ACCN4 - Management Accounting Chapter 1 Summary

ACCN4 - Further Aspects of Management Accounting

Chapter 1 – Manufacturing Accounts
What is a manufacturing account?
A retailer buys and sells completed products, whereas a manufacturer has to produce the products to sell.
A manufacturing account is therefore prepared to show all the costs associated with the making of these products within the factory.
A simple manufacturing account is split into two sections.
The prime cost section, which calculates the total of the direct manufacturing cost of the products, and the direct costs, which include raw materials, direct
labour and royalties.
The manufacturing overheads section which identifies the other costs associated with the production of the products, for example factory rent, machine
maintenance and machine depreciation.
When the sections are combined the production cost of manufactured goods can be found.
Manufacturing account
£ £
Inventory (stock) of raw materials at 1 January (opening inventory) X
Purchases of raw materials X
Carriage inwards X
Returns outwards (X)
Net Purchases X
X
Stock of raw materials at 31 December (closing inventory) (X)
Cost of raw materials consumed X
Manufacturing wages X
Manufacturing royalties X
Prime cost X
Depreciation of manufacturing machinery X
Factory rent X
Other factory overheads X
X
st
Inventory (stock of work in progress) at 1 January (opening inventory) X
Inventory (stock) of work in progress at 31st of December (closing stock) (X)
Production cost of manufactured goods X
Factory Profit @ certain % X
Transfer Price X
What is work in progress?

Manufacturing is a continuous process and so not all goods are complete at the end of the end of financial period.
The partially finished goods are referred to as inventory of work in progress.
The total production cost of manufactured goods in manufacturing account is therefore made up of prime cost + factory overheads - closing work in progress.
Preparing manufacturers income statement

At the end of the production process the total production cost of manufactured goods is transferred to the income statement. This figure replaces the purchases
of goods for resale within the calculation of cost of sales.
The completed goods are often referred to as finished goods. These are place in the income statement within the calculation of cost of sales.
£ £
Revenue (sales) X
Returns inwards (X)
Net revenue (sales) X
Opening inventory (stock) of finished goods X
Production cost of manufactured goods X
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X
Closing inventory (stock) of finished goods (X)
Cost of sales (cost of goods sold) (X)
Gross Profit X
How is inventory recorded in the balance sheet of the manufacturer compared to the retailer?
There are three types of inventory within the manufacturing business:
1. Inventory of raw materials.

2. Inventory of work in progress.
3. Inventory of finished goods.
The balance sheet of the manufacturing business therefore has to show all three types held at the yearend within the current assets, whereas the retailer would
normally only have to show one, normally the finished goods.
All of the inventory in the current assets is valued at the lower of the cost and net realizable value. This continues the application of the prudence and the
realization concepts.
Manufacturing Profit
Some manufacturing businesses transfer their products from the factory to increase the income statement at total production cost plus notational mark-up
percentage. This is referred to as transfer price. The difference between the production cost of completed goods and the transfer price is called factory
profit, or manufacturing profit.
What are the benefits of using a transfer price?

The process does not increase the overall profits of the business and merely identifies the profit made by their particular cost centres.
In this way the profit from the manufacturing is separated from the trading profit mad elsewhere in the business. The part that the factory contributes to the
overall profitability of the business recognized.
This allows the unit cost of goods manufactured to be compared with the cost of buying in completed goods form an outside source and enables a manager to
evaluate a ‘make or buy situation or decision.
What are the drawbacks of using a transfer price?

The profit loaded transfer price should be realistic so direct comparisons with the cost of buying in goods can be made. However there is a risk of an
unrealistic view of the factory profitability being given unless other production prices are researched and used to set the transfer price.
This techniques does not improve overall the profitability of the business, rather it just splits the total profit between the cost centres.
If a set percentage is used to calculate the transfer price this may fail to motivate the factory managers and other workers, especially if their bonuses are
dependent on the amount of factory profit.
Recording manufacturing profit

A manufacturing profit is recorded at the end of the manufacturing account. The transfer price then replaces purchases of goods for resale within the resale
within the income statement.
The provision for unrealized profit

Unrealized profit should not be recognized within the balance sheet and final accounts as it contravenes both the realization and prudence concepts. In the
balance sheet inventories of finished goods should be shown at the cost of production and therefore if a transfer price is used these inventories will include an
element of unrealized profit on finished goods.
Inventory at cost pus profit percentage

x percentage
100 profit percentage
Balance Sheet extract:
£ £
Current Assets
Inventory of raw materials x
Inventory work in progress x
Inventory of finished goods x
Less Provision of unrealized Profit (x)
x
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Chapter 2 - Marginal Costing

Marginal costing is costing method which only considers marginal costs, which are those costs that are incurred when one extra unit is produced, for example
direct costs.
Direct Costs – are those costs which can be identified with the actual production unit: namely the cost of direct material, cost of direct labour and any
variable cost which increases as production increases.
Variable Costs – these costs will vary with the level of production.
Indirect Costs – the costs that cannot be identified with the actual production unit and are not considered, for example staff administration costs.
The marginal costing method is used when:
Calculating the breakeven part for a product.

Considering whether to make or buy a product.
Calculating the cost of a special product.
A business has a limiting factor which restricts its activity.
Types of Costs
Within the marginal costing model it is important to distinguish between the types of costs, as fixed costs are not considered.
VARIABLE COSS: These costs vary in direct proportion with the level of production, for example direct wages and materials.
FIXED COSTS: these costs do not vary in direct proportion to the level of production, for example rent payable, supervisor’s salaries and insurance.
SEMI-VARIABLE: these costs are partly fixed and partly variable, for example telephone costs which have a fixed line rental but a variable call charge cost.
Contribution
 The calculation of contribution is an important part of marginal costing as it identifies the amount of money made per unit towards covering fixed costs
and profit.
 Once the fixed costs are covered, profit is made.
CONTRIBUTION – is calculated as the difference between selling price per unit and variable cost per unit.
STATEMENT TO SHOW THE TOTAL CONTRIBUTION AND PROFIT
£
Revenue (Sales) X
Variable Costs (X)
Total Contribution X
Fixed Costs (X)
Profit for the year X
Break-Even analysis
 One of the marginal costing techniques is break-even analysis, which identifies the level of output necessary to make neither a profit nor a loss.
 The number of units required to be sold at the break-even point is calculated where total revenue equals total costs.
Total fixed costs
Contribution per unit
At the break-even point, total revenue equals total cost. There are two methods of calculating this amount:
1. Break-even in units x selling price

2. Contribution to revenue (sales)
Total fixed costs

Contribution per unit/selling price per unit
Margin of Safety
 The margin of safety I the amount of units between the amounts of revenue (sales) made and the amount need to break-even where the amount of revenue
(sales) exceeds the break-even point.
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MARGIN OF SAFTEY – the difference between the number of sales units achieved (or maximum output) and the number of units at the break-even point,
where the amount of revenue (sales) achieved must exceed the breakeven point otherwise a loss is made.
MOS = Budgeted Sales − Break-even Sales.
Budgeted Sales – Break-Even Sales

TARGET PROFIT – The break-even formula Budgeted Sales can also be slightly amended to find the units
requires to be sold to achieve a specified target profit.
Target profit is the amount of net operating income/profit that management desires
to achieve at the end of a business period. Management needs to know the required level of
business activities to get target profit.
Total fixed costs + target profit
Contribution per unit.
CONTRIBUTION IS THE DIFFEENCE BETWEEN SALES AND VARIABLE

COSTS OF PRODUCTION.
Contribution = total sales – total variable costs of production.
Contribution = selling price per unit – variable costs per unit.
TOTAL CONTRIBUTION CAN ALSO BE CALCULATED:
Contribution per unit x number of units sold
Break-even chart
This information can all be represented on a break-even char. A diagram shoeing where budgeted production exceeds the breakeven point and so profit is
made.
To draw the break-even chart the steps are as follows:
1. Label the axes clearly.

2. Calculate the break-even point by using the formula: (total fixed costs/contribution per unit)
3. Calculate the break-even point in using the formula: break-even point in units x selling price per unit
4. Plot the break-even point on the chart. (Should be relatively in the middle of the chart).
5. Draw the fixed costs line cross the chart as a horizontal line.
6. Draw the sale revenue line starting from (0, 0) and going through the break-even point.
7. Draw the total cost line starting from the point where the fixed cost line crosses the y-axis and going through the break-even point.
8. Complete the chart by identifying the profit and loss areas.
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The Chart can be used to graphically use to illustrate:
The break-even point where the total cost cross total revenues.
The margin of safety being the difference between the break-even point and the maximum output production level; this is usually expressed in units.
Profit or loss at various levels being the difference between the total costs and the total revenues lines at different production lines.
Limitations of break-even analysis

There are many limitations of break-even analysis:
It assumes that there are no changes to inventory levels throughout the year. So everything being produced during that period is presumed to have been
sold. This is unrealistic as most businesses have changing levels of inventory throughout the year.
It does not allow product mix and is usually calculated for single product, which is unrealistic.
Cost behaviour is assumed to be either fixed or variable, so semi-variable costs are not considered. Again this is unrealistic as many costs have
behaviour that is no either perfectly fixed or perfectly variable but a combination of the two.
Fixed costs are assumed to remain fixed for the whole period of time, so stepped fixed costs are not considered. Stepped fixed costs are costs that
remain fixed until a certain level of business activity is reached when they increase in increments. They will remain fixed until the next level of business
activity.
Variable costs are assumed to be perfectly linear with the level of production, so changes in costs are not considered, for example overtime or bulk-
buying discounts.
The selling price is assumed to remain fixed throughout the year, so seasonal sales or discounts are again not considered.
Applying Marginal costing in decision making situations

Marginal costing can be used in a variety of business situations:
Whether to make or buy products.

Whether to accept special order.
How to maximize profits were there are limited resources available.
Make or Buy situations

Businesses are faced with decisions on whether the business should continue to manufacture the products themselves or whether to buy the products in
from a supplier.
Businesses are often faced with a choice of satisfying customer demand with inventory made bought in as it is unable to produce the goods required by
itself.
On a purely financial basis the decision whether to make or buy in should be based on whether to make or buy in should be based on whether a positive
contribution should be made.
How to reach make or buy decisions

The procedure is to identify the behaviour of each cost and revenue, it is also to identify whether a cost varies with the level of production or does not
vary with production and is therefore fixed.
Special Orders
Before accepting special orders it is necessary to consider both the financial and non-financial factors.
Financially it is important as to whether the order provides positive contribution or not.
Non-financial factors are important to, for example whether the order will lead to further orders and expand their share of the market, whether the spare
capacity will be utilized, whether staff will have to be retrained to make their product and will they wish to be retrained, will machinery have to be
adapted if the specification of the product has been changed, how reliable is the customer, and how much to the normal trading will take place.
Limiting Factors
A business will often manufacture multiple products but have limited resources available to do so, for example limited labour hours or limited machine hours.
An optimum production plan has to be devised in order to maximize profit with resources available.
The process is as follows:
1. Calculate the contribution per unit.

2. Calculate the contribution per limiting factor.
3. Rank the products in order of the product with the highest contribution per limiting factor down to the product with the lowest.
4. Devise a production plan to maximize profits using the rank order.
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Chapter 3 – Absorption Costing

Absorption costing absorbs the factory overheads into the total production cost for each cost unit produced in a factor. Whereas marginal costing only
considers the variable costs, absorption costing considers all production costs including fixed and variable overheads.
The process of absorption occurs when all production overheads are allocated and apportioned to a cost centre, which is a location such as a production
department. The total is then absorbed back into the cost unit, such as a product or service using overhead absorption rate.
The methods of absorption costing include:
Direct labour hour rate.

Direct machine hour rate.
The basis selected is based on which facto most influences the overhead, for example if the production department uses mostly labour hours it is described as
labour intensive and the direct labour hour rate is chosen. If the production department uses mostly machine hours it is described as machine intensive or
capital intensive and the direct machine hour rate is chosen.
Calculation of overhead absorption rate (OAR)

The stages used to calculate the overhead absorption rate are as follow.
1. Distinguish between production departments, for example a cutting department, and service departments, for example the canteen.
2. Decide between on the correct basis to be used to apportion the overheads between departments, for example according to percentage of the total
floor space for the cutting department and the proportion of employees working in the department for the canteen.
3. Draw up a schedule to apportion the overheads between all the departments.
4. Complete the schedule by apportioning the total o the overheads of each service department to each of the production departments.
5. Total up the overheads for each production department.
6. Divide the total for ach department by the correct basis, for example labour hours or machine hours depending on whether the department is labour
intensive or machine intensive to give the OAR for each production department.
To calculate the OAR is the rate at which the overheads are absorbed into the cost unit. It is calculated as:
Department overhead in pounds

Department direct machine hours or direct labour hours
Use of overhead absorption rate

Once the OAR has been calculated it is possible to calculate the full cost of the unit.
Chapter 4 – Activity based costing

Activity based costing?
This type of costing was developed as an alternative to absorption costing. The organizations activities are analysed into groups of costs, one group for each
major activity. These costs are called cost pools. Factors are then identified which cause the costs to change. These costs are called cost drivers. The cost of
the output is then calculated according to the outputs of level of the activity.
A cost rate per activity is calculated as:
Cost Pool
Cost Driver
Activity Cost pool Cost driver Cost rate
Examples of cost pools and cost drivers

Activity Cost Pools Cost Drivers Cost Rate
Cost of receiving goods into the Cost of receiving goods
Receiving goods into stores. Number of deliveries into stores.
stores. Number of deliveries
Cost of setting up production Cost of setting up
Setting up production equipment Number of set-ups required
equipment Number of set ups
Cost of administration
Student administration in a college Cost of administration Number of students
Number of students
Cost administration of issuing Number of requisitions from Cost of issuing goods
Issuing goods to production
goods to production department production department number of requisitions
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Comparisons between the different methods of costing

Marginal Costing Absorption Costing Activity Based Costing
For decision making, as t charges
each product with an accurate cost
For decision making, as it identifies For decision making, as it includes
based on its use of an activity. If an
the extra costs and revenues a portion of fixed costs into each
activity changes, the related effect
Uses incurred by the production and sale cost unit e.g. Calculating he selling
on the cost can be assed, so costs
of an additional unit e.g. Make or price using the pricing strategy ‘full
can be controlled. For example how
buy decisions, limiting factors. cos plus’.
much will costs increase by if there
is an extra batch run?
Easily understood and applied in Avoids apportioning overheads
decision making, being cost All costs are considered, so a total using a basis that may not be
effective. Contribution is identified, production cost per unit is relevant, e.g. machine hours for
Benefits which is useful, e.g. I make or buy identified. The effect of an increase administration costs. Batch sizes
decisions and where there are in any one cost can be assessed, influence costs, e.g. set-up costs are
limiting factors such as limited whether it is direct or indirect. more expensive of small production
labour hours. runs.
The final basis used to calculate the
overhead absorption rate may not be
Indirect and direct costs are both relevant or all the overheads in the
There are still cost pools that are not
divided into either fixed or variable production department. New
caused by one specific cost driver
costs. Fixed costs are not allocated technology has led to a reduction in
but several, e.g. the cost of
Limitations to cost centres and cost units, but the use of labour hours as a valid
marketing is caused by the number
are regarded as time-based and are basis. If inventory levels decrease,
of staff hours and number of
linked to accounting periods rather absorption costing records a lower
marketing campaigns.
than unis of output. profit than the absorption costing
records as a costs from previous
periods are set against income.
Chapter 4 – Standard costing and variance analysis

What is standard costing?
Standard costing is the preparation and use of costs which should be achieved with efficient working conditions and manufacturing performance. These costs
ought to be achieved and are called standard costs. Standard costing involves the comparison of these predetermined standard cost with actual costs. Any
difference between the standard and the actual cost is called a variance, which should be investigated.
How to calculate standard costs

Direct materials (number of metres x £ per metre) + Direct labour (number of labour hours x £ per hour) = standard cost per unit.
The purposes of standard costing

Frequently used within a manufacturing business as it provides detailed information to management which helps to establish why performance budgeted
differs from actual performance.
 Assists in budget setting and evaluating performance.

 Acting as a control device by highlighting those activities which are not performing as expected and may need manufacturing and corrective action.
 Providing information on future costs for future decision making.
 Providing a motivating target for employees to aim for.
 Providing an acceptable cost for valuing inventory.
Setting standards
 Standards are usually based on past performance. This is the most cost effective method, but there may be past inefficiencies which would then be built into
the future standards.
 Standards can also set using engineering studies where workers are observed time and motion studies. However, again these can be misleading as well as
costly to establish as they take time to complete and workers may not give a realistic impression of their normal working performance as they may feel that
they will be judged on it. Woking to quickly will set too high standards which cannot be achieved and working too slowly may result in dismissal.
Advantages and disadvantages of standard costing

Advantages
 Predetermined standards make the preparation of forecasts and budgets much easier as the information has already been collected.
 Cost and revenues are controlled through the uses of variances that is the comparisons of standard costs with actual results, which will highlight the
efficiencies and inefficiencies within the business. Remedial actions can then be taken.
 The recording of inventory issues is simplified as they are all at the standard costing bookkeeping system.
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 Employees can be motivated to achieve targets which should result in better performance in better performance especially if rewards are given when targets
are achieved or passed.
Disadvantages
 Standards have little use if either set to high or too low, and so must be regular reviewed and reset.
 Collecting the information may be time consuming and time consuming.
 In a rapidly changing technological economy the information may be quickly become out of date.
 Standards are best used for business which have well established and repetitive process so the resetting of standards is kept to a minimum.
Variance Analysis
What is variance analysis?
Variance analysis is the process of comparing the actual costs and revenues with standard costs and revenues and investigating any reasons for the difference
between them. Corrective action can then be taken by each budget manage. Variances are categorised into favourable or adverse variances.
Favourable variances has positive effective on profit, that is the actual costs are lower than the standard, or actual revenue is higher than the standard.
An adverse variance has a negative effect on profit that is the actual costs are higher than the standard, or actual revenue is lower than the standard.
A manager will usually will look into the possible causes of an adverse variance as this decrease profit. A favourable variance will increase profit, but if there
is a large favourable variance it may still need to be investigated as it could be result in poor budget setting. Remember that if budgets are easily achieved they
lose validity as targets.
Variances and sub variances

 Material total cost variance: the difference between the standard expected cost and the actual cost of the material. The sub variances are the price sub-variance
and usage sub-variance.
 Labour total cost variance: the difference between the standard expected cost and the actual cost of labour. The sub variances are the rate sub-variance and
efficiency sub variance.
 Sales total revenue variance: the difference between the standard revenue expected and the actual revenue received from revenue. The sub variances are the
price sub-variance and the volume sub-variance.
How to calculate variances using variances using formulae

Material price variance – Actual Quantity of Material (Actual Price Paid per Metre – Standard Price Paid per Metre) also AQ (AP – SP).
Material usage variance – Standard Price Paid (Actual Quantity of Material Used – Standard Quantity of Material Used) also SP (AQ – SQ).
Labour Rate Variance – Actual Hours (Actual Rate – Standard Rate) also AH (AR – SR).
Labour Efficiency Variance – Standard Rate (Actual Hours – Standard Hours) also SR (AH – SH).
Interrelationship between cost variances

Often the cost variances may be interlinked by a common cause. The reason for one sub-variance can lead to the occurrence of another sub variance. This is
called interrelationship. In the case study there are two possible interrelationship between the two variances:
The material is of better quality so the labour force wastes less and therefore appears to be more efficient.
The labour is more skilled so the material is not wasted therefore there is better material usage.
Possible reasons for the cost variances

If we assume that the standard cost are based on reasonable and achievable budgets and are not either ideal standards or basic standards which are out of date,
then there are many other reasons which could explain how variances arise.
Variance Direction Explanation Cause

 Higher price charged by the
supplier.
More paid for the material per  Unexpected delivery costs.
ADVERSE
metre/kilogram.  Better-quality material.
Material Price  No bulk discounts.
 Scarcity of materials.
 Lower price charged by suppliers.
Less paid for the material per
FAVOURABLE  Lower quality materials.
metre/kilogram.
 Unexpected trade/cash discounts.
 Lower quality material.
 Theft, obsolescence,
ADVERSE More materials used for production.
deterioration.
Material Usage  Less-skilled workforce.
 Higher, more efficient workforce.
Fewer materials used for
FAVOURABLE  Efficient production processes.
production.
 Higher – quality material.
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 Unexpected overtime.
 Productivity bonuses.
More paid per hour to the
ADVERSE  Trade union action.
workforce.
Labour Rate  Rise in minimum wage rates.
 Better skilled workforce.
 Lower-grade workforce.
FAVOURABLE Less paid per hour to the workforce.
 No overtime or bonuses.
 Lower-skilled workforce.
 Lower quality of materials.
 Unfavourable working
conditions.
 Lack of training.
Labour Efficiency ADVERSE More hours used for production.  Lack of supervision.
 Works to rule/strikes (if paid).
 Machine breakdowns.
 Lack of materials/orders.
Too many unproductive hours, e.g.
coffee breaks.
 More-Skilled workforce.
 Better-quality material.
 Fewer non-productive hours.
FAVORABLE Less hours used for production.
 More training/supervision.
 Advances in machinery
technology.
Cost reconciliation
Variances are often used by management to analyses the change in total costs for period. Budgeted cost are reconciled to actual costs. Budgeted costs are
reconciled to actual costs.
£ADV £FAV £
Budgeted Costs X
Material Price Variance X
Material usage variance X
Total Variance X
Labour rate variance X
Labour efficiency variance X
Total variance X
Actual cost X
How to calculate sales variances using formulae.

Sales price variance: actual sales x (actual selling price – standard selling price) can also be shown as AS (ASP – SSP).
Sales volume variance: Standard selling price x (actual sales units – standard sales units) can also be shown as SSP(AS – SS)
Possible reasons for revenue variance

Variance Direction Explanation Cause
 Responding to change in
fashion.
 Responding to increased
Actual selling price is lower than
ADVERSE competition.
expected.
 Responding to lack of demand.
 Reduced quality of product.
 Pricing strategy.
Revenue (sales) price
 Action as market leader.
 Lack of competition.
 Increased quality increases
Actual selling price is higher than
FAVOURABLE demand.
expected.
 Price – creaming pricing
strategy used.
 Start of product life cycle.
Revenue (sales) volume  Changes in tends and fashion.
 Loss of market share.
Actual revenue level is lower than  End of product life cycle, so
ADVESER
expected. market is saturated.
 Lack of demand due to lower
quality.
FAVOURABLE Actual revenue level is higher than  Changes in tends and fashion.
expected.  Higher quality increases
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demand.
 Lack of supply by competitors.
Profit Reconciliation
All of these variances can be used to produce a profit reconciliation which reconciles budgeted profit with actual profit.
Budgeted Sales – (Budgeted direct costs + budgeted fixed costs) = Budgeted Profit
Actual Sales – (Actual direct costs + actual fixed costs) = Actual Profit
£
Budgeted Profit X
Sales Price Variance X
Sales Volume Variances X
Cost Variances X
Actual Profit X
Chapter 5 – Capital Investment Appraisal

Capital investment appraisal is the process of calculating future cash flows of a capital project, for example the purchase of a new machine or capital
investment in the development of a new product, in order to make a decision on whether the capita project should be undertaken.]Two types of capital
investment appraisal are considered within the specification:
 Payback.
 Net Present value.
Payback
Payback is the time taken for the cash inflow generated by a capital inflow generated by a capital project to equal the cash outflow. More simply it is the
length of time that is required for the net cash inflows to cover the cost of investment. The shorter the payback period the better. This especially important if
the business has cash-flow problems or will have to borrow money for the capital project as the inflows can first be used to reduce the loan and then cab first
be used to reduce the loan an then can be used for other potentially income earing processes.
How to calculate payback time

Cost of investment – cumulative net cash
Year with cumulative net cash inflow nearest cost of investment = inflow nearest year X 365 days/52 weeks/12 months
Net cash inflow of next year
Cumulative net cash

Net Cash Inflows
inflows
£ £
Year 1 35000 35000
Year 2 A 35000 70000 B
Year 3 40000 C 110000
Year 4 50000 160000
(80000 – 70000)
2 Years + X 12 months
40000
= 2 Years and 3 months.
Net Present Value

How to calculate cost of capital
Cost of capital per annum
Value of capital
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The net present value is the sum of the net cash inflows (future cash inflows less future cash outflows after each has been discounted back to the present) less
the initial cost of the investment.
If the net present values answer is present then the investment could to be undertaken on purely financial grounds. If here is a choice of capital
projects then the one with the highest positive net present value should be considered on financial grounds.
A negative net present value should be rejected on financial grounds as it means that the sum of future net cash inflows does not cover the initial
cost of the investment.
Advantages and disadvantages of using net present value as a method of capital investment appraisal
Advantages
The method considers the time value of money by using the discount factors.
It includes all the net cash inflows from the whole life of the capital project.
Disadvantages
It is more complex to calculate then he payback method.
It is based around selecting the relevant cost of capital which may be difficult to determine with any reliability. The higher the cost of capital, the
lower the net present value.
T should not be considered on its own, for the project may still not be worth investing in due to the social non-financial factors and a slow payback
which could outweigh the benefit of the positive net present value
Chapter 6 – Budgeting
What is budgetary control?
A budget is a short tem financial plan of standard costs and revenues prepared for the future to control resources so the business objectives can be achieved.
All functional budgets are used to prepare the master budget, which is a budgeted profit and loss account and forecast balance sheet. Budgeting is the
preparation of budgets for each budget centre, and budgetary control is when each budget centre manager has a responsibility:
Justifiably use resources,

Control costs.
Achieve the activities set by budget in accordance with the business objectives.
Benefits of budgeting
Control: A budget is a formal authorization to a budget centre manager of a specified amount to be allocated to specify activities, thereby resources
such as cash and labour hours controlled.
Planning: by using a budget, the use of resources, for example cash, materials and labour hours, is planned in order to achieve the objectives of the
business.
Communication and coordination: Budgets communicate plans to managers responsible for carrying them out. They also ensure coordination
between manages responsible of sub units so that each is aware of the others requirements, for example between the stores, production and sales
department.
Motivation: Budgets are often intended to motivate managers to perform in line organisational objectives. This especially applies if the managers
had been included in the drawing u of the budgets, which will then be realistic and achievable, and if there are rewards for achievement of budget
targets.
Preformation evaluation and monitoring: the performance of managers is often evaluated by reference to budgetary standards. Any variance
between the budget and actual results will then be assed and corrective action can then be taken.
Aid to decision-making: If each manager bases their budget decision-making around their budget then all department decisions will relate to the
corporate plan and business objectives.
Disadvantages of budgeting
A budget must b produced within limiting factors that surround the business, for example the amount of market demand for its product; number of
skilled employees available; availability
Of material supplies; the space available either as working area or for storage; amount of cash or credit facilities to finance the business.
A budget which is unrealistic or unachievable is of limited use and may do more harm than good, especially considering the negative effect it will
have on the workforce who will feel that they are underperforming and the productivity may decline further.
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Likewise a budget must not be set to low as this may be demotivational. This can happen when there is no goal congruence, or agreement, between
the objectives of the manager and the objectives of the business. A manager may deal that the budget is to be used to evaluate and judge his
performance and so may endeavour to set the budget to an easily achievable target, which at the same tie may not motivate his team.
Budgets can restrict activity so that managers are not innovative and fail to take advantage of unexpected opportunities as their actions are too
strictly controlled.
Through careful control of their budgets throughout the year managers may have a surplus available at the end of the year managers may have a
surplus available at the end of the year, but rather than save this surplus they will spend it so their budget will not be reduced next year. So budget
may indivertibly encourage the waste or inefficient use of resources.
Revenue (sales) budget

The revenue budget records the amount of nits expected to be sold as well as the expected revenue value per period.
PERIOD 1 PERIOD 2 PERIOD 3 PERIOD 4

REVENUE (SALES)
UNITS
REVENUE (SALS)
VALUE (UNITS X
PRICE)
This is a forecast predicting watt the revenue will be in the future, perhaps based on previous periods’ revenue or market research.
Production Budget
The production budget is the budget as all production costs will be based on the quantities stated within the budget.
PERIOD 1 PERIOD 2 PERIOD 3

UNITS UNITS UNITS
REVENUE (SALES) X X X
OPENING INVENTORY (X) (X) (X)
CLOSING INVENTORY
X X X
(RESTRICTED)
PRODUCTION X X X
Purchases Budget
The purchase budget provides information on the cost of materials.

PRODUCTION UNITS
MATERIAL COST (COST PER
UNIT/MATERIAL X UNITS(
Labour Budget
The labour budget identifies the amount of labour hours required to produce the levels of production stated in the production budget. The labour budget also
helps managements plan work patterns, for example shifts, as well as calculating the expected labour costs.

UNITS PRODUCED X UNITS X UNITS X UNITS
MACHINERY
DEPARMENT:
X HOURS (NUMBER OF X HOURS (NUMBER OF X HOURS (NUMBER OF
MACHINERY HOURS x MACHINERY HOURS x MACHINERY HOURS x
MACHINERY HOURS
NUMBER OF UNITS NUMBER OF UNITS NUMBER OF UNITS
PRODUCED) PRODUCED) PRODUCES)
X HOURS (FIGURE X HOURS (FIGURE X HOURS (FIGURE
NUMBER OF X HOUR FROM MACHINERY FROM MACHINERY FROM MACHINERY
SHIFTS HOURS ÷ HOURS IN A HOURS ÷ HOURS IN A HOURS ÷ HOURS IN A
TOTAL SHIFT) TOTAL SHIFT) TOTAL SHIFT)
£X (FIGURE FROM £X (FIGURE FROM £X (FIGURE FROM
LABOUR COST NUMBER OF X SHIFTS x NUMBER OF X SHIFTS x NUMBER OF X SHIFTS x
(MACHINERY A TOTAL PRICE OF A TOTAL PRICE OF A TOTAL PRICE OF A
DEPARTMENT) DAYS SHIFT FOR DAYS SHIFT FOR DAYS SHIFT FOR
MACHINERY) MACHINERY) MACHINERY)
ASSEMBLY
DEPARTMENT:
X HOURS (NUMBER OF X HOURS (NUMBER OF X HOURS (NUMBER OF
ASSEMBLY HOURS x ASSEMBLY HOURS x ASSEMBLY HOURS x
ASSEMBLY HOURS
NUMBER OF UNITS NUMBER OF UNITS NUMBER OF UNITS
PRODUCED) PRODUCED) PRODUCED)
NUMBER OF X HOURS B X HOURS (FIGURE X HOURS (FIGURE X HOURS (FIGURE
SHIFTS FROM ASSEMBLY FROM ASSEMBLY FROM ASSEMBLY
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HOURS ÷ HOURS IN A HOURS ÷ HOURS IN A HOURS ÷ HOURS IN A

TOTAL SHIFT) TOTAL SHIFT) TOTAL SHIFT)
£X (FIGURE FROM £X (FIGURE FROM £X (FIGURE FROM
LABOUR COSTS NUMBER OF X SHIFTS x NUMBER OF X SHIFTS x NUMBER OF X SHIFTS x
(ASSEMBLY A+B TOTAL PRICE OF A TOTAL PRICE OF A TOTAL PRICE OF A
DEPARTENT) DAYS SHIFT FOR DAYS SHIFT FOR DAYS SHIFT FOR
ASSEMBLY) ASSEMBLY) ASSEMBLY)
TOTAL LABOUR COST £X £X £X
TRADE RECEIVABLES BUDGET

A summary of expected movement in money owed by the customers of the business.
PERIOD X
BALANCE B/F X
CREDIT REVENUE (SALES) X
RECIEPTS (CREDIT SALES FROM PREVIOUS PERIOD) (x)
RECIEPTS (CREDIT SALES FROM TWO PERIODS BEFORE) (x)
BAD DEBT (x)
BALANCE C/F x
Trade Payables Budget

Identifies the amount of money owed to suppliers at the end of each period.
PERIOD X
BALANCE B/F X
CREDIT PURCHASES X
RECIEPTS (CREDIT PURCHASES FROM PREVIOUS PERIOD) (x)
RECIEPTS (CREDIT PURCHASES FROM TWO PERIODS
(x)
BEFORE)
BALANCE C/F x
Master Budget
Information is taken from all the functional budgets and a set of forecast financial statements is produced.
£ £
These are calculated using the information from
the revenue (sales) budget. Each period’s
Revenue revenue (sales) units is added together and then
multiplied by the selling price.
X
This is calculated using the opening units from
period 1 in the production budget. This is
Opening Inventory
multiplied by the standard cost.
X
Is calculated using the information from the
production budget. Each periods production units
Cost of Production are added together then multiplied by the
standard cost.
X
Closing inventory is calculated using the closing
inventory of units from period 3 in the
Closing inventory production budget. This is then multiplied by the
standard cost per unit.
(x)
Cost of Sales (x)
Gross Profit X
Bad Debts X
Overheads x
X
Profit for the Year X
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Chapter 7 - Social Accounting

Social accounting is then used to describe social accountability, whereby businesses must consider the non-financial as well as the financial aspects of any
decisions they make. It is argued that business must not be driven by the motive of profit maximisation alone, but must consider the wider aspects of each
decision.
Consideration must be given as the internal decisions can also affect external stakeholders, such as the local community, the workforce, the environment and
society at large. Social accounting recognises that any business that fails to consider accountability to society of its decisions may find that some of those
decisions may find that some of those decisions are counter-productive and that profitability falls as society responds negatively to their actions.
Examples of possible social accounting scenarios

Scenario Stakeholders affected Possible considerations
Employees Ill health, refuse to work, strike action.
Drop in house prices, residents moving away,
Local Community
New machinery or plants which cause pollution decline in area.
Environmental pressure Groups. Bad publicity, picketing, boycotting product.
Owners (Shareholders) Bad publicity reducing share prices.
Loss of jobs, remaining employees demotivated
Employees
as fearful of losing their own jobs, low morale.
Concerns over costs of redundancies, security of
Banks/Lenders
loans.
Replacement of staff through redundancy by
Bad publicity in short term but hope of future
robotics Owners
profits.
Local unemployment, decline in area as workers
Local Community
move away in each of employment.
Trade Union May take action to prevent job losses.
Customers May refuse to buy and look at competitors.
Workforce May refuse to work because of health concerns.
Suppliers May have reputation harmed by association.
Introduction to cheaper and more harmful
Owners (shareholders) Bad publicity may reduce share price.
product to product change
Trade unions May take action on behalf of employees.
Pressure groups Bad publicity, picketing, boycotting product.
Competitors May under-price to increase market share.
Essay Questions
Explain, with reference to relevant accounting principles, how inventories (stock) should be valued on the balance sheet.
Inventory (stock) should be valued at the lower of cost and net realisable value (IAS2).
If the transfer price is used to value inventory (stock) then current assets will be overvalued for profit which has not yet been realised and cost of sales will be
lower and so profit will overvalued too unrealised profit should be deducted from the inventory value in the balance sheet.
This is an application of the prudence concept (IAS1) and ensures that assets and profit are not overstated so that a true and fair view can be given of the value
of the business both within the balance sheet (current assets) and the income statement (profit and loss account) with the level of profit.
Inventory (stock) must be valued in a consistent manner year on year to ensure that comparisons can be made.
Realisation concept can also be applied.
Explain two limitations of using absorption costing as a method of calculating the selling price.
Two possible limitations of using of absorption costing used to calculate the selling price are:
• the basis used to calculate the OAR may not be relevant for all the overheads in the production department leading to an inaccurate selling price
• with improvements in new technology there may be a reduction in the use of labour hours as a relevant basis leading to under absorption of the overheads
within the selling price
• in general calculating OAR based on units does not distinguish between the different consumption of overheads in different departments leading to over or
under absorption for a particular product
• apportionment of service departments overheads to production departments may be too arbitrary, leading to inaccurate selling price
• all figures are estimated therefore may lead to an over or under absorption within the selling price.
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Explain:
(i) two possible reasons for the labour efficiency variance
(ii) the effect of the labour efficiency variance on the budgeted profit for the first year.
(i) The variance arose because the staff were more highly motivated due to improved management and better working conditions.
Productivity improvements due to training and development of the workforce.
This may be because of better machinery so the workforce could be more efficient.
(ii) The labour efficiency variance will increase profit.
Explain two limitations of using absorption costing.

 calculations based on budgeted figures which can be inaccurate.
 the choice of basis that is used to calculate the OAR can be arbitrary may not be relevant for all the overheads.
 new technology has led to a reduction in the use of labour hours as a valid basis for absorption costing, yet is still used.
 if inventory levels change this can effect profit figures as under or over absorption can occur.
 not effective as a decision making tool for example in make or buy decision, or does not identify contribution which can be used to calculate the break-
even point.
Explain two reasons why the labour budget would benefit the Finance Manager.
 co-ordinate between production department and human resources department on the amount of staff needed
 control of labour hours and production, to control costs and stock levels needed for production
 plan the maximum level of production with the labour hours and employees required
 control the amount of cash paid for labour
 monitoring the labour budget against actual labour costs and take relevant action.
Advise the Finance Manager on the usefulness of the labour sub-variances as a means of identifying how to improve
profitability
 the variances show whether the difference between budgeted costs and actual costs increase or decrease the budgeted profit.
 the variances will alert the Finance Manager to identify which areas need investigation.
 however the usefulness of the variances depends on whether the budget was set accurately and the targets were achievable and also whether there have
been events outside the Finance Manager’s control which created the variance, for example an increase in minimum wage.
Discuss the possible implications for the business of continuing to use this second-hand machine.
 possible legal action taken against the business which could be costly
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 possible action by pressure groups which can negatively affect sales
 workforce may be reluctant to work for the business despite extra pay and protective gear
 ill health within workforce may reduce production
 bad reputation leading to a reduction in sales
 fumes may not cause damage extra costs will reduce profitability unnecessarily
 the short-term saving in buying a second hand machine may lead to long term extra costs and reduced profit
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ACCN4 - Management Accounting Chapter 1 Summary

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ACCN4 - Further Aspects of Management Accounting

ACCN4 - Further Aspects of Management Accounting

A simple manufacturing account is split into two sections.

What is work in progress?

Preparing manufacturers income statement

1. Inventory of raw materials.

What are the benefits of using a transfer price?

What are the drawbacks of using a transfer price?

Recording manufacturing profit

The provision for unrealized profit

Inventory at cost pus profit percentage

Chapter 2 - Marginal Costing

The marginal costing method is used when:

Calculating the breakeven part for a product.

STATEMENT TO SHOW THE TOTAL CONTRIBUTION AND PROFIT

Total fixed costs

Contribution per unit

1. Break-even in units x selling price

Total fixed costs

Budgeted Sales – Break-Even Sales

CONTRIBUTION IS THE DIFFEENCE BETWEEN SALES AND VARIABLE

TOTAL CONTRIBUTION CAN ALSO BE CALCULATED:

Contribution per unit x number of units sold

To draw the break-even chart the steps are as follows:

1. Label the axes clearly.

The Chart can be used to graphically use to illustrate:

Limitations of break-even analysis

Applying Marginal costing in decision making situations

Whether to make or buy products.

Make or Buy situations

How to reach make or buy decisions

The process is as follows:

1. Calculate the contribution per unit.

Chapter 3 – Absorption Costing

The methods of absorption costing include:

Direct labour hour rate.

Calculation of overhead absorption rate (OAR)

Department overhead in pounds

Use of overhead absorption rate

Chapter 4 – Activity based costing

A cost rate per activity is calculated as:

Activity Cost pool Cost driver Cost rate

Examples of cost pools and cost drivers

Comparisons between the different methods of costing

Chapter 4 – Standard costing and variance analysis

How to calculate standard costs

The purposes of standard costing

 Assists in budget setting and evaluating performance.

Advantages and disadvantages of standard costing

Variances and sub variances

How to calculate variances using variances using formulae

Interrelationship between cost variances

Possible reasons for the cost variances

Variance Direction Explanation Cause

How to calculate sales variances using formulae.

Possible reasons for revenue variance

Chapter 5 – Capital Investment Appraisal

How to calculate payback time

Cumulative net cash

= 2 Years and 3 months.

Net Present Value

Justifiably use resources,

Revenue (sales) budget