management accounting

1

Management Accounting SCDL

By Prof. AUGUSTIN AMALADASM.COM., AICWA.,PGDFM.,B.Ed.

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1.Production

Prime Cost

1.Godown

1.canteen

2

Cost of sales

6.sales5.profit

1.Factory administration

4.Sales and distribution3.General administration

Total cost

Bin card

Stores ledger

Cost calculations/operating activity

++ =

+

+

Danger

Facility department

Factory cost/works cost

3

FLOW OF CASH/SHORT TERM AND LONG TERM

information

Accounts payable

RAW mATERIAL

ADRLong term loansPreference

Shares

Bad debts

Accounts receivable

DebtorsWork in progress

information

OverheadsLabour

Equity shares

CASH

GDR

informationIn

form

ati

on

4

FLOW OF CASH - LONG TERM

ADRLong term loansPreference

SharesEquity shares

CASHShort term

GDR

land

furniture

investments

goodwill

building

Patent rightsKnow how

Copy right

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FLOW OF CASH-SHORT TERM

information

Accounts payable

RAW mATERIAL

Bad debts

Accounts receivable

DebtorsWork in progress

information

OverheadsLabour

informationIn

form

ati

on

Discounting billscreditorsCash creditBank overdraft Sale of investments

Bad debts

Bad debts

Issue of long term fundsSale of fixed assets

Bank overdraft

cash cash

6

Accou

nting

Labou

r la

ws

mark

eti

ng

Costing

technical technology

political

prod

uction

statisticalShar

e m

arke

t

MANAGEMENT ACCOUNTS

INFORMATIONINFORMATION

INFORMATIONINFORMATION

INFORMATION

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Techniques in management accounting

Management Accounting

Cost accounting

Mathematics

operation research

statisticsRatios

Financial accounts

Budgetary control

Cash flow statementFFS Trend percentages

Marginal costing

Variance analysis

Comparitive statement Common size statements

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Structure of the syllubusChapter-1

Financial accounting

1. Introduction

2. BasicAccounting

3. Process ofaccounting

4. BRS

5. Rectification ofErrors

Final accounts

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Cost Accounting

6. CONCEPTS

7. ELEMENTS OF COST

8. MATERIAL

9. LABOUR

10. OVER HEADS

11. MARGINAL COSTINGtechniques

12. BUDGETARYCONTROL

13.STANDARD COSTINGTECHNIQUES

14. UNIFORM COSTING

CO

NTR

OL

10

Anything incurred during the production of the goods or service to get the output into the hands of the customer

The customer could be the public (the final consumer) or another business

Controlling costs is essential to business success Not always easy to pin down

where costs are arising!

Costs

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Differences between cost accounting/Management Accounting/financial accounting

Financial Accounts Cost Accounts Management Accounts

1.Recording

2.Outsiders

3.Past

4.Statutory

5.Preparation of profit/loss A/c

And balance sheet

6.Audit& reporting

1.Estimation and control

2.Internal

3. Future

4. Not all organisations

5.Costing records

6.Cost audit once in two years

1.Collection Analysis and decision making

2.Management

3.Future

4.Non-statutory

5.Using various techniques

6.Supply the required information

To correct persons on time

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Users of information

organisation

shareholders

public

Benefactors

governmentbanks

Debenture holders

Loan vendor

Preference shareholderscreditors debtors

customers

dividend

liquidity

Dividend/value in the share market

Interest/return of capital

Interest/return of capital

Timely payment Timely supply

Good product

Less pollution

Good name

tax

14

Techniques in management accounting

Management Accounting

Cost accounting

Mathematics

operation research

statisticsRatios

Financial accounts

Budgetary control

Cash flow statementFFS Trend percentages

Marginal costing

Variance analysis

Comparitive statement Common size statements

15

See you in the next chapterBRS

Life education

God and Poor man

16

Chapter-2: Basics of financial accounting 1.Concepts 2.system of accounting 3.Types of Expenditure 4.Terms used in financial accounts 5.Double entry / Single entry 6. Depreciation methods 7. Practical consideration relating to

depreciation

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1.concepts& conventions Meaning: Basic assumptions upon which the basic

process of accounting based. a] Business entity concept- b] Dual aspect concept c] Going concern concept d] Accounting period concept e] Cost concept f] Money measurement concept g] Matching Concept

ConventionsCoservativismMaterialityConsistency

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a] Business entity concept-

Business is different from the owner We pass Journal entry when owner contributes

towards capital. When amount / goods withdrawn for personal

use we make an entry in the business When Income tax paid by the owner out of

business money we make an entry In the books of accounts.

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b] Dual aspect concept

Every debit has equal amount of credit Asset =Liability Liability creates asset If asset>Liability= profit If Liability> Assets= loss

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c] Going concern concept

Business will go for at least for a reasonable period.

Depreciation is provided based on this assumption.

If this assumption is not made all Fixed assets will be valued at realised value like current assets.

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d] Accounting period concept

Fixing time limit for accounts Profit for the period It can be one week or two weekor 6

months/one year or 5 years But to find profit we normally consider 12

months period Financial year for income tax point of view 1st

April-31st March of the following year Calendar year –January to December Divali to Divali

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e] Cost concept

The cost to the organisation (Actual) is recorded in the books

Assets are not recorded according to the market price every year.

Depreciation is calculated on cost not based on market price

Accounting records may not show the real worth of the business

Market price may be disclosed with in bracket in the balance sheet

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f] Money measurement concept

Every thing which can be expressed in terms of Money is recorded in the books

Beautiful women are working /Handsome boys working in IBM /Efficient engineers worth 5000 crores –How do you record?.

Good working environment? Highly motivated employees?

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g] Matching Concept

Matching Cost with revenue It is used to estimate correct profits Accrual/ cash basis of accounting

Even cash paid /received if it belongs to accounting period we consider them as expenditure /income

Salary outstanding for the last month? Income from Investments yet to be received? Rent received in advance for next year?

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Conventions

Customs and traditions that are followed by the accountants while preparing the financial statements.

Why do we respect elders? Why do we shake hands? Why do Young Indians hate receiving

dowry?

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Coservativism

To be on the safer side Expect future losses as current year loss not future income is treated as current

year income. Stock is valued cost price / market price

which ever is lower Making provision for bad debts is based

on this assumptions.

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Materiality

Material impact on profitability are considered

Insignificant transactions ignored from recording

Pen purchased, pencil purchased? Wine purchased regularly?

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Consistency

Accounting policies and proceedures should be followed consistently

Method of depreciation should be followed consistently.

Stock valuation- cost/market price whichever is lower is consistently followed

If not followed it amount to change in the policy of the company

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2.system of accounting (26)

1.Cash system: unless cash received /paid in

the accounting year can not be considered as income/expenses respectively

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2.Mercantile

Mercantile/Accrual/due concept: Even cash received/paid but due for

payment/due for receipt (yet to be received/payable) if they belong to current accounting year are considered.

If last year expenditure paid this year? If you receive/paid in advance ?

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Mercantile love!!!!???

Last year I loved her? Next year I shall love him depends on type of bike model!!!!

32

Life Education

If I do not get married to him I will not be happy- Girl said

If I do not get married to her I will not be happy- Boy said

If both get married what will happen!!!!

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3.Types of Expenditure(30)

A) Capital expenditureB) Revenue expenditureC) Deferred Revenue

expenditure

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A) Capital expenditure(30)

Expenditure incurred which will :a) Increase Production capacityb) Increase earning capacityc) Reduction in the cost of operation.Example: purchase of fixed assets

Purchase of Machinerypurchase of investment

If such expenditure is not to do with the basic functions of the business such expenditure is capital expenditure.

How do you consider if you buy goodwill, copy right or patent right?

35

Capital expenditure-continue(page-30)

Both tangible and intangible assets included

Intangible assets such as patent right, copy right, technical know-how, francises, goodwill etc.,

Depreciation is provided on fixed assets which will appear in the profit and loss account

They appear in the Balance sheet

The life is more than one year

They should not appear in the profit and loss account

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Revenue Expenditure(page-30)

Expenditure incurred which will :a) Not Increase Production capacityb) Not Increase earning capacityc) maintain the capacity No Depreciation is provided on fixed assets which

will appear in the profit and loss accountThey appear in the profit and loss accountThe life is not more than one year

They should not appear in the balance sheet

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Deferred revenue expenditure(page-30) Deferred means- postponed Heavy revenue expenditure Vodafone incurred 200 crores for advertisement after

merger with Hutch It can not be written off within a year It appears in the balance sheet as last item Every year some portion is written off in the profit and loss

account. Research and deveopment expenditure, initial

advertisement expenditure, preliminary expenditure are example

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Terms(page-27)

Account

Debit

Credit

Journal

Ledger

Narration

casting

Polio

Brought forward(B/f)

Trail balance

Assets

Liabilities

Capital

Drawings

Debtors

depreciation

Creditors

Balance sheet

Accounts receivable

Accounts payable

Debit note

Credit note

Trade discount

Cash discount

Debentures

Equity shares

Preference shares

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Terms used in costing(unit 7)Direct material

Direct labour

Direct expenses

Prime cost

Raw material; cost per unit can be identified, in the individual cost centre;

Engaged in manufacturing process

Hire charges of machinery-direct expenses

Factory

Indirect material

Indirect labour

Indirect expenses +

Works cost

Consumable stores, cotton waste ,oil

Wages to storekeeper, foremen, works manager’s salary, repairs to factory building, insurance to machinery factory lighting

Factory

Indirect material

Indirect labour

Indirect expenses +

Total cost

Stationary, salaries to accounts staff, postage, internet, bank charges, audit, administration expenses, depreciation

Administration section

Factory over headsFactory over heads

Office and administration overheads

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Indirect material

Indirect labour

Indirect overheads

Cost of sales+

Profit

Sales

Packing material, samples,salaries to sales personnel,commission to sales manager, warehouse charges,advertisement,repairs to distribution van, discount to customers

Sales departmentSelling and distribution

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Life education

Lady in a seashore

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5.Double entry / Single entry

Is Accounting based on business concept or religious concept?

Giving first and receiving later. Giving cash receiving machinery We consider both aspects such as debit

and credit

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Rules of acccounting

Personal rule/Account-supplier debtors, owner, banker, outstanding wages

Real rule/Account- cash, bank, building, furniture, goodwill, patent rights

Nominal rule/account: income and expenditure: salary, rent , insurance, commission, internet expenses, cell phone expenses.

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Personal rule

Debit the receiver credit the giver Example: Computer chips purchased on credit

from wipro Here credit Wipro as Wipro is the giver of

computer. Sold goods to Meena Meena is the receiver-debit

45

Excercise Amount collected from debtors? Amount deposited to bank?

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Real rule

These are the accounts of assets and liabilities

Rule: debit what comes in

Credit what goes out

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Excercise

Goods supplied for cash Cash withdrawn from bank Cash withdrawn from bank for personal

use Land purchased by giving a cheque Building sold on credit

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Nominal rule

Related to Expenses and income

Rule: Debit all expenses and losses

Credit all incomes and gains

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Excercise

Rent paid Rs 50,000 Wages paid Rs.1,00,000 Wages outstanding-Rs.60,000 Commission received-25,000 Discount allowed to customer – Rs.1,000 Telephone bills paid-Rs.2500 Shares issued at premium-Rs.2,00,000

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Suitable questions to pass journal entry If cash transaction, person is not important Every birth of an account there is a death

of the account Ask what comes in? Or what goes out?

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Depreciation Accounting(34)

Reduction in the value of assets Use factors, time factor,obsolescence are

the factors Statutory requirement AS(6) Fixed assets are depreciated Current assets are not depreciated Land and cattle are not depreciated.

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Depreciation methods

Straight line method Written down value method Sinking fund method Machine Hour rate method Unit cost method Depletion asset method Depreciation Fund method Sum of digits method Accelerated depreciation method

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Impact on books

Depreciation Expense Net income Asset Equity Return on assets Return on Equity Turnover Ratios Cash flow NPV IRR Pay back

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Impact of Tax

Block asset method Purchase of Asset Sale of Asset Short term/Long-term Capital asset Asset used less than 180 days during the

previous year Asset purchased preceding previous year but put

into use less than 180 days during the current previous year

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Divisible profit and depreciation(Page:39-41) Profit after adequate

depreciation[Sec.205(2)] Profit after interest-depreciation of the

current year- Depreciation of the previous year- loss of the previous year

Depreciation as per Schedule XIV of the Companies Act

Section 350 –calculated on WDV

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Methods(35) 1. straight line method: Cost (- )estimated scrap value

Estimated life in years 2. written down value or diminishing balance method. cost of the asset=1,00,000; rate of depreciation =10% #Depreciation for the 1st year=1,00,000*10%=10,000 Value at the end of first year= 1,00,000-10,000= 90,000 ##Second year depreciation=90,000*10%=9000

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Methods(37)

3. production unit method: Depreciation= (cost-scrap)(units produced during the year)

no of units the machine

can produce during its life

Suppose cost=1,00,000; scrap=5000; total life in units=10000 units. No. of units produced during the year=3000

Depreciation=(1,00,000-5000)(3000)/10,000

=Rs 28,500

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Production hour method

It depends on number of hours produced instead of units produced

We calculate production hour rate Multiply the no.of hours used during the

year with the rate gives depreciation

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Joint factor rate method(38)

Both fixed element and variable elements are considered

Cost is divided into fixed and variable Fixed part is divided based on time Variable elements are divided by total

units which gives rate per unit

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Annuity method

C*r Depreciation= n 1- 1/(1+r) - 1 Depreciation is constant It depends on future cash inflows It assumes that the capital invested would have

earned interest had been invested otherwise

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Sinking fund method

Amount available would be equivalent to the original cost

C*r

Depreciation= n (1+r) – 1Calculation of 26380 is wrong. I should be 16380.

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Endowment policy method

Insurance policy is taken to replace the asset.

The depreciation is equal to the insurance premium paid

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Renewal method(39)

When asset is renewed full amount is written off.

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Bye-bye to chapter-2

Chineese tree

Life education

65

Chapter-3

Journalising Ledger (subsidiary books) Posting Trial balance Trading and profit and loss account Balance sheet

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Final Accounts Adjustments

Direct expenses Indirect expenses Opening stock given in adjustment Closing stock given in the adjustment Wages outstanding in trail balance Income from investment due given in trail balance Meaning of adjustment Income tax Life insurance premium Goods drawn by the owner

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Domestic house hold Expenses Income tax refund Income from house property Accrual basis of Accounting Un expired insurance Income received in Advance Interest on Capital Provision on Doubtful debts provision for Discount on debtor Deffered revenue expenditure

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Reserve Fund Goods Distributed as free sample Manager’s Commission Goods on sale or approval basis Hidden adjustments

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Terms used in final accounts

Trading account Profit and loss account Profit and loss appropriation account Balance sheet Capital Long term liabilities Current liabilities Fixed assets

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Terms

Investments Current assets Adjustments Closing stock Depreciation Outstanding expenses Prepaid expenses

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Terms

Accrued income Income received In advance Bad debts Provision for doubtful debts Interest on capital Drawings Deferred revenue expenses

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Terms

Abnormal expenses Goods distributed as free sample Goods sent on approval Commission payable to manager

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Important adjustments In various problems Illus:2 page-77 i) repairs tp plant ii)Income

tax of X Iii) Provision for bad debts Iv) adjustment no.b,e and f V) calculation of works manager’s

commission and general manager’s commission

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Important adjustments In various problems Illustration 3: i) adju.e and I and trading account purchases and

sales Illustration 4: bank loan, adj. a,d and g. Illustration 5: loan, adj.b and c. Illustration 6: adj: b,f and h Illustration 7: adj:b and d Illustration 8: adj.f Illustration 9: adj. d and e Illustration 10: loan, adj.a

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Bank reconciliation statement

Cash book Pass book Cheques issued but not debited Cheques deposited but not cleared Bank charges entered in the pass book Income from investments entered in the pass

book Electricity, water, telephone , internet bills paid

directly by bank entered in the pass book Clerical errors in the pass book or cash book

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Exercise:-11 page121

Q.2 –page-116 and questions no.6 page-119 .

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Life education

Child likes to hug in the evening

78

Chapter 5: Rectification of Errors(page-126) Reasons for errors in accounting: 1.error of omission 2.error of commission 3.Error of principle 4. Compensating error

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Errors not affecting trial balance

1.error of omission 2.Error of principle 3.compensating error 4. complete omission 5.error of commission

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Suspense Account

If trial Balance does not tally ie debit is not equal to credit then temporarily to close down we open a suspense Account on the deficit side known as suspense account.

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Rectification: Steps

Rectify only the account in which error is committed.

Book means complete set of accounts Accounts means mistake only in the

account If suspense account is given and if one

side error suspense account has to be either debited or credited accordingly.

82

Problems in errors Problem:7 page-139

1. Drawings A/c debit

to General expenses a/c credit

2. Sales Account debit

to Machinery A/c credit

3. Rent a/c debit

To land lord a/c

4. Repairs a/c

To Building

5. Suspense a/c debit

To Harish a/c

To Cash A/c

2500

1300

160

245

500

2500

1300

160

245

250

250

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Problem:6 page-138particulars amount amount

a.Machinery Dr.

To Purchases a/c

To Wages a/c

b.Suspese a/c Dr.

to Mohan a/c

Cash a/cDr.

To Mohan

1100

2700

400

700

400

2700

400

84

particulars

Mohan a/c Dr.

To sales susp.

c. Suspensea/c

ToYogesh a/c

d.Furniture a/cdr

To P/L a/c

e.Machi.a/cdr.

To Purchases

To trade exp.

700

900

600

18200

700

900

600

17000

1200

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Life education

Thomas Thomas Cooper –Cooper –DictionaryDictionary

86

Chapter-6 Cost Accountancy-terms Cost centre

Impersonal and personal cost centre

production and service cost centre Concept of cost

87




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The bottom line is that the organization

is out "hard" or "real" money.[1 Examples:

· Hardware and software purchases · Professional services

· Maintenance · Labor

· Medical benefits · Insurance

· Internet Service Provider fees · Wide area network fees

89

Economic Costs

Economic costs are "opportunity costs." Instead of doing X, you had to do Y. These

are not hard-currency costs and it is dangerous to lump them into the cost-savings category with accounting costs because their effects will not necessarily

show up on the bottom line.

90




91

Economic Costs




92




93

The bottom line is that the organization

is out "hard" or "real" money.[1 Examples:

· Hardware and software purchases · Professional services

· Maintenance · Labor

· Medical benefits · Insurance

· Internet Service Provider fees · Wide area network fees

94

Economic Costs




95

Terms in costing

Accounting Costs : These are costs that impact an organization’s general ledger. For example, buying a product results in a chain of events wherein a purchase order is processed, a product/service is received, then an invoice arrives from the vendor

96

Economic Costs




97

Example : · Reducing firefighting on incidents related to

problematic changes is robbing resources from planned work (projects) and applying them to unplanned, reactive work (incidents).

If you say that better change management reduced unplanned work by 20 percent, that is not an accounting cost savings, but it did free up resources to work on projects.

It would be wise to identify what project progress was enabled through the action.

98

Example-2

· By training users, incidents handled by the service desk decreased 5 percent. Again, this is not an accounting cost savings unless a resource is dismissed, thus impacting labor, benefits and so on.

99

mixing accounting and economic cost mixing accounting and economic cost

savings together and instead wrap both types of costs with a business case explaining the benefits of the proposal.

100

Overhead

These are indirect costs that are absorbed by IT. For example, a portion of building rent is often allocated to IT based on some cost driver such as percent of floor space allocated.

101

illustration

If IT occupies 10 percent of a building, then accounting will likely allocate 10 percent of the rent to IT. This overhead cost must then be factored into the services that IT offers in order for proper charge backs, pricing and so on

102

Sunk Costs

These are costs that, once spent, cannot be Recovered. If something is purchased that cannot be returned or sold off, then that item should be considered a sunk cost.

Most of the times they are irrelevant to take future decision.

103

Cost Drivers

When determining costs, it is worthwhile to understand what drives the costs. In other words, if you do X, then you see a corresponding increase in cost Y. To illustrate, if you must buy a PC and software licenses for each new person hired, then the addition of new users is one of the cost drivers for the associated PC and software expense accounts.

104

Salvage Value/Salvage Costs

If you can sell an asset for more than its book value, then you are actually booking another form of income. On the other hand, if the salvage value is lower than the book value, then accounting will need to write the asset off.

If you have to pay someone to take things away due to hazardous materials laws, then you may even incur expenses relating to the disposal of the asset.

105

Differential cost

Increased or decreased cost due to the increased or decreased volume of operations.

Additional cost due to operation.

106

Normal cost and abnormal cost(150)

Normal costs incurred at a certain level of output

Abnormality in cost due to unforeseen situations

107

Relevant cost and relevant benefit

Required for decision making Costs that are affected by by the decision Costs and benefits that are independent of a decision are

not relevant and need not be considered. Future cash inflows and future outflows are relevant. Sunk costs are irrelevant Allocated common costs are irrelevant Opportunity costs are relevant (shadow price) Incremental costs are relevant incremental benefits are

relevant. Avoidable costs are relevant and unavoidable costs are

irrelevant for decision making.

108

Relevant and irrelevant

Five engineers already employed on monthly salary but will not be sent out if not employed in an another project. The salary paid to those engineers are relevant or irrelevant to estimate the price for the project?

Two more engineers are selected exclusive to the new project-are the costs relevant to take decision for new project?

109

Direct and indirect costs

Direct Costs are costs that can be specifically and exclusively identified with the particular object (product)

Salary of processing associate Indirect Costs are costs that can not be specifically

and exclusively identified with the particular object (product)

Salary of team leader Direct costs are allocated. Indirect costs are

apportioned.

110

product costs Period costs

Product cost are those costs that are identified with goods purchased or produced for resale.

Period costs are those costs that are not included in the inventory valuation and as a result are treated as expense in the period in which they are incurred.

Product costs will generate income.but period costs do not generate income.

111

Treatment of period and product costs

Product code

Period code

Manufacturing cost

Non manufacturing costs

Recorded as an assetIn the balance sheet

And becomes an Expense in the P/L

A/C When the product

Is sold

Recorded as anExpense in the P/L A/c

In the current Accounting year

sold

unsold

112

Variable, fixed, semi variable and semi fixed

Cost (Rs.) Variable cost

cost(Rs.)

Out put(units) fixed cost

Activity level(units)

113

Step fixed cost

Total

Fixed cost

Activity level(Units)

114

Variable, fixed, semi variable and semi fixed.Fixed cost Supervisors’ salary, leasing

charges for cars, depreciation on building

In the long run all costs are variable.

Variable costs

Semi variable cost

direct material, direct labour and direct expenses.

Both fixed and variable elements in the costs.

115

Incremental costs and Marginal cost Differential costs and revenues are the

difference between costs and revenues for the corresponding item under each alternative being considered.

Marginal cost/revenue - one extra unit of output cost/revenue.

117

Red Car, Inc. Cost of Goods Manufactured Schedule For the Year Ended March, 20xx

Direct materials used

Beginning raw materials inventory

Add: Cost of raw materials purchased

Total raw materials available

Less: Ending raw materials inventory

Total raw materials used

direct labor

Manufacturing overhead

Indirect materials

Indirect labor

118

Continuation

Depreciation—factory building Depreciation-factory equipment Insurance-factory Property taxes—factory Total manufacturing overheadTotal manufacturing costsAdd: Beginning work-in-process inventoryLess: Ending work-in-process inventory Cost of goods

manufactured

119

ADVANTAGES OF COST ACCOUNTING

It reveals profitable and unprofitable activities. It helps in controlling costs with special

techniques like standard costing and budgetary control

It supplies suitable cost data and other related information for managerial decision making such as introduction of a new product, replacement of machinery with an automatic plant etc

120

ADVANTAGES OF COST ACCOUNTING It helps in deciding the selling prices, particularly during

depression period when prices may have to be fixed below cost

It helps in inventory control It helps in the introduction of a cost reduction

programme and finding out new and improved ways to reduce costs

Cost audit system which is a part of cost accountancy helps in preventing manipulation and frauds and thus reliable cost can be furnished to management

121

ESSENTIALS OF A GOOD COST ACCOUNTING SYSTEM

The method of costing adopted. It should be suitable to

the industry It should be tailor made according to the requirements of

a business. A ready made system can not be suitable It must be fully supported by executives of various

departments and every one should participate in it In order to derive maximum benefits from a costing

system, well defined cost centres and responsibility centres should be built within the organisation

122

ESSENTIALS OF A GOOD COST ACCOUNTING SYSTEM controllable and uncontrollable costs of each responsibility

centre should be separately shown cost and financial accounts may be integrated in order to

avoid duplication of accounts well trained and educated staff should be employed to

operate the system It should prepare an accurate reports and promptly submit

the same to appropriate level of management so that action may be taken without delay

resources should not be wasted on collecting and compiling cost data not required. Only useful cost information should be compiled and used whenever required.

123

ESSENTIALS OF A GOOD COST ACCOUNTING SYSTEM-continues It helps in deciding the selling prices, particularly during

depression period when prices may have to be fixed below cost

It helps in inventory control

It helps in the introduction of a cost reduction programme and finding out new and improved ways to reduce costs

Cost audit system which is a part of cost accountancy helps in preventing manipulation and frauds and thus reliable cost can be furnished to management

124

Life education

Threat is an opportunity Strength is your weakness Strengthen your weakness

125

Unit-7 Elements of costs

Learning: Cost sheet Elements of cost Operating cost Operating profit Non operating profit

126

Terms used in costing(unit 7)Direct material

Direct labour

Direct expenses

Prime cost

Raw material; cost per unit can be identified, in the individual cost centre;

Engaged in manufacturing process

Hire charges of machinery-direct expenses

Factory

Indirect material

Indirect labour

Indirect expenses +

Works cost

Consumable stores, cotton waste ,oil

Wages to storekeeper, foremen, works manager’s salary, repairs to factory building, insurance to machinery factory lighting

Factory

Indirect Office and administration overheadsmaterial

Indirect labour

Indirect expenses +

Total cost

Stationary, salaries to accounts staff, postage, internet, bank charges, audit, administration expenses, depreciation

Administration section

Factory over headsFactory over heads

127

Indirect material

Indirect labour

Indirect overheads

Cost of sales+

Profit

Sales

Packing material, samples,salaries to sales personnel,commission to sales manager, warehouse charges,advertisement,repairs to distribution van, discount to customers

Sales departmentSelling and distribution

128

Marginal costing cost sheet ££Sales Revenue xxxxx

Less Marginal Cost of Sales Opening Stock (Valued @ marginal cost) xxxx Add Production Cost (Valued @ marginal cost) xxxx Total Production Cost xxxx Less Closing Stock (Valued @ marginal cost) xxx) Marginal Cost of Production xxxx

Add Selling, Admin & Distribution Cost xxx Marginal Cost of Sales (xxxx)

Contribution xxxxx Less Fixed Cost (xxxx) Marginal Costing Profit xxxxx

129

ABSORPTION COSTING PRO-FORMA

££Sales Revenue xxxxxLess Absorption Cost of Sales Opening Stock (Valued @ absorption cost) xxxx Add Production Cost (Valued @ absorption cost) xxxx Total Production Cost xxxx Less Closing Stock (Valued @ absorption cost) (xxx) Absorption Cost of Production xxxxAdd Selling, Admin & Distribution Cost xxxxAbsorption Cost of Sales (xxxx)Un-Adjusted Profit xxxxxFixed Production O/H absorbed xxxx Fixed Production O/H incurred (xxxx) (Under)/Over Absorption xxxxxAdjusted Profit xxxxx

130

Reconciliation Statement for Marginal Costing

and Absorption Costing Profit $ Marginal Costing Profit xx ADD

(Closing stock – opening Stock) x OAR xx = Absorption Costing Profit xx

Where OAR( overhead absorption rate) =Budgeted fixed production overheadBudgeted levels of activities

131

Cost sheet

Prime cost+ Factory over heads Factory cost/works cost+ Administration over heads Office cost+ Selling overheads Total cost Profit sales

132

Factory cost/

works cost

1.Production

Prime Cost

1.Godown

1.canteen

Cost of sales

5.sales4.profit



Total cost

Bin card

Stores ledger


++ =

+

+

133

Operating activity Non- operating activity

Dealers in furniture

Dealers in housesMy house is for sale

My furniture is for sale

?

?

Pro

fits

are

oper

atin

g pr

ofits

Non

ope

ratin

g pr

ofit

134

Operating/ Non operating

Operating (OP) Non operating (NOP)

1.Profits derived by doing basic functions

2.Efficiency depends on operating profit

3.Gross Profit- Office and administration overheads- selling and distribution overheads=OP

1.Profits derived other than basic functions

2.We should not consider NOP to study efficiency except on sale of company/firm.

3. Sale of asset-cost of such asset=NOP

135

BPOs

Self-less service canteen

Self help roomWhat activity?

136

Exercise Number: 3 page-175 unit 7. Exercise Number: 6 page-177 unit 7

137

Factory cost/

works cost

Prime Cost=R.material=40,000D. labour=12,000

Components=50,000Primary packing=50001.Godown

1.canteen

Cost of sales=1,76,338

5.sales4.Profit44084



Total cost=1,60 307

Bin card

Stores ledger


+

+=

+

+

p.3

Consumable =4000Royalty=8000FOH=16050

5000+20,257 16031

2,20,422

138

Exercise:6/177

particulars Units 500 @ old price

Units500@current price)

Units 600

Direct Material[(40,000*600/500)*120/100]

Direct labour[(60,000*600/500)*105/100]

Prime Cost

Manufacturing Cost[25% on prime cost]

Factory cost

Administration cost:Management expenses

Rent

General Expenses

TOTAL COSTSelling expenses

Cost of salesProfit [20% on sales=25% on cost]

sales

40,000

60,000

1,00,000

25,000

1,25,000

30,000

5,000

10,000

1,70,00015,000

1,85,000

15,000

2,00,000

48,000

63,000

1,11,000

27,750

1,38,750

30,000

5,000

10,000

1,83,75015,000

1,98,750

49,688

2,48,438

57,600

75,600

1,33,200

33,300

1,66,500

30,000

5,000

10,000

2,11,50015,000

2,26,500

56,625

2,83,125

139

Material cost-stages in the movement of material

1.Purchase requisition

3.Purchase order

4.Receipts and inspection

5.Cheking invoice

6.Accounting for purchase

7.Receipt of material

8.Issue of material

9.Return of material

10.Transfer of material

2.Selection of source of supply

140

Valuation of material movements

Basic cost Less: Trade discount Add: Container cost Add: Sales tax-on basic cost after trade

discount - on container Add: insurance freight Less: Credit for drums

Total cost

Add: Stores overhead on total cost Unit cost = Overall cost /No. of Units-normal loss units

141

Normal loss and abnormal loss

Effective cost per unit=

Costs incurred before abnormal loss period-recovery from normal loss units

Number of units-normal loss units

Abnormal loss units * Effective cost per unit=Abnormal loss

142

example

Units purchased= 10,000 Costs of purchases=1,00,000 Due to leakages number of units lost=50 Loss of units due to breakages=2000; insurance claim initiated. Effective cost per unit=1,00,000-0/10,000- 50 =Rs.10.05025 Abnormal loss=2000*10.05025=20100.50 How do you calculate normal loss?

Page 200 unit-1

143

Calculate normal loss?

We do not calculate normal loss but to calculate effective rate per unit we consider normal loss units and recovery from normal loss.

144

Valuation of issues

FIFO LIFO Average price method Weighted Average method Highest In First method Specific price Standard Price

145

Points to remembered for stock valuation under various methods 1.All the methods used for the calculation of

issues to production The costs of purchase and other related costs

should be passed on to customers Any deficit in stock taking to be considered

as issue Any excess will be considered as purchase at the

latest price Goods returned from production to be valued at the

price of issue.

146

Example

Date Particulars Receipts Issues Balance

Qty. Rate Rs. Qty Rate Rs. Qty Rate Rs.

1st Jan 08

5th

6th

8th

Op. balance

Purchase

Purchases

Issue

100 7.00 700

200 8.00 1600

250 ?

500 6.00 3,000

Stores ledgerMaximum levelMinimum levelRe-order level

DescriptionUnit

Location

FIFO

147

Example



1st Jan 08

5th

6th

Op. balance

Purchase

Issue

100 7.00 700

500 6.00 3,000


DescriptionUnit

Location

LIFO

148



1st Jan 08

5th

6th

Op. balance

Purchase

Issue

100 7.00 700

500 6.00 3,000

Stores ledger Maximum levelMinimum levelRe-order level

DescriptionUnit

Location

Average price method

149



1st Jan 08

5th

6th

Op. balance

Purchase

Issue

100 7.00 700

500 6.00 3,000


DescriptionUnit

Location

Weighted Average method

150

Techniques of Inventory control (Unit 8-page 211) 1. Economic Ordering Quantity 2. Fixation of inventory levels 3. Inventory Turnover 4. ABC Analysis 5. Bill of Materials 6. Perpetual Inventory system

151

1.Economic ordering Quantity(212)

EOQ=Root of (2AO/C) Where A=annual demand in units O= Cost of placing order (cost from

the time we order till we receive goods) C= Carrying cost per unit per year

(measured in terms of percentage on cost per unit)

Assumptions: normally on an average ½ of the units are in the store all the time.

152

Exercise:14 page 248

EOQ=Root of (2AO/C) = Root of(2*600*400/(40%*15) = Root of 80000 =282.845 units Total cost of inventory

annually=(600*15)+(3*400)+(1/2*282*40%*15)=9000+1200+846

=Rs.11,046.

153

If 10% discount is given cost per unit=15-(10%of 15)=13.5

Total cost=(600*13.5)+(2*400)+(1/2*500*40%*13.5)

= 8100+800+1350 = Rs.10,250 Advise: Purchase 500 units as annual cost of

inventory is cheaper.

If safety stock is required at any point of time in order to calculate holding cost we add the safety stock with the ½ of EOQ stock.

Holding cost includes storage and interest on locked up capital

154

If 10% discount is given

If 10% discount is given cost per unit=15-(10%of 15)=13.5

Total cost=(600*13.5)+(2*400)+(1/2*500*40%*13.5) = 8100+800+1350 = Rs.10,250 Advise: Purchase 500 units as annual cost of

inventory is cheaper. If safety stock is required at any point of time in order

to calculate holding cost we add the safety stock with the ½ of EOQ stock.

Holding cost includes storage and interest on locked up capital, handling, insurance of godown

155

2. Fixation of inventory level(218) Re-order level=Maximum leadtime

*Maximum usage Minimum level= Reorder level-(Normal

usage*Normal lead time) Maximum level=Re-order level+ Re-order qty-

(Minimum usage*Minimum Lead time Average level=(Maximum level+ Minimum

level)/2 Danger level=Normal usage*Lead time for

emergency purchases

Note: Re-order quantity=EOQ

156

See page-220 and 223 illustrations

EOQ is calculated inorder to find Re- order quantity

Re-order quantity is different from Re-order level

Sometimes minimum stock=safety stock

See page 222

157

3. Inventory (Stock) turnover ratio

It explains operating efficiency of the organisation.

How quickly raw material are converted into finished goods and also gives number of days of conversion.

It explains number of times in a year raw material are converted into finished goods

158

3.Stock turnover ratio=

Value of materials consumed in a year

Average stock

Average stock= (Opening stock+ Closing Stock)/2

Page-225

159

ABC analysis

Classify the various inventories according to their importance(70% of the value)

A-High cost per unit but less quantity (70% of the value)-large investment-effective control on supply

B- Moderate price per unit but moderate quantity (20% in value)

C-less cost per unit but large quantity(10% in value)-control on availability of material

Always Better Control

BetterControl Always

Control Always Better

160

5. Bill of materials

Bill of materials is a list of materials required for a job.. It also indicates quantity required for each item.

It helps in cost computation, material to be purchased by purchase department, that the order to be executed indicator.

161

6.Perpetual inventory control system(page-229)(Unit number 8) Stocks are recorded as soon as placed in the

godown and also recorded immediately as soon as stock is taken out.

They are recorded in Bin card and stores ledger. It helps if insurance claim initiated and also

fixing various level of stock,adjusted for discrepancies and periodical profits are estimated.

162

Problems-clarification

Problem number-02,10,16 from exercise Page-243,246 and248 respectively in unit-

1

163

Labour costs-unit 9 page-252

Selection,training,wage sheet preparation

Recording, time keeping and time booking

Analyse wage sheet, reports to mgt.

Selection,training,wage sheet preparation

Recording, time keeping and time booking

Analyse wage sheet, reports to mgt.

Personnel department

Time keeping department

Costing department

164

Methods of remunerating workers (unit 9 page-258) 1.Time basis 2.Result basis 3. Bonus systems

4. Indirect monetary remuneration

5. Non-monetary incentives

1.Time basis 2.Result basis 3. Bonus systems

4. Indirect monetary remuneration

5. Non-monetary incentives

Group

Individual

Profit sharing Co-partnership

165

Payment by results(page-261)

Payment by results

a) Straight piece rateNo. units*units produced

b) Piece rate withguaranteed time rate

c) Differential piece rate

1.Taylor differential pieceRate(page262)

No guaranteed wageBelow standard-low piece rateAbove standard-high piece rate

2.Merrick differential rate planNo guaranteed wage

Efficiency Piece rateUpto 83% Normal

Upto 100% 110% of normal rate

Above 100% 130% of normal piece

3. Gantt task bonus Below standard

-time rateAt standard-time wage+

increase in rateAbove std

.-High piece rate

166

Individual Incentive systems

Halsey premium system

50-50AH* HR+ (Time saved/2)*

HRTime rate guaranteed

Halsey-weir system

1(W):2(ER)

AH* HR+ (Time saved/3)*HR

Time rate guaranteed

Rowan planThe more you save

The more the incentives

(AH*HR)+(SH-AH)/SH* (AH*HR)

W ER

AH-Actual hoursSH-Standard Hours

HR-Hourly rate

167

Other Wage payment system

a.Bar

th p

rem

ium sy

stem

Wag

e=Hou

rly ra

te*

Root o

f SHR.*A

H

Emerson’s Efficiency

Bonus System

Guaranteed wages

Wage=(AH*HR)+

Bonus%*(AH*HR)

Below 66 2/3%-No bonus

66 2/3 to 100%- upto 20%

Above 100%-Bonus20%

+1% for

every1% increse

in efficiency

Bedaux Point system

Wage=AH*HR+

(75%Of BS*HR)/60

Every hour there are

Standard points=BS

Accelerated premium system 2Wage (Y)=.8*X

Where Y=EarningsX=Efficiency

168

Group Incentive schemeIndirect monetary benefits(271)

Profit sharing-Bonus-8.33% of wages statutory bonus.Maximum-20%

Copartnership-ESOP

169

Problems

Page-292; prob-6 &9 Page-293; prob-11

170

Overheads-unit 10 page-295

Classification of over heads Indirect material, indirect labour, indirect

expenses Factory overheads, administration over head,

selling and distribution over heads Fixed overheads, variable overheads, semi

variable overheads Controllable and uncontrollable overheads Normal and abnormal overheads.

171

Classification(206)

Element wiseIndirect material, indirect labour,

indirect expenses

FunctionFactory

administration, selling and

distribution over heads

VariabilityFixed,

variable, semi variable

overheads

ControllabilityControllable and

Uncontrollableoverheads

NormalityNormal and

Abnormal overheads.

172

Primary apportionment(page-299) Common over heads belong to production

and service departments are apportioned on the following basis or any other suitable basis:

1.Canteen-no.of workers2.Rent-Area

3.Power-HP/KWH4.General lighting-light points

5.Depreciation-value of assets

1.Supervision-no.of employees

2.Telephone expenses-no.of calls made3.Fire insurance

-value of stock/asset

173

Secondary apportionment Apportionment of service department cost

centre to production department

Methods of Apportionment(Page303)

Simultaneous Equation method

RepeatedDistribution method

174

Overhead absorption rate(page-307)

Amount of overhead/direct Material cost or /Direct Wage cost or

/Prime Cost or /labour hours or

/Number of machine Hours

Prob.-pages 309,336

175

Unit-11

Marginal Cost-Volume-Profit Analysis and Relevant Costing

176

Marginal cost, Budgeting and standard costing Presented by

Prof. L. Augustin AmaladasM. Com., AICWA.,PGDFM.,B.ED.

6th January 2008

IBM

177

1. How is breakeven point computed and what does it

represent?

2. How do costs, revenues, and contribution margin

interact with changes in an activity base (volume)?

Learning Objectives

C6

178

3. How does cost-volume-profit (CVP) analysis in

single-product and multiproduct firms differ?

4. What are the underlying assumptions of CVP

analysis and how do these assumptions create

a short-run managerial perspective?

C6

Continuing . . . Learning Objectives

179

5. How do quality decisions affect the components of

CVP analysis?

6. What constitutes relevance in a decision-making

situation?

C6


180

7. How can management best utilize a scarce

resource?

8. What is the relationship between sales mix

and relevant costing problems?


C6

181

9. How can pricing decisions be used to

maximize profit?

10. How can product margin be used to determine

whether a product line should be retained or

eliminated?

C6


182

11.How are breakeven and profit-volume

graphs prepared? (Appendix 1)

12. What are the differences between

absorption and variable costing?

( Appendix 2)

13.Why is linear programming a valuable tool

for managers? (Appendix 3)

C6


183

The Breakeven Point (BEP)

The level of activity, in units or dollars, at which

REVENUES = COSTS

184

Basic Assumption: Relevant Range

Company is operating within the relevant

range of activity specified in determining the revenue

and cost information used.

Total$

Activity Level

RelevantRange

185

Basic Assumption: Revenue

Total revenue fluctuates in direct proportion to level of activity or volume. On a per unit basis, the selling

price remains constant.

Total$

Activity Level

186

Basic Assumption: Variable Costs

Total variable costs fluctuate in direct proportion to level of activity or volume. On a per unit basis,

variable costs remain constant.

Total$

Activity Level

187

Basic Assumption: Fixed Costs

Total fixed costs remain constant relative to activity level changes. Per-unit fixed costs decrease as

volume increases and increase as volume decreases.

Total$

Activity Level

188

Basic Assumption: Mixed Costs

Mixed costs must be separated into variable and fixed elements.

Total$

Activity Level

189

Cost Behavior Example

Selling price per ice bucket $40

Variable production cost per ice bucket $20Variable selling cost per ice bucket 4Total variable cost per ice bucket $24

Fixed production costs $100,000Fixed selling and administrative costs 20,000

190

Contribution Margin Per Unit

Contribution margin per unit equals selling price per unit less variable cost per unit.

sp -vc = cm

$40 - $24 = $16

191

Contribution Margin Ratio

Contribution margin ratio is per-unit contribution margin divided by selling price, or total contribution margin divided by total sales dollars.

cm/sp=cm%

$16 / $40 = 40%

192

Breakeven Point

Breakeven point is the point at which

profits are zero because total revenues

equal total costs, or

Total revenues = Total variable costs + Total

fixed costs

193

Continuing . . . Breakeven Point

Total fixed costs In units = ---------------------

CM per unit

Total fixed costs In sales dollars = ---------------------

CM ratio

194

Continuing . . . Breakeven Point

$120,000 In units = ----------- = 7,500 ice buckets

$16

$120,000 In sales dollars = ----------- = $300,000

.40

195

CVP Analysis: Fixed Amount of

Profit Before Taxes (PBT)

Total fixed costs + PBTIn units = ------------------------------

CM per unit

Total fixed costs + PBTIn sales dollars = ------------------------------

CM ratio

196

CVP Analysis: Fixed Amount of

Profit Before Taxes (PBT)

$120,000 + $64,000Break evenIn units=------------------------ = 11,500 buckets

$16

$120,000 + $64,000In sales dollars =------------------------ = $460,000

.40

197

CVP Analysis: Variable Amount

of Profit Before Taxes

Assume PUBT desired is 25% on sales

Therefore, PUBT = .25 ($40) = $10

Total fixed costsSales in units =---------------------------

CM per unit - PUBT

$120,000Sales in units =--------------- = 20,000 ice buckets

$16 - $6

198

CVP Analysis: Variable Amount

of Profit Before Taxes

Assume PUBT desired is 25% on sales

Therefore, PUBT = .25 ($40) = $10

Total fixed costsSales in $ = ---------------------

CM% - PUBT%

$120,000Sales in $ =--------------- = $800,000

.40 - .25

199

Income Statement

Dollars Percentages

Sales $800,000 100%

Variable costs 480,000 60%

Contribution margin$320,000 40%

Fixed costs 120,000 15%

Income $200,000 25%======= ==

200

CVP Analysis - Multiple Products

Ice ServingBuckets Sets

Selling price $40 $24Variable cost 24 12Contribution margin $16 $12

Contribution margin ratio 40.0% 50.0%Sales mix* 80.6% 19.4%

*5:2 ratio

201

Continuing . . . CVP Analysis -

Multiple Products

Ice ServingBuckets Sets

Contribution margin ratio 40.0% 50.0%

Sales mix* 80.6% 19.4%

Weighted contribution margin 32.2% 9.7%

Contribution margin ratio per bag 41.9%

*5:2 ratio

202

Continuing . . . CVP Analysis -

Multiple Products

Total fixed costs BEP in sales dollars = -----------------------

CM ratio per bag

($120,000 + $30,000*) BEP in sales dollars = ----------------------------

.419

= $357,995

*$30,000 of additional fixed cost is incurred to produce both units

203

Scarce Resource -- Machine Hours

Ice Juice Crushers Extractors

Selling price per unit $15 $12Variable production cost per unit: Direct materials $3 $3 Direct labor 4 2 Variable overhead 3 1Total variable cost 10 6Unit contribution margin $5 $6Units of output per machine hour 30 20Contribution margin per machine hour $150 $120

204

Sales Mix Decisions

How many of each product?

205

Relevant Costs in

Product Line Decisions

Revenues associated with product Variable costs associated with product Avoidable fixed costs Consider product margin

Revenues - Variable costs - Avoidable fixed costs

206

Exhibit 6-12: Partial Product Line

Income Statement

ElectricSkillet

Sales $75,000Total direct variable expenses 43,750Total contribution margin $31,250Total fixed expenses* 39,500Net loss ($8,250)

*Fixed expenses:Avoidable fixed expenses $25,000Unavoidable fixed expenses 4,500Allocated common costs 10,000 Total $39,500

207

Exhibit 6-13: Product Margin for

the Electric Skillet Product Line

Electric

Skillet

Sales $75,000

Total direct variable expenses 43,750

Total contribution margin $31,250

Avoidable fixed expenses 25,000

Product margin $6,250

208

CVP Graph

Total$

Volume

Total Costs

Total RevenuesBEP

209

Profit-Volume Graph

BEP

Fixed Costs

Volume

Profit or Loss

Total$

210

Absorption Costing

Also known as full costing Treats costs of all manufacturing components as inventoriable, or

product, costsDirect materialsDirect laborVariable factory overheadFixed factory overhead

Presents expenses on income statement according to functional classifications

Cost of goods soldSelling expensesAdministrative expenses

211

Variable Costing

Also known as direct costing Includes only variable production costs as

inventoriable, or product, costsDirect materialsDirect laborVariable factory overhead

Fixed factory overhead costs treated as period expenses Income statement separates costs by cost behavior

May also present expenses by functional classifications within behavioral categories

212

Absorption Costing

Income Statement

Sales XXXCost of Goods Sold:

Beginning inventory XXXCost of goods manufactured XXX Cost of goods available XXXEnding inventory XXX

Cost of goods sold XXXGross Margin XXXOperating Expenses:

Selling XXXAdministrative XXX XXX

Income before Taxes XXX

213

Variable Costing

Income StatementSales XXXCost of Goods Sold:

Beginning inventory XXXCost of goods manufactured XXX Cost of goods available XXXEnding inventory XXX

Variable cost of goods sold XXXProduct Contribution Margin XXXVariable Selling Expense XXXTotal Contribution Margin XXXFixed Expenses:

Factory XXXSelling XXXAdministrative XXX XXX

Income before Taxes XXX

214

Absorption Costing vs. Variable

Costing Income Statements

Absorption Costing Variable Costing:

Sales $60,000 Sales $60,000

Cost of sales 30,000 Variable costs:

Gross profit $30,000 Cost of sales 30,000

Operating expenses: Operating expenses 6,000

Variable $6,000 Total variable costs $36,000

Fixed 20,000 Contribution margin: $24,000

Total operating expenses $26,000 Fixed costs 20,000

Income $4,000 Income $4,000

215

Costs and Budgeting

216

Costs

217

Costs

Anything incurred during the production of the good or service to get the output into the hands of the customer

The customer could be the public (the final consumer) or another business

Controlling costs is essential to business success

Not always easy to pin down where costs are arising!

218

Cost Centres

219

Cost Centres

Parts of the business to which particular costs can be attributed

In large businesses this can be a particular location, section of the business, capital asset or human resource/s

Enable a business to identify where costs are arising and to manage those costs more effectively

220

Full Costing

A method of allocating indirect costs to a range of products produced by the firm. e.g. if a firm produces three products - a, b, and c

- and has indirect costs of £1 million, assume proportion of direct costs of 20% for a, 55% for b and 25% for c

Indirect costs allocated as 20% of 1 million to a, 55% of £1 million to b and 25% of £1 million to c

221

Absorption Costing

All costs incurred are allocated to particular cost centres – direct costs, indirect costs, semi variable costs and selling costs

Allocates indirect costs more accurately to the point where the cost occurred

222

Marginal Costing

The cost of producing one extra unit of output (the variable costs)

Selling price – MC = Contribution Contribution is the amount which can

contribute to the overheads (fixed costs)

223

Standard Costing

The expected level of costs associated with the production of a goods/services

Actual costs – Standard costs = Variance Monitoring variances can help

the business to identify where inefficiencies or efficiencies might lie

224

Total Revenue

225

Terms and formulae in Marginal costing 1. Contribution=S-Vc 2.P/V ratio=C*100/sales BEP(units)=FC/Contribution per unit BEP (Volume)= FC/PV ratio Or BEP units*SP per unit Margin of safety (Units)=Profit/Contribution per unit Margin of safety(Volume)=MS units*SP per unit. Break-even at the required profit=(FC+Required

profit)/Contribution per unit or PV ratio

226

Total Revenue

Total Revenue = Price x Quantity Sold

Price can be raised or lowered to change revenue – price elasticity of demand important here Different pricing strategies can be used – penetration,

psychological, etc.

Quantity Sold can be influenced by amending the elements of the marketing mix – 7 Ps

227

Break Even

228

Break Even AnalysisCosts/Revenue

Output/Sales

Initially a firm will incur fixed costs, these do not depend on output or sales.

FC

As output is generated, the firm will incur variable costs – these vary directly with the amount produced.

VC The total costs therefore (assuming accurate forecasts!) is the sum of FC+VC

TC Total revenue is determined by the price charged and the quantity sold – again this will be determined by expected forecast sales initially.

TR The lower the price, the less steep the total revenue curve.

TR

Q1

The break even point occurs where total revenue equals total costs – the firm, in this example, would have to sell Q1 to generate sufficient revenue to cover its costs.

229


Output/Sales

FC

VCTCTR (p = £2)

Q1

If the firm chose to set price higher than £2 (say £3) the TR curve would be steeper – they would not have to sell as many units to break even

TR (p = £3)

Q2

230


Output/Sales

FC

VCTC

TR (p = £2)

Q1

If the firm chose to set prices lower (say £1) it would need to sell more units before covering its costs.

TR (p = £1)

Q3

231


Output/Sales

FC

VC

TCTR (p = £2)

Q1

Loss

Profit

232


Output/Sales

FC

VC

TCTR (p = £2)

Q1 Q2

Assume current sales at Q2.

Margin of Safety

Margin of safety shows how far sales can fall before losses made. If Q1 = 1000 and Q2 = 1800, sales could fall by 800 units before a loss would be made.

TR (p = £3)

Q3

A higher price would lower the break even point and the margin of safety would widen.

233

Costs/Revenue

Output/Sales

FC

VC

TR

Eurotunnel’s problemHigh initial FC. Interest on debt rises each year – FC rise therefore.

FC 1

Losses get bigger!

234

Break Even Analysis

Remember: A higher price or lower price does not mean that

break even will never be reached! The break even point depends on the number of

sales needed to generate revenue to cover costs – the break even chart is NOT time related!

235

Break Even Analysis

•Importance of Price Elasticity of Demand:

•Higher prices might mean fewer sales to break even but those sales may take a longer time to achieve

•Lower prices might encourage more customers but higher volume needed before sufficient revenue generated to break even

236

Break Even Analysis

Links of break even to pricing strategies and elasticity

Penetration pricing – ‘high’ volume, ‘low’ price – more sales to break even

Market Skimming – ‘high’ price ‘low’ volumes – fewer sales to break even

Elasticity – what is likely to happen to sales when prices are increased or decreased?

237

Budgets

238

Budgets

Estimates of the income and expenditure of a business or a part of a business over a time period

Used extensively in planning Helps establish efficient use

of resources Help monitor cash flow and identify departures from

plans Maintains a focus and discipline

for those involved

239

Budgets

Flexible Budgets – budgets that take account of changing business conditions

Operating Budgets – based on the daily operations of a business

Objectives Based Budgets - Budgets driven by objectives set by the firm

Capital Budgets – Plans of the relationship between capital spending and liquidity (cash) in the business

240

Budgets

Variance – the difference between planned values and actual valuesPositive variance – actual figures less than

plannedNegative variance – actual figures above

planned

241

Preparation of Budget

Sales budget quaterly-Estimated based on market survey

Production budget(Finished goods:Anticipated Desired Sales+ closing stock- Opening stock

Material Purchase Budget(Raw material)=Production budget+Desired Closing stock-Opening stock

242

Production budget

For Finished goods

Anticipated Desired Sales+

closing stock- Opening stock

243

Material Purchase Budget

For Raw Material

Production budget+Desired Closing stock-

Opening stock

244

Cash Budget-Sample-1Particulars Jan Feb Mar Apr. May Jun.

A. Cash Inflow

Issue of shares

Issue of Debenture

Collection from Debtors

B. Cash Outflow

Fixed Assets purchase

Stock purchase paid

Preliminary expenses

Sundry creditors paid

Other expenses paid

c. Net Cash inflow(A-B)

Opening cash balance

Closing Balance

245

Cash Budget-Sample-2Particulars Jan Feb Mar Apr. May Jun.

A. Cash Inflow

Issue of shares

Issue of Debenture


B. Cash Outflow


Stock purchase paid



Other expenses paid



Closing Balance

246

Cash Budget-Sample-3Particulars Jan Feb Mar Apr. May Jun.A. Cash Inflow

Issue of shares

Issue of Debenture


B. Cash Outflow


Stock purchase paid



Other expenses paid



Closing Balance

247

Problems

Page-130and132 unit-2 Problem-11 and 13 respectively.

248

Flexible Budget-Sample-1

Particulars 50%

Capacity

60%

Capacity

80%

CapacityA)Number of units sold

Selling Price per unit

Sales

B) Cost

1) Material cost

2) Direct wages

3) Variable Overheads

a) Factory

b) Selling and Distribution

4) Fixed Overheads

a)Factory

b) Selling and distribution

C) Profit ie A-B

249

Flexible Budget-sample-2

Particulars 50%

Capacity

60%

Capacity

80%

CapacityA)Number of units sold

Selling Price per unit

Sales

B) Cost

1) Material cost

2) Direct wages

3) Variable Overheads

a) Factory

b) Selling and Distribution

4) Fixed Overheads

a)Factory

b) Selling and distribution

C) Profit ie A-B

250

Problems in flexible budget

Pages-127,128,129 respectively in

Unit-2 Problems 4, 5,7 and 8

251

Standard CostingSystem

Unit-13

Managerial Accounting

252

Standard Costing

It is also known as variance costing.

Standard cost- Predetermined cost

Standard Costing- is a management accounting tecnique to analyse variances

253

Steps in Standard costing

Set standard cost Study the actual cost Compare the actual with the standard costWhich gives variancesAnalyse the variancesFix responsibilitiesTake suitable action and create effective

control system .

254

Management Accounting-Module-IIMarginal costing, Budgeting, standard costing and Uniform costing

255

Similarities and Difference between Budgetary control and standard costing

Similarities: 1.Both the tools available to the management for

the purpose of controlling the costs 2.Both based on setting standard, comparison

with actual and study the variance 3. If standard costing prevails in the company

then budgetary control is effective.

256

Differences

1.Budgetory control can be operated without standard costing

2.Budgets gives the limits on expenses but standard costs are minimum targets to be attained.

3.Budget can be prepared for various areas of activities but standard is used for production and manufacturing cost

257

Differences

4.Budgetary variances may point out efficiency or inefficiency. But standard costing goes beyond

The efficiency or inefficiency and find out the root cause for the variance.

5.Standard is always for improvement. Budgets are based upon the future or estimated

costs. But standard costs are ideal costs under ideal situation.

258

Types of standards

1.current standard2.ideal standard3.Expected standard4. Normal standard

259

Analysis of variances

Material Labour Overheads

price

Mix

yield

usage

cost

+

=

yield

Mix

Rate

efficiency

cost VariableOverheadvariances

Fixed Overheadvariances

+

=

Price+ Mix+ Yield=Cost Rate+ Mix+ Yield=Cost

260

Material Variance

Actual Quantity*Actual cost per unit

Actual Quantity*Std. cost per unit

Revised std. QuantityFor input*

Std. cost per unit

Revised std QuantityFor output*

Std. cost per unit

1 2 3 4

Price(2-1) Mix(3-2) Yield(3-2)

Usage(4-2)Cost(5-1)

261

Exercise: Material Variances

Actual Quantity*Actual cost per unit

400*6=2400500*3.6=1800400*2.8=1120 5320

Actual Quantity*Std. cost per unit

400*6=2400500*3.75=1875

400*3=12001300 5475

1300(5:4:3)/12Revised std. Quantity

For input*Std. cost per unit 541.66*6=3250433.33*3.75=1625 325*3=975 5850

Revised std QuantityFor output*

Std. cost per unit 500*6=3000400*3.75=1500 300*3=900 5400

1 23

4

Price(2-1) Mix(3-2) Yield(3-2)

Usage(4-2)Cost(5-1)

+155 +375 (450)

(75)

+80

262

Explanations for 3

Actual input(1300) is shared in the standard ratio of 500:400:300 ie 5;4:3

Then multiply by standard price Do not bother about how each material is

measured ie. One may be in Kg.,another in litre etc.

263

Explanations for 4

We move from output to input The output is 1080. We find normal input if normal

loss is 10% (given in the problem) If Input is 100 and normal loss is 10% then

output=90

1080*100/90=1200 Share 1200 in the standard ratio of 5:4:3 500, 400,300.

Output Input 90 100 1080 ?

264

Labour Variances(Page-191 prob.8

Actual Hours*Actual cost per Hour

28*40*4=448018*40*3=21604*40*2= 320

6960

Actual Hours*Std. cost per Hour

28*40*3=336018*40*2=14404*40*1= 160

2000 4960

2000*(30:10:10)/50Revised std. Hours

For input*Std. cost per Hour

1200*3=3600 400*2= 800 400*1= 400 4800

Revised std HoursFor output*

Std. cost per Hour 1152*3=3456 432*2= 864 216*1= 216 4536

1 2 3 4

Rate(2-1) Mix or gang(3-2)

Yield(3-2)

Efficiency(4-2)

Cost(5-1)

-2000 -160 -264

-424

-2424

265

Explanations for 4

Going from Output hours to input hours

There are 1800 hours are shared in the ratio of 32:12:6

266

Variable overhead Variances(Page-156)

Actual Hours*Actual Rate per Hour

Actual Hours*Std. Rate per Hour

Revised std HoursFor output*

Std. cost per Hour

1 2 3 4

Expenditure(2-1)

Efficiency(4-2)

Cost(5-1)

EmptyEGG

267

Fixed overhead Variances(Page-157)

Actual Over heads

Budgetedoverheads

Revised std. HoursFor actual input*

Std. cost per Hour

Revised Std HoursFor output*

Std. cost per Hour

1 2 3 4

Expenditure

Efficiency(4-2)

Cost(5-1)

Std. Hours*Std.fixedOH Rate

per hour

268

“Learning gives creativityCreativity leads to thinkingThinking provides knowledgeKnowledge makes you great”

- A.P.J.Abdul Kalam

269

Thank You all

management accounting

Business

basic accounting

accounts profit

system of accounting

cost of sales

cost audit

basics of financial

required information

elements of cost