chapter 1: introduction

Management accounting and financial accounting

Management accounting and financial accounting often use the same data
Crucial difference is the purpose of use:
Financial accounting:
Provide insight to investors and other stakeholders
Management accounting:
Provide insight to managers

Understand the purposes of accounting systems.
depends on the organization
official records
bookkeeping
general ledger
information systems
sap, oracle
spreadsheet
production and customer data?
customer relationship management systems
(Management accounting data is mainly about:
!he value of assets
!he costs of products and processes
!he results of activities
Production, sales etc"
for e#ample:
product pricing and marketing
strategy and long$range planning
resource allocation decisions
efficiency of operations
performance measurement and management
evaluation of managers and employees


Know the terms planning, control and budgets.
Planning: Choosing goals" Predicting results under various %ays of achieving those goals and then
deciding ho% to attain the desired goals"
Control: Covers both the action that implements the planning decision and the performance evaluation of
the personnel and operations
Budgets: the &uantative e#pression of a plan of action and an aid to the coordination and implementation
of a plan"

upply chain
!he flo% of goods, services and information from cradle to grave, irrespective of %hether those activities
occur in the same organization or other organizations"

!alue chain
!he se&uence of business functions in %hich utility is added to the products or services of an
organization"






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chapter ": cost terms and purposes
Cost ob#ects
' cost object is anything for %hich you %ant to kno% the cost
For e#ample:
' product
' service
'n activity
' department

Cost dri$ers
'ny factor that affects total costs" ' change in the cost driver %ill cause a change in the total costs

%irect $ersus indirect costs
Direct costs are directly linked to a cost ob(ect
Costs can be traced to cost ob(ects
Indirect costs cannot reasonably be linked directly to a cost ob(ect
)e need a rule to link them to cost ob(ects: this is the essence of cost allocation

&i'ed $ersus $ariable costs
Variable costs are costs that change in relation to a change in a cost driver
Cost drivers often reflect the level of activity in an organization
Fixed costs do not change in relation to the level of activity

er$ice, merchandising and manufacturing companies.
(ie)enhuis, boe)enwin)el, computer fabrie).

chapter *: #ob costing
Cost pool
'll costs that need to be traced or allocated to cost ob(ects

+ cost allocation base are.
' factor that determines ho% indirect costs are allocated to cost ob(ects

,ob and process costing.
!%o basic techni&ues for allocating costs to cost ob(ects
*se of techni&ues depends on type of production process
+ome production processes result in clearly distinct units of output
,ther production processes result in a mass product in %hich thousands of e&ual units are
produced
-ob costing: one uni&ue cost ob(ect
audit by accounting firm
aircraft
building . construction
Process costing: mass product
computer chips
oil
peanut butter

-eneral approach to #ob costing.
/" )hat is the cost ob(ect?
0" )hat are the direct costs of the (ob?
materials
labor hours


1" )hat indirect costs are associated %ith the (ob?
support activities
common (shared resources
2" +elect a cost allocation base for the indirect costs
labor hours
units
"""
3" Calculate the allocation rate
4ndirect costs allocated to cost ob(ect per unit of the allocation base
5" 'ssign the costs to the (ob
!race direct costs and allocate indirect costs using the allocation base and rate
.'ample
6ent of 077 m
0
office building in 0778: 9/07,777
Floor space department ': 83 m
0

Floor space department :: /03 m
0

'llocation base is m
0
of floor space
)hat is the allocation rate?
/07,777 . 077
;
9577 per m
0

'llocated to ': 9577 # 83 ; 923,777
'llocated to :: 9577 # /03 ; 983,777

/ormal and actual costing.
Calculating a cost allocation rate re&uires the period activity level
number of design hours
total production volume
<ou only kno% the e#act level at the end of the period
:ut can you %ait months for costing information?
'ssume a =normal> activity level
e#pected
standard
?ormal costing
*se the normal activity level (volume to calculate allocation rate
Multiply this rate by the units of the allocation base used for the (ob
!ake actual costs for direct costs
'ctual costing
use actual activity levels to calculate allocation rate

Proration
Method 1: 0n proportion to allocated costs














allocated costs proration
10P 2 34,444 5 1"6 2 1",444
&- 2 34,444 5 1"6 2 1",444
C7- 2 *84,444 5 936 2 93,444
:7:+; 2 <44,444 1446 2 144,444
Method ": 0n proportion to closing balance












Method *: direct write=off










chapter >: process costing
Production data February
%ork started in this period: 577
%ork finished: 277
ra% materials /77@ completion
completion rate for conversion: 57@
A&uivalent units of %$i$p
direct materials: 077
conversion cost: 57@ B 077 ; /07
+uppose:
!otal cost to account for: 9 11,027
materials costs: 9 //,277
conversion costs: 9 0/,C27
Duestion is: ho% much belongs to sold product and ho% much to )4P?
A&uivalent unit costs
Materials cost: //,277 . 577 ; 9 /E per e&" unit
Conversion costs: 0/,C27 . (277F/07 307 ; 9 20 per e&" unit
Cost of completed output
277 B (/EF20 ; 9 02,277
Cost of %$i$p
materials: 077 B /E ; 9 1,C77
conversion: /07 B 20 ; 9 3,727
total costs: 1,C77 F 3,727 ; 9 C,C27
so be sure to calculate materials and conversion cost of %$i$p separately
!otal cost accounted for
02,277 F C,C27 ; 9 11,027

closing
balance before
proration
proration
10P 2 "44,444 5 146 2 14,444
&- 2 *44,444 5 1<6 2 1<,444
C7- 2 1,<44,444 5 9<6 2 9<,444
:7:+; 2 ",444,444 1446 2 144,444
proration
10P 4
&- 4
C7- 2 144,444
:7:+; 2 144,444
Process costing in < steps
/" summarize flo% of goods
opening %$i$p, units started, closing %$i$p
0" calculate output in e&uivalent units
1" compute e&uivalent unit costs
2" calculate total costs to account for
3" assign total costs to units completed and units in closing %$i$p
make sure that they add up to the total costs to account for

!%o %ays to deal %ith this
%eighted average method: take all costs from opening %$i$p and %ork started during
period, and divide over e&uivalent units
first$in$first$out (F4F, method: treat current and previous production separately

1eighted a$erage
,pening stock March: 9 C,C27
materials: 9 1,C77 (077 units, fully completed
conversion: 9 3,727 (077 units, 57@ completed
Production data March
%ork started: 377
%ork completed: 337
materials costs: 9 C,377
conversion costs: 9 /8,E77
%$i$p completion: /77@ for direct materials, 17@ for conversion

tep 1: physical flow of goods
opening %$i$p: 077
started: 377
completed: 337
ending %$i$p: /37
tep ": e?ui$alent unit output
direct materials: 337 F /77@ B /37 ; 877
conversion: 337 F 17@ B /37 ; 3E3
tep *: .?. unit costs
direct materials (877 e& units
%$i$p costs: 9 1,C77
current period costs: 9 C,377
cost per e&uiv unit: (1,C77 F C,377 . 877 ; 9 /8"38
conversion costs (3E3 e& units
%$i$p costs: 9 3,727
current period costs: 9 /8,E77
cost per e&uiv unit: (3,727 F /8,E77 . 3E3 ; 9 1C"33
tep >: :otal cost to account for
C,C27 F C,377 F /8,E77 ; 9 13,027
tep <: +ssign costs to completed output and w=i=p
cost of completed output
337 B (/8"38 F 1C"33 ; 9 17,C5E
cost of %$i$p
materials: /37 B /8"38 ; 9 0,515
conversion: 23 B 1C"33 ; 9 /,813
total costs: 9 2,18/
accounted for: 17,C5E F 2,18/ ; 9 13,027



&0&7 Method
,pening stock March: 9 C,C27
materials: 9 1,C77 (077 units, fully completed
conversion: 9 3,727 (077 units, 57@ completed
Production data March
%ork started: 377
%ork completed: 337
materials costs: 9 C,377
conversion costs: 9 /8,E77
%$i$p completion: /77@ for direct materials, 17@ for conversion

tep 1: physical flow of goods
!reat %$i$p and ne% production separately
opening %$i$p: 077 (57@ conversion
started and completed: 137
closing %$i$p: /37 (17@ conversion
tep ": .?ui$alent units
materials: 137 F /37 ; 377
conversion: (/77@ G 57@ B 077 F 137 F 17@ B /37 ; 283 units
tep *: .?. unit costs
direct materials
current period costs: 9 C,377
cost per e&uivalent unit: C,377 . 377 ; 9 /8"77
conversion
current period costs: 9 /8,E77
cost per e&uivalent unit: /8,E77 . 283 ; 9 18"5C
teps > @ <
!otal cost to account for: 9 13,027
cost of completed output: 9 17,EE2
%$i$p: 9 C,C27
materials: 137 B /8"77 ; 9 3,E37
conversion: (C7 F 137 B 18"5C ; 9 /5,072
cost of %$i$p: 9 2,025
materials: /37 B /8"77 ; 9 0,337
conversion: 23 B 18"5C ; 9 /,5E5
accounted for: 17,EE2 F 2,025 ; 9 13,027

)hy is there a difference?
Here:
Fifo method has only =cheap> units in stock
)' still has some of the more e#pensive inputs in stock


chapter <: cost allocation
:he four purposes of cost allocation
!o facilitate economic decision making
!o give incentives to managers and employees
!o (ustify costs to outside parties
For financial accounting reasons






ingle rate method
' fashion chain has t%o shops
*trecht: 07 employees, 277 m
0
floor space, direct costs 9 0 mln
6otterdam: /3 empl, 577 m
0
, direct costs 9 0"3 mln
!hese divisions are supported by:
purchasing: department costs 9 /"3 mln
general mgt: department costs 9 / mln

For direct costs as the allocation base:
Iirect cost ;
9 0 mln F 9 0"3 mln ; 9 2"3 mln
!hus, for each / 9 of direct cost, there %ill be
9 0"3. 9 2"3 ; 9 7"35 indirect cost
4ndirect costs *trecht is 0 mln B 7"35 ; 9 /"// mln
4ndirect costs 6>dam is 0"3 mln B 7"35 ; 9 /"1E mln
9 0"3 mln

%ual rate method
Iual$rate: classify costs in subpools"
Aach subpool has a different allocation rate or a different allocation base"
For instance:
For purchasing, the allocation base is direct cost
For general, the allocation base is employees

Purchasing: cost pool ;/"3 mln
'llocation base; direct cost ; 2"3 mln
Jeneral: cost pool ; 0"3 mln
*trecht: (0 . 2"3B /"3 mln ; 9 7"58 mln
6>dam: (0"3 . 2"3B /"3 mln ; 9 7"C1 mln
9 /"37 mln
Jeneral: cost pool ; / mln
'llocation base ; 13 employees
*trecht: (07 . 13B / mln ; 9 7"38 mln
6>dam: (/3 . 13B / mln ; 9 7"21 mln
9 /"77 mln


:hree support department allocation methods
/" Iirect allocation
allocate the costs of service departments to operating departments only
no accounting for inter$service department activities
0" +tep$do%n allocation
allocate the costs of the service departments in a specific order
1" 6eciprocal allocation
account for inter$service department activities in both directions

%irect allocation
!%o production departments:
/" +mall and medium sized firms (K+mallL
0" Multinationals (KMultiL
!%o service departments
/" Jeneral management
Costs: 90777
0" 4!
Costs: 95777
JM 4! +mall Multi Total
Dept.Costs 9 2000 9 6000
JM /7@ 07@ 27@ 17@
4! 03@ /3@ 13@ 03@
JM 2.8 1.8
4! 8./0 3./0
JM 9//21 9C38 90777
4! 91377 90377 95777
Total 9 4643 93357 98000

tep down allocation

-M &irst
-M 0: mall Multi :otal to mall @ Multi
%ept.Costs 2"444 23444
-M 146 "46 >46 *46
0: "<6 1<6 *<6 "<6
-M "AB >AB *AB
0: 9A1" <A1"
-M 2>>> 288B 2339 21<<3
0: 2*9<B 2"38< 23>>>
:otal 2>3>* 2**<9 28444







0: &irst
-M 0: mall Multi :otal
to
mall
@
Multi
%ept.Costs 2"444 23444
-M 146 "46 >46 *46
0: "<6 1<6 *<6 "<6
-M >A9 *A9
0: <A19 9A19 <A19
-M 2"1<1 2131> 2*93<
0: 2193< 2">94 2193< 2>"*<
:otal 2>3"1 2**9B 28444


Ceciprocal allocation
-M 0: mall Multi
%ept.Costs 2"444 23444
-M 146 "46 >46 *46
0: "<6 1<6 *<6 "<6

JM ; 0777 F 7"/JM F 7"034!
4! ; 5777 F 7"0JM F 7"/3 4!
+mall ; 7"2 JM F 7"13 4!
Multi ; 7"1 JM F 7"03 4!
JM ; 0777 F 7"/JM F 7"034!
4! ; 5777 F 7"0JM F 7"/34!

+olve through substitution:
7,EJM ; 0777 F7"034! etc"
JM ; 2283
4! ; C//0
+mall ; 7"2 JM F 7"13 4! ; 250E
Multi ; 7"1 JM F 7"03 4! ; 118/



-M 0: mall Multi :otal
Iept"
Costs
92000 96000
JM 922C 9CE3 9/8E7 9/121 91/11
4! 9070C 9/0/8 90C1E 9070C 92C58
Total 9250E 9118/ 9C777



Common costs allocation methods
' cost of operating a facility, operation, activity or other cost ob(ect that is shared by t%o or more users"
.'ample:
Paul ,>+hes lives in Jal%ay" 4nvited for intervie% in Mosco%, ticket;9/077,$ 'nother invite for intervie%
in Prague, ticket Mosco%$Prague;9C77,$" He decides to combine the tickets to get Jal%ay$Mosco%$
Prague; 9/377

tand=alone cost=allocation method
Cost allocation divided fairly across the employers
Mosco% employer: 9/077.(9/077F9C77 B 9/377; 7"5B9/377;9E77
Prague employer: 9C77.(9C77F9/077 B 9/377; 7"2B9/377;9577

0ncremental cost=allocation method
Cost divided trough employers by taking total amount and allocate original costs to primary party
(Mosco% and the rest to the secondary party (prague
Mosco%(primary original costs 9/077
Prague(secondary rest amount 9177

chapter 3: #oint costs
-oint costs are the costs of a production process that yields multiple products simultaneously
Main issue is ho% the allocate the (oint costs over the different end products
Common in for e#ample chemical and food industries
-oint costs are incurred for producing t%o or more products (outputs
so %e have multiple cost ob(ects
Common costs are also incurred for multiple cost ob(ects
Main difference
common costs are a choice: you can use separate processes
(oint costs are a necessity (given the production process

.'ample
Production of one batch of /0 mln kg of peanuts
-oint costs of 9 /7 mln
+atay sause
yield: E mln kg
price: 9 /"58 per kg
specific costs: 9 2 mln
Peanut butter
yield: / mln kg
price: 9 /7 per kg
specific costs: 9 3mln

Physical measures
allocation base is kg, liter, unit
Measure ; kg of product: E F / ; /7 mln kg
-oint cost ; 9 /7 mln
+auce: E./7 B /7 mln ; 9 E mln
:utter: /./7 B /7 mln ; 9 / mln

ales $alue
allocation base is euro sales
Measure ; sales value of products:
+auce: E mln kg # 9 /"58 per kg ; 9 /3 mln
:utter: / mln kg # 9 /7 per kg ; 9 /7 mln
/3 F /7 ; 9 03 mln
-oint cost ; 9 /7 mln
+auce: /3.03 B /7 mln ; 9 5 mln
:utter: /7.03 B /7 mln ; 9 2 mln

/et realiDable $alue
allocation base is euro sales minus direct (separable costs
Measure ; ?6M of product: sales G separable costs
+auce: /3 mln G 2 mln ; 9 // mln
:utter: /7 mln G 3 mln ; 9 3 mln
!otal ?6M ; 9 /5 mln
-oint costs ; 9 /7 mln
+alt: //./5 B /7 mln ; 9 5"E mln
Chlorine: 3./5 B /7 mln ; 9 1"/ mln

Constant gross margin
Margin on individual products is margin on overall process
Measure ; same gross margin for all products
Jross margin ; +ales $ costs
!otal sales value: /3 F/7 ; 9 03 mln
!otal costs: /7 F 2 F 3 ; 9 /E mln
Jross margin ; 9 5 mln
Jross margin @ ; 5.03 ; 02@
Margin should be 02@ for both products

+auce
o Margin should be 7"02 # 9 /3 mln ; 9 1"5 mln
o !hus allocation should be /3 G 2 G 1"5 ; 9 8"2 mln
:utter
o Margin should be 7"02 # 9 /7 mln ; 9 0"2 mln
o !hus allocation should be /7 G 3 G 0"2 ; 9 0"5 mln


chapter 9: absorption costing and $ariable costing
Assential difference: to %hat e#tent do %e incorporate fi#ed costs in value of stock?
,ne possibility: take fi#ed costs as a period cost
all fi#ed costs are e#pensed in the current period
ariable costin! "also: direct costin!#
,ther possibility: include fi#ed costs in inventory
fi#ed costs are part of the unit cost
they are absorbed in the unit cost: absorption costin!

Formula for ad(ustment
(& G b B (f.b
(actual activity level G budgeted activity level B (fi#ed costs . budgeted activity level
4n %ords: the difference bet%een the actual and the budgeted volume times the budgeted
fi#ed costs per unit
)hat if you produce less than budgeted?
too fe% units that carry the fi#ed costs: %e need to take an e#tra charge for the remaining
fi#ed costs

+mall factory producing carrier bikes
Fi#ed costs per month: 9 177
+elling price per unit: 9 /7
Mariable costs per unit: 9 5
?ormal (budgeted production: /37









6ate for allocating fi#ed costs to units:
9177 . /37 ; 90 per unit
*nit costs:
9 5 F 90 ; 9C per unit
February
Production: /37
+ales: /07
And stock: 17
February:
Cogs ; 9C # /07 ; 9E57
Fi#ed costs accounted for: /37 # 90 ; 9177
6eal fi#ed costs: 9177
'd(ustment needed: 97


-an Feb Mar 'pr
sales /37 /07 /57 /57
production /37 /37 /17 /57
March:
:egin stock: 17 units
Production: /17 units
+ales: /57 units
And stock: 7
Cogs ; 9C # /57 ; 9/0C7
Fi#ed costs accounted for: /17 # 90 ; 9057
6eal fi#ed costs: 9177
'd(ustment needed: $927

'pril:
:egin stock: 7 units
Production: /57 units
+ales: /57 units
And stock: 7
Cogs ; 9C # /57 ; 9/0C7
Fi#ed costs accounted for: /57 # 90 ; 9107
6eal fi#ed costs: 9177
'd(ustment needed: 907

Assential difference is treatment of fi#ed costs:
MC: Fi#ed costs are not allocated but taken as period costs
?o ad(ustment neededN
'C: Fi#ed costs are allocated to products and some end up in stock
'd(ustments needed if actual production differs from planned production
4f production;sales
no difference in period result
4f productionOsales
result ac O result vc
part of the fi#ed costs are not e#pensed this period, but taken into inventory (so out of
the cost of goods sold
4f productionPsales
result ac P result vc
(e#tra fi#ed costs are taken out of inventory and into the cost of goods sold

'dvantages variable costing
:etter for short term decisions: if %e make an e#tra batch, the e#tra profit e&uals
contribution margin B number of units
no possibility for pumping up profits
'dvantages absorption costing
:etter for long term decisions: full cost price includes all costs:

chapter 8: brea)=e$en analysis
Cost$volume$profit (CMP analysis
' simple techni&ue to make business decisions regarding the production and sales of products
Calculating ho% profit depends on sales volume
:asic tenet: by selling products %ith a positive contribution margin (per unit you first earn back
your fi#ed costs and then start making profit
)here is this Kbreak$even pointL?
!erminology
:reak even point: sales level at %hich profit is zero
revenue driver: factor that affects revenues (products sold, services delivered, number of
hotel nights
operating profit: result before ta#es
net profit: operating profit G ta#es
contribution margin (per unit
P G M
%hat you earn per unit to cover your fi#ed costs, and contribute to your profit
revenue
D # P
total costs
F F D # M
break$even sales: %hen is profit 7?
D # P ; F F D # M
D ; F . (P G M
Firm data
fi#ed costs: 577
variable cost per unit: 5
price: /7
:reak even point:
D ; F . (P G M
D ; 577 . (/7 G 5 ; /37

Ho% much must %e sell to achieve a certain target?
Profit ; D # (P G M G F
D ; (F F Profit . (P G M
Firm data
F ; 577, M ; 5, P ; /7
+uppose profit target is 077
D ; (F F Profit . (P G M
D ; (577 F 077 . (/7 G 5 ; C77 . 2 ; 077

%hat is the effect on the break even sales level of an increase in
Price
decreases
variable cost
increases
fi#ed cost
increases


chapter B: cost estimation
Cost estimation approaches
4ndustrial engineering method. %ork$measurement method
'nalyses the relationship bet%een input and output in terms of physical units
Conference method
e#pert kno%ledge . opinions about cost(s(drivers
'ccount analysis method
breaking up accounts in fi#ed and variable costs
Duantitative analysis
re&uires a number of observations
6egression analysis

/" Choose the dependent variable
0" 4dentify the independent variable or cost driver
1" Collect data on the dependent variable and the cost driver
2" Plot the data
3" Astimate the cost function
5" Avaluate the estimated cost function

/ature of the cause and effect criterion.
/" 4t may be due to a physical relationship bet%een costs and the cost driver"
0" Can arise from a contractual arrangement
1" Can be implicitly established by logic and kno%ledge of operations" 'n e#ample is %hen the
number of component parts is used as a cost driver"

chapter 14: rele$ant costs
Five step approach to (economic decision making in organizations
/" gathering information
0" making predictions
1" choosing an alternative
2" implementing decision
3" evaluating performance

)hat to remember about opportunity costs
Chosen course of action does not only involve monetary costs, but also means that other things
cannot be done
,pportunity costs take into account the benefits foregone by not choosing the best
available alternativeQ
,pportunities do not al%ays make themselves kno%n
not easy to estimate the e#act opportunity costs

+unk costs
past investments
materials
machines
soft%are
anything
you cannot change the past
you can>t make money in the past
sunk costs are never relevant
is it a shame to thro% something good a%ay? not if you can make more money by doing
so

Many people find this counterintuitive
!hey are strongly committed to their initial choice and find it hard to look at economic decisions
from a rational economic perspective
A#ample: the ne% 'msterdam sub%ay line
,riginal estimate of costs: 9/"2 bln
+uppose that right no% 9/ bln has been spent
?e% estimate is that total costs %ill be 9 1 bin
+hould %e continue?
?ote that the 9/ bln that has already been spent are sunk costs
!hey should not affect your decisionN
'lternatives are:
?o sub%ay, %hich re&uires 97
' sub%ay %hich re&uires 9/"5 bln

Jood and bad cost accounting systems
' good cost accounting system provides insight in the relevant costs
'llo%s managers to see %hat drives costs and to make smart decisions
'll costs vary %ith something (in the long term
Many accounting systems used in practice are of mediocre &uality
+ome researchers have even &uestioned the relevance of cost accounting

'n import firm sells tropical food items to both restaurants and consumers
!otal indirect costs a year are 9/77,777
6estaurants
+ales: 9177"777 a year, personnel: 8 F!A, normal number of orders per year:
07,777, +&uare meters used: 007
Consumers (through store
+ales: 9037"777 a year, personnel: /7 F!A, number of orders: 17,777, s&uare
meters used: /77
)hich allocation base should %e use to allocate the 9/77,777 to the %holesale and the consumer
division?
4t depends on type of indirect costs
4s the cost level more closely associated %ith the sales level, the number of orders, the
number of employees, or s&uare meters used?
Iifferent types of indirect costs may re&uire different allocation bases
4n general an allocation base is better, if it better reflects the actual use of an indirect cost by a
cost ob(ect
!he closer it gets to Kcost tracingL
4f you look at real %orld organizations, a very large proportion (ust allocates all indirect
costs based on some measure of volume or in proportion to direct costs

chapter 11: acti$ity based costing
!echni&ue developed in the /E87>s
'ckno%ledges that costs arise from the fact that organizations do something: they perform
activities
insert parts
set up the production line for a ne% batch
process an invoice
perform maintenance on it$hard%are
take calls at a helpdesk

!he basic tenet of ':C is that %e should look for activities in organizations that cause costs
Cost drivers
+ince these activities are performed for specific departments of products relations bet%een cost
pools and cost ob(ects can be identified"
A#ample: order processing
you do this to take orders and perform administrative activities (booking, preparing
invoices
the more orders, the bigger your administration
cost pool: order administration department
cost driver: number of orders

':C recognizes that cost drivers e#ist at different levels"
,utput$unit level
:atch level
Product sustaining level
Facility sustaining level
Cost at higher levels are indirect from a lo%er level perspective

,utput level costs
costs that are made for each unit individually
ra% materials
depreciation



:atch level costs
costs that are made for a group of units
set$up costs
distribution
note that you can lo%er the costs per unit by increasing batch size
Product sustaining costs
also for services
design costs
marketing activities?
Facility sustaining costs
support the organization as a %hole
general management
building %ith multiple product lines

!he activity rate is the cost Kper unit of activityL
'ctivity rate ; activity cost pool . total units of activity
For e#ample: costs of maintenance department may depend on hours %orked on maintaining
machines
!otal costs are 9277,777
!otal hours %orked are /0,777
'ctivity rate ; 11"11 per hour
4f some departments have machines that re&uire more maintenance, they get allocated more costs

+teps to take in ':C
/" %hat are the cost ob(ects?
0" %hat are the direct costs of the cost ob(ects?
1" %hat activities are performed?
2" %hat cost pools are associated %ith activities?
3" calculate the activity rates
5" allocate the activity costs to the cost ob(ects
8" add direct costs

chapter 1": pricing and profitability
0nfluences on pricing.
$ Customers
$ Competitors
$ Costs

hort=run pricing is based on rele$ant costs, full costs are important in long=run pricing.

:arget costing
!he estimated long$run cost per unite of a product that, %hen sold at the target price, enables the
company to achieve the target operating profit per unit"

;oc)ed=in costs
!he costs that have not yet been incurred but that %ill be incurred in the future on the basis of decisions
that have already been made"

;ife=cycle costing.
!racks and accumulates the actual costs attributable to each product from start to finish"

Customer profitability analysis, and notice the similarity to activity based costing"



chapter 1>: moti$ation, budgets and responsibility accounting
force planning
%hat is that you %ant to achieve?
coordination and communication
%hat is re&uired for this in terms of activities and resources?
evaluation of performance
so ho% %ell did you do?
motivation
by setting goals and tying re%ards to evaluation
allocation of decision rights
budget holder can make choices %ithin his . her budget
he . she is responsible for the budget result
this is the concept of responsibility accounting

master budget: overall plan for the organization
it consists of various components that are linked
revenue budget
production budget
marketing budget
etc
note that the starting point is revenue budget
this gives the e#pected activity level
budgets are the plans for the coming period
cost budget
costs you make for your activities
=allo%ed costs>
target is met if costs are belo% allo%ed costs
revenue budget
sales that you must make
target is met if sales are higher than planned sales

static budget: no correction for activity level
fle#ible budget: allo%ed costs are corrected for actual activity level
in evaluating budgetary performance, %e correct for the actual activity level
since variable part of the budget %ill change if the volume (; activity level changes
this can be done at various levels of detail

Colling budgets
:udget or plan that is al%ays available for a specified future period by adding a month, &uarter or year in
the future as the month, &uarter or year (ust ended is dropped

KaiDen
:udgetary approach that e#plicitly incorporates continuous improvement during the budget period into
the resultant budget numbers

+cti$ity=based budgeting.
'pproach to budgeting that focuses on the costs of activities necessary to produce and sell products and
services

:he four types of responsibility centers
/" cost centre G manager accountable for costs only
0" revenue centre G manager accountable for revenue only
1" profit centre G manager accountable for revenues and costs
2" investment centre G manager accountable for investments, revenues and costs
:he concept of controllability.
Controllability is the degree of influence that a specific manager has over costs, revenues or other items in
&uestion"

chapter 1<: fle'ible budgets and management control 0
Horngren uses the follo%ing terminology
level 7 variance: actual profit $ budgeted profit
level / variance: the static budget variance of the separate revenue and cost items
level 0 variance: the fle#ible budget variances, correcting for the actual activitity level
level 1 variance: price and efficiency variances that e#plain the fle#ible budget variances
the static budget variance is the difference bet%een the actual and static budget amounts
you cannot simply do budgeted amount G actual amount to get the correct =sign>: it depends on
%hether it is a revenue item or a cost itemN
al%ays ask yourself: does the variance amount increase or decrease profit?

actuals static
budget
variances
units sold 237 377
revenues C3,377 /77,777 /2,377 u
variable costs 27,377 27,777 377 u
fi#ed costs 0E,777 17,777 /,777 f
operating
profit
/5,777 17,777 /2,777 u

%e have to correct the budget for differences in activity amounts
here: sales volume
calculate the fle#ible budget, e"g"
budgeted variable cost per unit: 27,777 . 377 ; C7
fle#ible budgeted variable costs: 237 B C7 ; 15,777
so the allo%ed variable costs at this activity level are 15,777

actuals fle#ible budget variances
units sold 237 237
revenues C3,377 E7,777 2,377 u
variable costs 27,377 15,777 2,377 u
fi#ed costs 0E,777 17,777 /,777 f
operating profit /5,777 02,777 C,777 u

the difference bet%een fle#ible budget and static budget is the volume variance
because this arises from volume (activity differences
combining volume and fle#ible budget variances:
static budget variable costs: 27,777
fle#ible budget variable costs: 15,777
actual variable costs: 27,377
the static budget variable cost variance of 377 u consists of a volume variance of 2,777 f and a fle#ible
budget variance of 2,377 u



actual fle# b variance fle#ible budget volume variance static budget
units 237 237 377
rev C3,377 2,377 u E7,777 /7,777u /77,777
var 27,377 2,377 u 15,777 2,777 f 27,777
fi#ed 0E,777 /,777 f 17,777 7 17,777
profit /5,777 C,777 u 02,777 5,777 u 17,777
volume variances are mainly important for evaluating the sales and marketing activities
these can influence the total volume
so the volume variance of /7,777 u for revenue is important information: the sales target has not been
met
fle#ible budget revenue variance
result of difference in selling price
fle#ible budget cost variances
can result from prices, but also from usage of inputs
fle#ible budget cost variance: difference bet%een actual costs and allo$ed costs
%hat determines the allo%ed costs?
'llo%ed input for actual output B budgeted price
%hat causes the fle#ible budget variance?
differences in price: materials bought for a different price, %age rate per labor hour different
differences in usage (efficiency: more or less materials . labor hours per unit of output

e#ample: producing one table re&uires 1 labor hours at a price of 07 per hour
during a certain period, 07 tables %ere produced, re&uiring 3C hours for a total labor cost of /,085
%hat is the budget result? 85 *
%hat is the price effect (if any? //5 *
%hat is the efficiency effect (if any? 27 F

generating one unit re&uires & units of a resource at price p
allo%ed costs: &b B pb
fle#ible budgetN
actual costs: &a B pa
budget result ; budgeted costs G actual costs
price variance ; actual usage B (actual price G budgeted price
efficiency variance ; budgeted price B (budgeted usage G actual usage

for one table, %e need /7 kg %ood at a price of /0 per kg
budgeted production for -anuary: 183 tables
actual production: 180 tables, for %hich 2,7E0 kg of %ood %ere used, at a total cost of 28,73C
budgeted (allo%ed costs: 180 B /7 B /0 ; 22,527
so variance is 22,527 G 28,73C ; 0,2/C u
actuals
price per kg: 28,73C . 2,7E0 ; //"37
usage per unit (table: 2,7E0 . 180 ; //
variances
price: 2,7E0 B (/0 G //"37 ; 0,725 f
efficiency: /0 B (1,807 G 2,7E0 ; 2,252 u
this adds up to 0,2/C u


possible reasons for lo%er materials prices
good bargain
lo%er &uality materials
bulk buying (leading to higher stocks
possible reasons for higher material use
lo%er &uality materials
scheduling problems (rush orders
lo%er skilled labor
possible reasons for lo%er labor rates
lo%er skilled %orkers
possible reasons for higher labor use
lo%er skilled %orkers
lo%er &uality materials
al%ays note the interdependencies
cheap material may mean inferior &uality, leading to more re%ork, more labor time
cheap labor may mean un&ualified staff, resulting in more hours needed, or in too much material used

chapter 13: fle'ible budgets and management control 00
overhead costs
in general: indirect costs of production or services
supervision, supplies, storage, it support, administrative support, marketing
in manufacturing settings also the fi#ed costs of machinery and e&uipment
the level of overhead costs has no direct link %ith the activity level of the main product or service
but if for e#ample more consultants are hired, the administrative support %ill increase
variable overhead cost: energy
cost driver: manufacturing hours
one unit of output re&uires 0 manufacturing hours
budgeted production is 3,777 units
budgeted energy costs are /3,777
so variable overhead rate of /3,777 . /7,777 ; /"37
actuals
3,077 units produced in /7,E07 machine hours
energy: total costs /3,0CC
:M ; /7,777 MH
'M; /7,E07 MH
+M; /7,277 MH (3,077 B 0 MH
:udgeted ,H 6ate /"37 per MH
'ctual ,H : /3,0CC
Fle#ible budget R 'M: /7,E07 B /"37
+pending$variance : /,7E0 F
Fle#ible budget R 'M: /7,E07 B /"37
Fle#ible budget R +M: /7,277 B /"37
Afficiency variance: 8C7 *
this adds up to 1/0 f

spending variance
this e&uals the price variance
note that the overhead rate of /"37 energy costs per machine hour can change because of savings in
energy use, or price changes per unit of energy
efficiency variance
results from changes in machine hour use (not because of efficient energy use
variable overhead: there is no direct link bet%een machine hours and energy use
fi#ed costs are assumed fi#ed
so no activity level re&uired
never an efficiency variance, only spending
ho%ever, volume variances are important
in case of absorption costing, costs per unit include a part overhead costs
this is similar to the manufacturing volume variance discussed %ith absorption costing
,verabsorbed ,verhead:;the amount of overhead applied O actual overhead incurred
*nderabsorbed ,verhead:; the amount of overhead applied P actual overhead incurred
Iisaggregation into:
,verhead spending variance
,verhead efficiency variance
,verhead volume variance


chapter 19: yield, mi' and ?uantity effects
budget: sales 077 units at /7, market size 377
market share 27@
actual: sales 007 units, market size 577
market share 15"8@
market size variance
27@ B (577 G 377 B /7 ; 277 f
market share variance
577 B (15"8@ G 27@ B /7 ; 077 u

%here do variances come from
measurement error
no kno%ledge of operations
incorrect standards
price changes, change in activities
standard set too high . too lo%
out$of$control operations
bad performance
uncontrollable factors
economy, competitors?

%ith substitutable inputs, differences in input combinations result in variances
oranges or apples for (uice
standard chemicals from different suppliers
mi# variances
if the inputs are used in different proportions
yield variances
efficiency of using inputs















Assume that:
A Company produces a product T.
Standard cost of producing a 500 liter batch of T is 135
See below for the standard materials and related standard cost of each component used in a 500-
liter batch.
Standard Standard
Input Quantity Costs
in liters per liter Total cost
P 200 0.2 40
Q 100 0.425 42.5
R 250 0.15 37.5
S 50 0.3 15

600 135 0.225

Quantity Total Purchase Quantity
Purchased price used
P 25000 5365 26600
Q 13000 6240 12880
R 40000 5840 37800
S 7500 2220 7140

85500 19665 84420

A total of 140 batches of T were produced during the current period.

We want to know: price variances, efficiency variances, mix variances and total yield variances



Price Variances

Purchased Standard Variance
Protex 5365 5000 -365
Q 6240 5525 -715
R 5840 6000 160
S 2220 2250 30

19665 18775 -890

Actual number of batches 140

Efficiency variances
Used Standard Ps Variance
P 26600 28000 0.2 280
Q 12880 14000 0.425 476
R 37800 35000 0.15 -420
S 7140 7000 0.3 -42

84420 84000 294





Actual Q Budget Q Ps Yield
Standardmix Standaardmix
P 28140 28000 0.2 28
Q 14070 14000 0.425 29.75
R 35175 35000 0.15 26.25
S 7035 7000 0.3 10.5

84420 84000 94.5 U

Used Actual Mix Standardmix Ps Mix variance
P 26600 28140 1540 0.2 308
Q 12880 14070 1190 0.425 505.75
R 37800 35175 -2625 0.15 -393.75
S 7140 7035 -105 0.3 -31.5

84420 84420 388.5



chapter "4: cost management
/" Prevention costs $ costs incurred in precluding the production of products that do not conform
to specifications
0" 'ppraisal costs G costs incurred in detecting %hich of the individual units of products do not
conform to specifications
1" 4nternal failure costs G costs incurred %hen a non$conforming product is detected before it is
shipped to customers"
2" A#ternal failure costs G costs incurred %hen a non$conforming product is detected after it is
shipped to customers"

short term approach to operations problems
identify bottleneck in operations
%hich activities limit the total output?
ma#imize throughput
sales revenues G direct variable costs
all other operating costs are assumed fi#ed
short term focus
in the long term, the bottleneck should be removed by investments or
restructuring of processes
optimize the bottleneck activities
reschedule to non$bottleneck activities
improve &uality of input into bottleneck activities
adapt performance measures
adherence to schedule: %orkers at non$bottleneck operations shouldn>t produce more
than is re&uired according to bottleneck schedule
also in services
hospitals
courts
universities

.'ample
T%C Co&pan' produces < en S
2 departments '$I involved:
Product < 1 types of material: 6M/ , 6M0 and 6M2
Product S 0 types: 6M0 and 6M1"



6esources ?eeded per unit
<
?eeded per
unit S
Material / T /77
Material 0 T/77 T /77
Material 1 T /77
Material 2 T /3
Iepartment ' /3 minutes /7 minutes
Iepartment : /3 minutes 17 minutes
Iepartment C /3 minutes 3 minutes
Iepartment I /3 minutes 3 minutes

Aach department:0277 minutes per %eek available
!,C>s operating e#penses T 17"777 per %eek
Iemand: /77 units < per %eek en 37 S
+alesprice: T 237 per < en T 377 per S
Material and labor are sufficiently available











Iepartment Product < Product S !otal needed time per
%eek
' /3 min"# /77 units /7 min" # 37 0777 min"
: /3 min" # /77 17 min # 37 1777 min"
C /3 min" # /77 3 min" # 37 /837 min"
I /3 min" # /77 3 min" # 37 /837 min"
Conclusion: department : is bottle$neck: there is not enough capacity to produce
/77 < and 37 S
Product +alesprice$
Materialcosts
!hroughput per unit
< T 237$ T0/3 T013
S T377$T077 T177

Product !hroughput per unit .
Minutes needed for :
!hroughput per minute
< T013 : /3 T /3,58
S T 177:17 T /7
!,C has to produce /77 units <" !his process takes /77 # /3 ; /377 minutes in department :
6emaining E77 minutes for S; 17 units"
A#treme !hroughput
/77 < and 7 S /77 # 013
(01"377
/77 < and 17 S /77 # 013 F 17# 177
(10"377
57 < and 37 S 57 # 013 F 37 # 177
(0E"/77
7 < and 37 S 37 # 177
(/3"777
6evenues /77 < 23"777
17 S /3"777 57"777
Cogs /77 < 0/"377
17 S 5"777 08"377
!hroughput 10"377
,per" A#penses 17"777
?et income 0"377


*nderstand the techni&ues to identify &uality problems" !,C is related to capacity constraint analysis
(Chapter /7"