturally, profit recorded would be
higher.
If there were opening and closing inventory, then the inventory

volumes must be compared to see which costing method results
in higher profit. The assumption here is that the fixed costs per
unit and variable costs per unit are the same for both previous
and current accounting periods. With absorption costing, when
closing inventory exceeds opening inventory, the total fixed cost
attached to the products in closing inventory are greater than the
total fixed cost of opening inventory. So, net fixed cost recorded
in the current term will be lower than the budgeted fixed cost for
the term. Again, part of the total cost (which is the fixed cost) gets
transferred to the forthcoming accounting period. As such, profit
reported under absorption costing method will be greater than
the marginal costing profit.
However, if opening inventory exceeds closing inventory, owing to

recording of fixed costs from the previous term, the net fixed costs
for the term would be higher than that of marginal costing fixed
costs. As a result, total cost recorded with absorption costing would
be greater and the profit lower than those of marginal costing.
In summary, when closing inventory exceeds opening inventory,

absorption costing profit is greater than marginal costing profit,
and vice-versa.
189
To reconcile the profits obtained under the two costing methods,

the following format is used:
Profit from marginal costing method X
Increase/(Decrease) in stock units × fixed

production overhead absorption rate X/(X)
Profit from absorption costing method X
Going back to Nilu Ltd, the profit reconciliation statement would

look like this:
Profit from marginal costing method 40,000
Decrease in stock units × fixed production (4,000)

Profit fromabsorption
overhead absorptionrate
costing method
(4,000) 36,000
At the same time, the following formula can be used to find a missing
value:
Marginal costing = Absorption costing profit

+ FC unit x (Opening inventory
− Closing inventory)
190
Topic Review (TLO C2e)

Reconcile the profits reported by absorption and marginal costing.
of production.
Product X Product Y
Sales (units) 15,800 26,300
What is the difference between marginal and absorption costing profits?
191
8f. Usefulness of Profit and Contribution information

Explain the usefulness of profit and contribution information respectively.
Profit information is directly linked to the term profitability. This

piece of information, when calculated as accurately as possible,
allows one to make informal decisions. It serves a long-term
purpose in determining whether a product, production line,
plant or even the business unit is a worthy investment or not.
Both fixed (general and specific) and variable costs are included
in profit calculations.
Contribution, on the other hand, serves a short-term purpose of

survival. General fixed costs are totally ignored when making
decisions using only contribution. As such, contribution is most
fit for short-term decisions. It tells one on whether the
immediate and short run commitments can be met or not.
In general, both profit and contribution are essential indicators

of a business survival.
192

Explain the usefulness of profit and contribution information respectively.
1. Which statement is false?

A. Profit includes fixed cost in its computations.
B. Contribution excludes fixed cost completely.
C. Profit is calculated only in absorption costing method.
D. Contribution is calculated only in marginal costing method.
2. The similarity between profits and contribution is that:

A. Both are calculated in absorption costing.
B. Both are calculated in marginal costing.
C. They are both necessary to make short term decisions.
D. They are both necessary to make long term decisions.
193
Chapter 8 Summary
1. There are two profit reporting methods – absorption costing and marginal costing. The primary
difference between the two methods lies in the treatment of fixed costs.
2. Marginal costing method treats fixed cost as period cost and is applied in full for the accounting
period.
3. Marginal costing profit reporting method has contribution, which is total amount of sales left after
deducting variable costs.
4. Four principles of marginal costing:

a. Fixed cost is the same throughout the entire accounting period.
b. Profit is directly affected by contribution per unit.
c. Profit should be measured only by analysing total contribution.
d. Extra cost of production is variable costs of production.
5. Absorption costing method treats fixed cost as products cost and is absorbed into individual product
units.
6. Absorption costing profit reporting method has gross profit, which is the amount of sales left after
deducting all production costs.
7. Profits of both methods will be the same when the volume of sales equals volume of production, at
which point opening inventory equals closing inventory.
8. In the long run, the total profits computed under the absorption costing method and the marginal
costing method would be almost the same.
194
CHAPTER 9: JOB AND BATCH COSTING Sunway TES
CHAPTER 9: JOB AND BATCH COSTING
Learning Outcomes
TLO B3l. Identify situations where the use of job or batch costing is appropriate.
TLO B3m. Calculate unit costs in job and batch costing.
TLO B3n. Describe the control of costs in job and batch costing.
TLO B3o. Apply cost plus pricing in job costing.
195
9a. The Use of Job and Batch Costing

Identify situations where the use of job or batch costing is appropriate.
A costing system is a system that collects costs’ information of a

business activity. The system helps determine profits, and also
provides a wide range of management data and information. One
way to categorise the costing system is by the nature of the
activity. Different methods of costing will be used according to the
way products are manufactured or processed or how services are
provided. In Paper 4, you will be exposed to the basics of job
costing, batch costing, service costing and process costing.
Whichever method is used, basic costing principles applied relate
to costs classification, allocation, apportionment and absorption.
This chapter focuses on only job and batch costing. Service costing
is discussed at length in chapter 11 and process costing in chapter
10.
Job Costing
Job costing is applied when there is a particular set of tasks carried
out for a specific order/customer. The main aim is to find profit
(or loss) on each completed job, and also to value incomplete jobs.
For that purpose, a job cost card must be created and be filled in
with all prime cost details – direct material, direct labour and
direct expenses.
A typical job cost card would show the following details:
 Direct material costs – computed based on stores issues

valuation methods and material-related bills;
 Direct labour costs - computed according to the employee

payment system, either time-related or output-related.
 Direct expenses – such as special tools, equipment or

machine hire specially for the particular job, royalty and
costs of specialised tasks (such as designing and machine-
setting).
Job costing is a technique to apply when customer orders come as

an identifiable job or a project. Orders may be different from one
another, meaning, they may not be identical jobs. In fact, the
orders may not even produce identical products; maybe similar.
Usually, each order can be completed in a relatively short duration
of time.
196
Each job is a code number, such as Job 1103. This is to clearly

identify the job order, tasks and resources related to it. Prior to
completion of the job, costs are only estimates; which mean that
overheads are based on predetermined absorption rates. The
estimated costs of the job will help set selling prices based on the
profits desired, or, determine the profits based on the selling
prices quoted.
Batch Costing
Batch costing is applied when there is production of a group of
identifiable product units, and the cost unit is the batch of
products.
A batch is a group of identical or similar products. Batch costing is

used in many instances – in shoe making factories, car or engine
repair shops, nuts and bolts manufacture, and even bakeries.
In shoe making factory, naturally the products are shoes, but they
come in different designs, sizes and colours. Each production run
to meet a customer demand would be considered as a batch.
Methods and techniques of batch costing are very similar to that

of job costing. Each batch has a number or a code. Utilization of
material, labour and overheads are estimated for each batch
based on standard values (and overhead absorption rate). Batch
costing employs the job costing format as well.
197

Learning Outcome (ACCA Study Guide Area C, Topic 3a):
Identify situations where the use of job or batch costing is appropriate.
1. State the similarities between job and batch costing methods.
2. State the difference between job and batch costing methods.
198
9b. Calculation in Job and Batch Costing

Calculate unit costs in job and batch costing.
Data or information for the job costing system is best collected

using the job cost card. Figure 10.1 shows a typical job cost card.
Direct materials x
Direct labour x
Direct expenses x
PRIME COST x
Factory overhead x
TOTAL PRODUCTION COST/FACTORY COST x
SDA overheads x
TOTAL JOB COST x
Figure 9.1 Job cost card
199

Calculate unit costs in job and batch costing.
1. Job 2106 has the following details:
Direct material:
Chemical AA 500 kg used at $12 per kg
Chemical BB 200 litres used at $25 per litre
Direct labour:
Skilled 300 hrs worked at $7.50 per hour
Semi-skilled 250 hrs worked at $6.50 per hour.
Hire of a special tool 50 hrs used at $20 per hour
The production overheads are absorbed at a rate of 150% of total labour cost. Selling and
administration overhead estimated at $500.
Calculate the cost of this job.
2. Teekee Ltd needs to calculate the cost of a batch of 300 units of component Y, which is manufactured
in department Lamda. It is known that direct material costs come up to $12,000, and direct labour
per unit is $8 per hour. According to standards set, three units of Y can be manufactured in an hour.
At the same time, Teekee Ltd has to hire a special device at a cost of $2,300 from its vendor to mould
a design on Y. The overhead absorption rate in Lamda is $4 per direct labour hour. The selling and
administration overheads are usually 20% of production cost.
Calculate cost per unit of component Y.
200
9c. Control of Costs

Describe the control of costs in job and batch costing.
For industries and work areas that employ job and batch costing
methods, most of the resources can be easily or directly traced to
the job or batch. This is a major advantage in cost control.
In these areas, it is relatively convenient to detect and control

wastage, and unused resources. Even inconsistent supplier pricing
and inefficient production can also be noticed.
This, in turn, gives room for improved efficiency and effective

usage of materials, labour, machinery and resources alike. More
monitoring and corrective actions can be administered, in order to
keep costs in control.
201

Describe the control of costs in job and batch costing.
1. How can costs be controlled in an office renovation job?
Answers:
202
9d. Application
Apply cost plus pricing in job costing.
There are two common approaches to job and batch pricing:

1. Mark-up
2. Margin
The key difference is in the computation of profit.
In the mark-up method, profit is a certain percentage of the cost.

Selling price is derived by adding this percentage to the cost.
Profit = % of Cost
Selling price = Cost + % of Cost
In the margin method, profit is a certain percentage of the selling

price. So, the cost is represented by the cost to sales ratio.
Profit = % of Selling price
Cost to sales ratio = 100% - Profit margin
Selling price = Cost + % of Selling price
Let’s take a job that costs $100.
1. Mark-up = 20%
Profit = 20% of cost = $20.
Selling price = Cost $100 + Profit $20 = $120
2. Margin = 20%
Cost to sales ratio = 80%
Profit = 20% × Cost $100 = $25
80%
Selling price = 100% × Cost $100 = $125
80%
203

Apply cost plus pricing in job costing.
Gillian Ltd was asked to tender for the manufacture of a specialist tool. Direct material costs $24 while
direct labour costs $48, paid at a basic rate of $4 per hour. Production overhead is absorbed at a rate of
$2.50 per direct labour hour. Administration overheads are absorbed at 25% of production cost.
Calculate the selling price of this job, if:
1. Mark-up profit is set at 40%.
2. Expected profit margin is 40%.
204
Chapter 9 Summary
1. Job costing is applied when there is a particular set of tasks carried out for a specific-order/customer.
2. Job costing is a technique to apply when customer orders come as an identifiable job or a project.
3. Job costing aims to find profit (or loss) on each completed job, and to value incomplete jobs.
4. A job cost card must be created and be filled in with all prime cost details:
a. direct material costs
b. direct labour costs
c. direct expenses
5. Selling prices can be set using the cost plus pricing method.
a. Calculate the full cost of the job
b. Add a percentage mark-up for profit
c. Add the mark-up profit to the total cost to obtain the selling price.
6. Batch costing is applied when there is production of a group of identifiable product units, and the
cost unit is the batch of products.
7. Utilization of material, labour and overheads are estimated for each batch based on standard values
(and OAR). Batch costing employs the job costing format as well.
205
CHAPTER 10: PROCESS COSTING Sunway TES
CHAPTER 10: PROCESS COSTING
Learning Outcomes
TLO B3p. Identify situations where the use of process costing is appropriate.
TLO B3q. Explain and illustrate the nature of normal and abnormal losses/gains.
TLO B3r. Calculate unit costs where losses are separated into normal and abnormal.
TLO B3s. Prepare process accounts where losses are separated into normal and abnormal.
TLO B3t. Account for scrap and waste.
TLO B3u. Distinguish between joint products and by-products.
TLO B3v. Explain the accounting treatment of joint products and by-products at the point of
separation.
TLO B3w. Apportion joint process costs using net realisable values and weight/volume of output
respectively.
TLO B3x. Discuss the usefulness of product cost/profit data from a joint process.
TLO B3y. Evaluate the benefit of further processing.
206
10a. Use of Process Costing

Identify situations where the use of process costing is appropriate.
Introduction
Process costing is used where units of production come from a
continuous process or a series of linked processes. It is the
method to use when it is almost impossible to identify distinctive
units of production. Process costing is most appropriate when
there is a continuous stream of processes, making it difficult to
identify production units separately or easily. Common industries
that apply process costing are manufacturers of soap, food and
beverages, paint, chemicals and cement, and also oil refineries.
Features of Process Costing

(1) Output is in the form of continuous stream of identical
and/or different units of production, making it is (almost)
impossible to identify separate units of production. So, it
is very difficult or (almost) impossible to compute the unit
production cost.
(2) Again, owing to the nature of the process, which is

continuous, input materials may be added at different
stages of processing. That may require added direct labour
work, and incurrence of additional overheads.
(3) It is common to have losses in the process due to reasons

such as defects, spoilage, wastage and evaporation.
Sometimes, where possible, the losses can be sold as
scrap.
(4) The input goes through a series of processing stages

resulting in the output of one process becoming the input
of another, until finished units are obtained.
(5) The output of production may be a single product, joint

products or by-products. Joint products refer to two or
more products with substantial sales value being produced
from the same series of processes, while by-products are
products obtained from the same process as the main
products but with relatively low sales value.
207

Identify situations where the use of process costing is appropriate.
1. Name and briefly explain the use of process costing in 3 different industries in your hometown.
Answers:
208
10b. Normal and Abnormal Losses/Gains

Explain and illustrate the nature of normal and abnormal losses/gains.
Before going into the main discussions of accounting for process

costing method, it is important to understand these terms – normal
loss, abnormal loss and abnormal gain.
Normal loss
A normal loss is an expected loss of output in a process. It is

anticipated before production commences. Usually, the loss units
are not given a value, which means that the cost per unit of the
loss units is nil.
However, sometimes, these losses can be sold as scrap, and so,

they are valued at scrap value. Losses that can be sold as scrap
reduces the cost of production.
Abnormal loss (ABL)
Abnormal loss refers to unexpected loss of output, which means

that it is not anticipated prior to production. The actual loss is
greater than normal loss. The abnormal loss volume is the
difference between actual loss and normal loss.
Abnormal loss reduces the contribution of good output, and

subsequently the profits.
Abnormal gain (ABG)
Abnormal gain refers to unexpected gain of output. That means

the actual loss is lower than normal loss. The abnormal gain
volume is the difference between actual loss and normal loss.
Abnormal gain reduces sales value of scrap, but increases the

contribution of good output.
209

Explain and illustrate the nature of normal and abnormal losses/gains.
True or false?
1. Every process always has either losses or gains.
2. Abnormal loss can happen due to miscalculation of expected losses.
3. Abnormal gain happens when output costs are greater than input
costs.
4. Output of a process can never exceed the total input.
210
10c. Unit Costs

Calculate unit costs where losses are separated into normal and abnormal.
Cost per unit refers to total costs of production divided by total

volume of production. But when there is normal loss,
Cost of one good unit = Production costs – Scrap value of normal loss
Input – Normal loss units
The costs of production computed after deducting the scrap value of

normal loss is called net production costs, and total output less
normal loss is called expected output. So,
Cost of one good unit = Net production costs

Expected output
Normal loss
Normal loss is valued at its scrap value.
Value of normal loss = normal loss units × scrap value
Abnormal loss (ABL)
Abnormal losses are valued at cost per unit of the good output, and
not scrap value.
Value of ABL = ABL units × Cost of one good unit
Abnormal gain (ABG)
Abnormal gain is also valued at cost per unit of the good output.
Value of ABG = ABG units × Cost of one good unit
211

Calculate unit costs where losses are separated into normal and abnormal.
1. In a particular process, 1,000 kg of material were input for conversion to finished product at a cost
of $15,020. The normal loss was 10%, but the actual output was 880 kg. Losses are sold for $8 per
kg.
Calculate the volume and the value of abnormal loss/gain.
2. 340 litres of chemical X were produced in a period. There is a normal loss of 10% of the material
input into the process. There was an abnormal loss in the period of 5% of the material input.
How many litres of material were input into the process?
3. Product X is manufactured using raw materials P and T, which are mixed in the proportions 1:2. P
can be purchased at $5.00 per kilo and T at $1.60 per kilo. Normal weight loss of 5% is expected
during the process. Last month, 9,130 kilos were manufactured from 9,660 kilos of raw materials.
Conversion costs in the month were $23,796. There was no work in progress at the beginning or the
end of the month.
Calculate, for Product X, the values of actual output, normal loss and abnormal loss.
212
10d. Process Accounts

Prepare process accounts where losses are separated into normal and abnormal.
A process account is a T account with two columns on each side,

one for volume and one for the monetary value of the quantity or
the item entry. Figure 9.1 shows the format and common entries
in a typical process account.
Process a/c
volume $ volume $
Input: Finished X Y
goods a/c
Direct X Y Output to X Y
material next
process
Direct X Y Normal X Y
labour loss OR
Scrap a/c
Absorbed X Y Abnormal X Y
overheads loss a/c
From previous X Y
process
Abnormal gain X Y
a/c
XX YY XX YY
Figure 10.1 Format of Process account
Normal loss is considered an output from the process. As such, it

is credited from the process account. If the normal loss has no
scrap value, the credit entry would simply be “Normal loss”.
However, if losses do have scrap sales value, then the entry reads
“Scrap”.
Take note that abnormal loss and abnormal gain cannot appear
together in the same process account. The two are mutually
exclusive. A particular process may either have abnormal loss OR
abnormal gain AND never both.
In the case of incomplete output, “Finished goods” entry is

replaced with “Closing work in progress (WIP)”.
213
EXAMPLE
A company manufactures a product that passes through two processes before completion. The following
data relates to the manufacture of the product in the previous month, where 100,000 units were input to
Process 1:
Process 1 Process 2
Basic raw material ($) 143,969 (from Process 1)
Materials added in process ($) 76,023
Direct labour costs ($) 47,104 34,337
Production overhead 125 108
(% of direct labour cost)
Normal loss 4.1 3.0
(% of input units)
Scrap value of process losses ($ per unit) 0.36 0.52
Output (units) 95,725 92,984
There was no work in progress at the beginning or end of the period. Lost units are fully complete.
Prepare the Process 1 and Process 2 accounts for the month.
214
ANSWER
215

Prepare process accounts where losses are separated into normal and abnormal.
Ed Chemicals (EC) Ltd converts a raw material KP into a finished product, KQ, all units measured in litres.
The normal loss is 10% and losses can be sold at $1 per litre. During December 20x7, 5,000 litres of KP were
used at a cost of $1.80 each. Direct labour costs amounted to $7,500 and overheads incurred totalled
$6,500. The actual output of KQ was only 4,100 litres.
Prepare the process and abnormal loss accounts.
Answers:
216
10e. Scrap and Waste

Account for scrap and waste.
Losses and gains are depicted in the following T accounts:
Abnormal loss a/c
$ $
Process a/c Scrap a/c
(ABL units × Cost of one good (ABL units × Scrap value)

unit)
Profit/Loss a/c
(ABL units
× (Cost of one good unit – Scrap

value))
Abnormal gain a/c
$ $
Scrap a/c Process a/c
(ABG units × Scrap value) (ABG units × Cost of one good

unit)
Profit/Loss a/c
(ABG units
× (Cost of one good unit – Scrap

value))
217
Scrap a/c
$ $
Process a/c ABG a/c
(Normal loss units × Scrap (ABG units × Scrap value)

value)
ABL a/c Cash from scrap sale
(ABL units × Scrap value)
218
Topic Review (TLO C4e)

Account for scrap and waste.
1. Ed Chemicals (EC) Ltd converts a raw material KP into a finished product, KQ, all units measured in
litres. The normal loss is 10% and losses can be sold at $1 per litre. During December 20x5, 5,000
litres of KP were used at a cost of $1.80 each. Direct labour costs amounted to $7,500 and overheads
incurred totalled $6,500. The actual output of KQ was only 4,100 litres.
Prepare the scrap account.
Answers:
219
10f. By-products and Joint Products

Distinguish between joint products and by-products.
Joint Products
Joint products are separate products that emerge from a single

process. They refer to two or more products of significant value
which result from a process, and their distinction is not noticed
during the production process. Each of these products has a
significant sale value to the organization. Joint products are not
separately identifiable until the point of separation (also called
the split-off point).
The problem with joint products is in apportionment of costs of

production (prior to separation) to the individual products. Two
methods are used to estimate the individual costs – the net
realisable value and the physical volume methods.
By products
A by-product is produced from a process together with other

products but with an insignificant sales value, often with a
relatively lower volume as well.
For example, if a process outputs three products, PQ, PR and PT, and
sells them all for $40, $25 and $3 respectively, it can be easily
determined that PT is a by-product.
Although the sale of by-products brings in added revenue, it is

treated only as an incidental source of income. The sales value is
deducted from the costs of production as an aim to reduce
production costs. Joint process costs are not apportioned to by-
products.
220

Distinguish between joint products and by-products.
True or false?
1. Loss making joint product can be discontinued.
2. A by-product may have similar saleable value as a good joint product.
3. It is common to have a process that outputs 2 joint products and a by-

product.
4. By-product are sold to increase sales revenue.
5. By-product are sold to decrease production costs.
6. Joint products are sold to increase sales revenue.
221
10g. Accounting for by-products and Joint Products

Explain the accounting treatment of joint products and by-products at the point of separation.
Joint products are completed outputs of a production process.

Therefore, they are treated the same as any finished good. This
means, joint products are credited from the process account, and
can be debited into another process account or to finished goods
account.
By-products are treated in a similar manner as normal losses with or

without scrap value. The sales value is computed and deducted from
the joint production costs. As such, the by-product will be a credit
entry in the process account, valued at its sales value.
222
Topic Review (TLO C4g)

Explain the accounting treatment of joint products and by-products at the point of separation.
1. A process generates 3 joint products, P, Q and R, and a by-product K. Selling price of the by-product is
$5 per unit. The volume of the products are as follows:
Product Units
P 300
Q 500
R 200
K 50
Fill in the missing boxes in the process account below.
Process a/c
units $ units $
(a) (e)
(b) (f)
(c) (g)
(d) (h) (i)
223
10h. Joint Process Costs

Apportion joint process costs using net realisable values and weight/volume of output respectively.
Let’s use the following data from a process to apply the two
apportionment methods:
Product Litres Selling price per litre ($)

A 100,000 1.00
B 20,000 10.00
C 80,000 2.25
The costs incurred in the process prior to the separation point of

these three products were $240,000.
Net realisable value (NRV) or Sales value method
In this method, the sales value of each product must be calculated

first, and then totalled up to obtain the total sales value.
Product Litres Selling price per litre ($) Sales value ($)
A 100,000 1.00 100,000
B 20,000 10.00 200,000
C 80,000 2.25 180,000
Total sales value = 480,000
From there, production costs apportioned to A would be A’s sales

value divided by the total sales value, and then the ratio obtained is
multiplied with the total costs, which results in ($100,000 ÷
$480,000) × $240,000 = $50,000.
Similarly,
Production costs apportioned to B

= $200,000 × $240,000 = $480,000
$100,000
Production costs apportioned to C

= $180,000 × $240,000 = $90,000
$480,000
Physical weight or production volume method
In this method, the total volume needs to be calculated. For the

example in use here, the total volume is 100,000 + 20,000 + 80,000
= 200,000 litres.
224
From there, production costs apportioned to A would be A’s volume

divided by the total volume, and then the ratio obtained is multiplied
with the total costs, which results in (100,000 litres of A ÷ 200,000
litres) × $240,000 = $120,000.
Similarly,
Production costs apportioned to B

= 20,000 litres × $240,000 = $24,000
200,000 litres
Production costs apportioned to C

= 80,000 litres × $240,000 = $96,000
200,000 litres
Regardless of which apportionment method is used, it must be

ensured that the total of all apportioned costs (to A, B and C) must
amount to the original $240,000 costs of production.
Presence of by-products
The sales value of the by-products must be deducted from the costs
of production before apportionment of costs to the joint products.
Let’s say a process produces three products with the following

details:
Product kg Selling price per litre ($) Sales value($)

X 100,000 25.00 2,500,000
Y 150,000 10.00 1,500,000
Z 20,000 1.00 20,000
It is quite obvious that Z is a by-product, because of its relatively very

low selling price compared to the other (joint) products.
If the production costs before split-off are $520,000, then the net
production costs to be apportioned are total costs of production
(before split-off) less revenue from by-products, which means only
$500,000 ($520,000 – $20,000) will be apportioned to X and Y.
225
In the value method, the total sales value applied excludes the sales
value of the by-product. Thus,
Costs apportioned to X = $2.5m × $500,000 = $312,500

$4m
Costs apportioned to Y = $2.5m × $500,000 = $187,500

$4m
In the volume method, the total output volume excludes the volume
of the by-product. Hence,
Costs apportioned to X = 100,000 × $500,000 = $200,000

250,000
Costs apportioned to Y = 150,000 × $500,000 = $300,000

250,000
226
Topic Review (TLO C4h)

Apportion joint process costs using net realisable values and weight/volume of output respectively.
A company operates a manufacturing process which produces joint products A and B, and by-product C.
Manufacturing costs for a particular month total $272,926. The following details are available for the
products of the process:
Product Selling price per kg ($) Production volume (kgs)

A 6.10 16,000
B 7.50 53,200
C 0.80 2,770
Calculate the cost per kg of the joint products,
1. Using market values to apportion joint costs.
2. Using physical volume to apportion joint costs.
Answers:
227
10i. Profit Cost/Profit Data

Discuss the usefulness of product cost/profit data from a joint process.
In processes that result in joint products, it may not be easily

noticeable whether each product is worth the production effort.
Hence, the apportionment exercise. Apportioning joint production
cost separates the costs accordingly to individual products. This
directly allows unit gross profit to be estimated.
It is important to do that to gauge profitability of the product, and

also the process. This reflects on the worthiness of the production
process. A rough estimation of the product cost allows the
organisation to set suitable, competitive selling prices. At the same
time, costs apportionment helps determine the need for further
processing of any or all of the joint products
228
Topic Review (TLO C4i)

Discuss the usefulness of product cost/profit data from a joint process.
1. Discuss the need to apportion joint production costs to the resulting products.
Answers:
229
10j. Further Processing

Evaluate the benefit of further processing.
Sometimes, one or more or the joint products may be further

processed to enhance contribution and profits. Although the sales
value after further processing is usually higher, it is important not
to forget the additional costs (incremental cost) that may incur.
So, the decision on whether to further process the product(s) or
not, requires a relatively accurate analysis of incremental costs
and incremental profits.
Let’s assume two joint products A and B are manufactured, and

one has an option to be processed further to enhance profit. The
sales value of A at split-off point is $90 per unit and B is $60 per
unit. Product A can be further processed at an extra cost of $2,000
per batch of 100 units (of A) to produce Product AA, which can be
sold for $120 per unit.
The sales value of 100 units of A would be $9,000, and AA would

be $12,000 with an incremental cost of $2,000. Yet, there will be
a $1,000 net increase in profits.
$
Incremental sales revenue 3,000
Incremental cost (2,000)
Incremental profit/(loss) 1,000
From the summary above, it clearly shows that it is wise to further

process A and sell off as AA. However, other issues such as losses in
further processing and non-cost related factors (such as availability
of resources and demand for further processed product) should be
considered as well prior to making the final decision.
Further processing decision is made when a particular product is not

profitable enough to be sold straight after the point of separation.
In some cases, the product itself is not complete enough to be sold
off straight away, which means it has to be further processed.
Sometimes, the product further processed just to increase its value
to gain better market share or customer base. Sometimes, it is just
the customer’s preference that the product be further processed.
All said, it must be noted that further processing is viable only if

there is an incremental profit.
230
Topic Review (TLO C4j)

Evaluate the benefit of further processing.
1. A process produces 2 joint products, X and Y. Product X is sold straight away but Y is subjected to
further processing. What might be the reasons?
Answers:
231
Chapter 10 Summary
1. Process costing is used where units of production come from a continuous process or a series of
linked processes. In such a process, it is almost impossible to identify distinctive units of production.
2. Common features of process costing are:

a. Output is in the form of continuous stream of identical and/or different units of production.
b. Input materials may be added at different stages of processing. That may require added
direct labour work, and incurrence of additional overheads:
c. It is common to have losses in the process, which can be sold as scrap.
d. Output of one process may become input of another.
e. Output of process may be a single product, joint products or by-products.
3. Normal loss is an expected output loss, expected before production starts. It can be sold as scrap at
scrap value and are credited from process account. Scrap value of normal loss reduces production
cost.
4. Abnormal loss refers to unexpected output loss. Its volume is the difference between actual loss and
normal loss. Such losses are valued at cost per unit of the good output and are credited from process
account.
5. Values of normal losses and abnormal losses are credit entries in the process account.
6. Abnormal gain refers to unexpected output gain. Its volume is the difference between actual loss and
normal loss. Abnormal gain is valued at cost per unit of the good output and are debited into process
account.
7. Unit production cost is equals to net production costs divided by expected output.
8. Four steps to prepare process account for completed units:

a. Determine output & losses (in units)
b. Calculate cost per unit of output & losses
c. Calculate total cost of output & losses
d. Complete Process a/c and all relevant accounts
9. Four steps to prepare process account when there are incomplete units:
e. Statement of equivalent units
f. Statement of cost per equivalent unit
g. Statement of evaluation
h. Complete Process a/c & relevant accounts
10. A by-product is produced from a process together with other products but is either of insignificant
quantity or insignificant sales value.
11. Joint products are separate products that emerge from a single process. Each of these products has a
significant sale value to the organisation. Joint products are not separately identifiable until the point
of separation (also called the split-off point).
12. Further processing decisions are made to increase contribution and profits. It is usually pursued only
is there is increased net revenue.
232

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MA2 MANAGING COST AND FINANCE

INTRODUCTION Sunway TES

Version: Jan 2019

Chapter 2 Summary ................................................................................................................................ 52

Chapter 4 Summary .............................................................................................................................. 113

7b. The Nature of Production and Service cost Centres....................................................................... 154

9c. Control of Costs .............................................................................................................................. 201

Relational Diagram of MA2 and MA1 topics in this chapter

A2 Cost Accounting systems

b) Describe the procedures and documentation

a) Explain and illustrate the use of codes in

Explain and illustrate the concept of cost

Describe methods of capturing, processing,

A3 Cost Classification C1 Chapter 5: Cost Classification

CHAPTER 1: FUNDAMENTALS OF COSTING

At the end of the chapter, you should be able to:

TLO 1a. Describe the management information requirements.

TLO 1b. Describe the cost accounting systems.

TLO 1d. Apply the high-low method to separate semi-variable costs.

TLO 1f. Analyse the effects of changing level of activity on costs.

1a. Management Information Requirements

Purpose of Management Information

Management information refers to processed data that which are

The purpose of it lies in its definition – to make informed

Features of Useful Management Information

Useful management information is said to have the following

Further qualities include cost effectiveness and that it must be

Nature, Source and Importance of Management Information

Where does data and information come from?

 Within the organisation (internal), or from outside (external).

Wherever the data comes from, it is important that it serves the

These are work units (such as departments or projects) with

There are four types of responsibility centres – cost, revenue,

Profit centres are parts of the organisation that focuses on both

It is important to know to measure the performances of all these

Role of Information Technology in Management Information

In this era of high-end technology, it is impossible and unwise to

Common data capture methods these days are beyond keyboard

So computer or information systems are integral parts of any

The primary role of the trainee accountant would be to process data

Their common responsibilities include:

Topic Review (TLO 1a)

Get into a group of four. Select an organisation of your choice.

1. The sources of data and information for that organisation.

2. The responsibility centres in that organisations, including reference to specific departments.

3. Areas in which IT will be required, and for what purposes?

1b. Cost Accounting Systems

Relationship Between Accounting Systems

The financial and management accounting systems use the same

The two accounting methods may be dealt with together in an

Accounting for Input Costs and Documentation Involved

The appropriate procedures and relating documentation of for all

Different types of coding system are used to contain different

This is the heart of management accounting! Different businesses

Further elaborations will be provided in upcoming chapters.

Topic Review (TLO 1b)

1. Which statement is false?

1c. Cost classification

A summary of the cost classification is given in Figure 1.1.

Production Selling, Distribution Finance

Direct costs Indirect costs

Material Labour Expenses

Fixed Variable Mixed Stepped

Step 3. VC per unit = HC-LC