BA2 – Fundamentals of Management Accounting

Ch 1: Context of MA.................................................................................................................................1
Ch 2: Cost Identification and classification................................................................................................5
Ch 3: Analysis and predicting cost.............................................................................................................8
Ch 4: OH analysis (indirect cost)..............................................................................................................10
Ch 5: Marginal and Absorption costing...................................................................................................13
CH 6: Budgeting......................................................................................................................................18
Ch 7: Standard Costing and Variance......................................................................................................24
Ch 8 Integrated Accounting Systems.......................................................................................................30
Ch 9: Performance Measurement...........................................................................................................33
Ch 10: Prepping acc and reports for mngmnt..........................................................................................38
Ch 11: Risk 1 – Summarising and Analysing Data (Decision Making).......................................................39
Ch 12: Probability...................................................................................................................................41
Ch 13: ST DM..........................................................................................................................................43
EXAM INFO.............................................................................................................................................47

Ch 1: Context of MA
LO:
- Explain need for MAs
- Characteristics of finx info for operational, managerial and strategic levels within orgs
- Explain role of MA
- Relationship btwn MA and orgs mngrs
Role of CIMA in developing the practice on MAing
- DM levels and Information characteristics

1
Management Accounting: “Application and principles of accounting and finx management to create,
protect, preserve and increase value for SkH of for-profit and NFP enterprises in the public and private
sector.”

Measurement, Analysis and Reporting of finx and non finx to aid DM of Mngrs, SrH and others.

Achieved by providing relevant info to mngmt, who use the info in DM. T
DM is what creates and increases the value of an org.
Effective comn is important skill, influences DM process
Mngmt must trust info provided (accurate etc) as they will act on it.
Vast amounts of data streamlined into useful info which enhances DM.
Businesses need to be able to respond quickly to changes to keep up with competition.
Effective MA is improving decisions and building successful organisations.

Global MA principles; Influence, Relevance, Trust, Value. The principles encourage integrated thinking,
leading to better DM

Influence: Comn provides insight that is influential. MAing begins and ends with conv.
Relevance: Relevant info available when needed. Past, present and future inc finx and non finx from
internal and external sources including Soc Environ and Econ data.
Trust: Accountability and scrutiny make the DM process more objective, balancing ST commercial interests
against LT value for SkH enhances creditability and trust.
Value: Impact on value analyses, MA connects orgs strategy to business model. Helps org simulate
different scenarios to understand their impact on generating and preserving value.

Management Info: Good DM is key to a successful business, and the key to good DM is relevant
information. Data organised in meaningful ways = info.
Characteristics of good information: ACCURATE
A: Accurate. Degree of accuracy depends on the reason it is required. 1000’s vs 1.00
C: Complete. Eg control report on variances needs to include all stnd and actual costs, so variance calcs can
be understood.
C: Cost Beneficial. Cost of producing info should not exceed the value. The value of info equates to £ saved
or generated as a result.
U: Understandable. By non fin mngr, use of technical language and jargon limited.
R: Relevant (Concise) to its purpose, redundant info should be removed
A: Authoritative info should be trusted and provided from reliable sources, so users can have confident in
their DM
T: Timely. Provided in good time to mngment to allow DM based on that info. OOD info results in poor DM.
E: Easy to use, does the info meet the users needs.

Information for different levels of management

Orgs generally split into 3 levels; Strategic, Managerial/tactical and Operational/functional.

Strategic
Managerial
2
Operational
Eg Pizza Chain.
Strategic:
Need to know about developments in markets they operate and general economic situation. New tech.
Activities of competitors.
DM at this level – large impact on org, LT, generally unstructured. Tends to be more summarised (eg
average £ of pizza £2) and more subjective (no of potential customers per week). Require more external
sources.
Moving into a new market eg selling frozen pizza in a supermarket, fundamental change to what the
company does.
New restaurant (N.B. in some larger organisations this may be a decision made at tactical level)

Tactical:
NTK product or service quality, speed of customer complaint, customer satisfaction levels, employee skills
and employee morale.
DM – Medium impact, medium term, bridge/link between strategic and tactical, characteristics of both.
Pricing

Operational:
NTK no rejects per machine, time delivering mats, no of labour and machine hours available.
DM – Small impact on whole org, only affecting one business unit or dept, ST, highly structured. DM @ this
level generally more accurate and detailed, and based on info more readily available ie basic rate of pay.
Usually internal sources.
Hiring a new waiter (day to day running)

Information Strategic Level Operational Level

Source Hx and Forecast Historical
Timeliness Less crucial at this level as Info available immediately as
decisions taken over a period of decisions are taken daily
months or yrs
Accuracy of info Subjective estimates Objective and accurate
Breadth Variety of info in different forms Focused on the decision to be made
covering many aspects of the
organisations ops.
Detail Highly summarised Detailed

Non finx information given in non £ terms eg no of customers. Although h profit is the main objective of
commcials orgs, performance measures should not focus on solely on profit. Mngmnt need info on no of
cust, complaints, faults, orders.

Requirements of different users

CMGA help orgs establish viable stratergies and convert the into profit (Comm context) or value for money
(NFP context).

Commercial – main objective to maximise wealth of shareholders. Key finx info focuses of profit of each
area/product/service.
Manufacturing, Retail and Service organisations require different type of information relevant to their op.

3
NFP – eg state schools, hospitals and charities which are run in the public interest. Main objective - value
for money.
Provide public service inline with gov requirements. No profit measure but a focus on cost management,
effectivity and efficiency
Society – sharholders, employees and customes will have an interest in how businesses are performng,
impact on local and wider community. Eg environmental reporting.

Purpose/Fundamentals of mngmnt acc: Planning, Control and DM

Planning – establishing objectives and goals of organisation ie what they’re tering to achieve, formulating
relevant stratergies (LT planning) that can be used to achieve objectives and goals.

Assesing past so decicions can be made as to what is achievable in the future.

Strategic – LT planning
Tactical – S-to MT (middle management)
Operational – ST for day to day ops
Budgets = estimate of rev and expen of a specified future period of time

Control – budgets and targets set. Without targets, difficult to judge performance.
Common performance measures:
 Variance analysis btwn bud and act.
 Finx and Profitability measures
 Non-finx measures
Control and production of performance measures allows management to focus on areas that require
attention and helps them drive the business forward and ‘add value’.

DM – Reliable information required to compare different courses of action and consequence of each.
Finx Acc “classification and recording of monetary transactions of an entity in accordance with established
concepts, pronciples, accounting standards and legal requirements and their presentation by means of
statements of P&L, SFP and cash flow statements during and at the end of the accounting period.
Fin Acc Mng Acc
External Internal use
Statutory requirement At discretion of management
Concerned with production of statutory Provision of info to mngmnt to aid DM
accounts for an organisation
Governed by rules and reg, set format Not governed by rules and regs can be provided in any
format.

Mngment Acc Value Adding Business Partners not only forecast, also identify opportunity for enhancing
organisational performance

Position within orgs p 18

- Dedicated Busines Partners
- SSC
- Outsourced
Professional standards/fundamental principles from code of ethics.
- Integrity (straightforward honest and truthful)
- Objectively (without bias or conflict of interest)
- Professional Competence and Due Care (CPD commitment to prof knowledge and skill)
- Confidentiality (specific permission or legal and professional duty to disclose)
- Professional Behaviour (relevel laws and regs)
4
5
Ch 2: Cost Identification and classification

Cost or unit or costing

Finx acc – cost recorded so profit can be calculated. True and fair value of assests can be presented in the
Fin Statements.
Mang acc – understanding of costs required to carry out main functions of PLANNING, CONTROL and DM.
Understanding cost enables production of :
- Cost to manufacture a product or provide a service
- Selling price
- Products and service to offer or supply
- Cost to run department or function
Historical cost: usually original cost paid of asses at time of acquisition. Applies to purchase of an assets.
NCA and CA (eg inventory). Out of date and may not reflect current value.

Economic value: “value organisation derives from owning and using the asset.” Can be >or < than historical
cost. Affected by; how used, alternative use or current inflation rate.

Cost unit: unit of product or service for which cost can be ascertained. Anything measurable and used for
cost control purposes.
Industry Sector Cost Unit
Brick Making 1,000 bricks – tangible
Electricity MwH
Professional services Billable hr – intangible
Education Enrolled student
Activity Cost unit
Credit control Account maintained
Selling Customer call

6
Composite cost units: @ plus parts ie tonne-mile. Not useful for cost control seperatley , when combined,
valid and useful for cost control
Business Cost unit
Hotel Bed-night
Bus company Passenger-mile
Hospital Patient-day
Cost Centre: Type of responsibility centres. Production or service location, function, activity or item or
equipment for which cost are accumulated.
Type of CC Eg
Service location Stores, canteen
Function Sales representative
Activity QC
Item of equipment Packing machine
Cost object (either cost unit or cost centre): anything for whinch cost can be ascertained. Eg product,
sevice, centre, activity customer or distribution channel.

Cost classification: “arrangement of items in logical group by nature, purpose or responsibility” enables
efficient systems to collect/analyse cost.

Nature Direct (Marginal/PRIME), indirect (OH) Depending on cost object, same cost may be
indirect or direct
Behaviour Stepped, fixed, variable and semi
variable
Element Material (for manufacture), Labour and Raw mats (further diveide into type),
Expense components, consumables, maintenance mats
Function Production, non-production cost

Costing
£ £
Cost split by: Element Direct Mats 15
Nature Direct Lab 5
Function Direct Expense 2

Prime cost: 22
Indirect as cannot be attribuited Production OH
to unit or batch, and cost must ID Mat 4
be shared equally over all cost ID Lab 6
objects on a fair and equitable ID Exp 6
basis. 16
TOTAL PRODUCTION (factory) COST 38
Non production OH (selling, 2
distribution and admin)
Total (full) cost 40
Profit 10
Selling Price 50
Incremental/Marginal cost. If another unit was produced, direct costs incurred, and assumed additional
incremental non production OH. Production OH are fixed.

OH = FC +(VCPU x units)

7
Cost behaviour: Fixed, variable, semi-variable and stepped. N.B is graph showing Total VC or CPU. Non
linear VC – curvilinear VC. Become steeper (if bonuses are paid with output) or less steep (if bulk discount
is offered).

Relevant costs: In DM only relevant costs and revenue used on if DM goes ahead. These feature:
- Future costs and revenue (not possible to change past)
- Incremental (increase in costs and revenues which occur as a direct result of the decision taken is
relevant. Common costs can be ignored for purpose of DM. N>B Differential, specific, avoidable.
- Cash Flows (future cost and rev must be cashflows arising from direct consequence of DM. Relevant
costs do not include items which do not involve cashflows.
In Ax assume all VC are relevant unless specified otherwise
Non relevant costs
Sunk Past/historical not relevant to DM as already paid eg R&D, market research, original cost of
raw materials currently in inventory even if used on project.
Committed Future and cannot be avoided, whatever DM is
Non-cash Costs that do not involve the flow of cash eg dpn of existing equipment
flows
Notional Do not result in outflow of cash, not or in the future. I.e HO charges to branches for rent.
costs Often appear in accounts but not ‘real’ cash expenditure. Or notional interest charged to
depts for internally generated funds.
General Usually not relevant, possible stepped fixed if cost increases as a result of the DM
fixed OH
Net book Not relevant, similar to dpn, determined by accounting conventions rather than cashflows.
values

Opportunity cost “value of benefit sacrificed when one course of action is chosen in preference to another.
Opportunity cost is represented by the forgone potential benefit from the best rejected course of action.”
Important concept in DM. DM is concerned with alternatives ad the cost of taking one decision is the profit
forgone by not taking the next best alternative.
If resources are scarce, consideration must be given to profits which could’ve been earnt from alternative
uses of production, eg skilled labour required for new project, withdrawal from normal production would
result in a loss of profit.
Effect of the cash flow must look at the whole organisation, not one department in isolation.

8
Ch 3: Analysis and predicting cost

High Low Method + Easy to use and - High and low could distort values because of
explain random variations, leading to poor estimations
- - Assumes linear relationship between
variables
- - Assumes hx data an assumes future costs can
be predicted using this.
- Assumes activity level is the only thing
affecting cost.
Line of best fit +easily - Inaccuracies as ‘line of best fit’ is subjective
understood - -assumes historical data can predict future
+ Takes into costs
account all - - Assumes only activity level affects cost
observations
Regression analysis + line of best fit - Reliance on hx data and assumes that hx
calculated behaviour of data continues into the future
+ more accurate - Assumes perfect linear relationship between
estimation of variables
relationship - On measures relationship btwn two variables,
between two sets reality is there are many independent
of data variables affecting the dependant variable.
+ information to - Only
complete easily intrapolated
available. tend to be
+Excel can reliable. Not
calculate reliable for
extrapolation.
9
Line of best fit: Plot data points and if relationship is evident calculate correlation coefficient.
Extrapolate line out toward y axis and where line intersects y axis, this is the fixed cost, ie at 0 units. VC are
given by the gradient of the line.
VC (gradient) =
Eg for 0 units costing £200 and 150 units costing £500
(500-200)/(150-0)= £2 per unit

Regression analysis – calculate line of best fit

Straight line y= a + bx (y total cost, a fixed cost and b vc pu and x activity level)

Where a and b are:

VC b = nxy - xy (gradient of the line)
nx2 – (x) 2
n = no of pairs of data  = sum of

Fixed cost a = y – bx (line should be on top to indicate average of y and x). (point of intercept of the y axis)
Least squares regression. See e.g. on page 80
Y
X

Reliability depends onr the strength of the relationhip between the two variables (correlation). Variables
are corrolatied if change in on accompany changes in the other.

Correlation coefficient (Pearson) r always lies on the range -1 to +1 strenght of corroltion determined by
proximity to 1 or -1
r = +1 = perfect positive
r = - 1 = perfect negative
r = 0 = no linear correlation

r2 = coefficient of determination gives the proportion of changes in y that can be explained by changes in
x , assuming a linear relationship, as a %age. Eg if r = 0.7, r 2 = 0.72 = 0.49 = 49% therefore 49% of the
observed changes in y can be explained by the changes in x but 51% of the changes are due to other
factors.

Extrapolation outside the relevant range is unreliable and forecasting outside the relevant range should be
avoided.

10
Ch 4: OH analysis (indirect cost)

1. Definition: Expenditure on labour, materials or services which cannot economically identified with a
specific saleable cost unit.
2. Absorption Costing (sharing)
i. Allocate and apportionment to production and service cost centres
ii. Reapportionment from service to production
iii. Absorption (Overhead Recovery) of OH into cost units using predetermined (i.e.
budgeted) OAR
a. Physical units produced
b. Labour hrs worked
c. Machine hrs operated
OAR = Production CC OH/Quantity of absorption base
iv. Also a %age based on DL cost, DM cost or prime cost. (p115)
- OH Cost/Direct X Cost= %
- % x Cost unit (eg hrly rate for dept)
however, number of disadvantages.

Total CPU = PRIME + OH = DC + IDC

OH are indirect costs (material, labour, expenses). DC can be identified clearly with a cost unit, OH costs
cannot.

Types of OH
Classified according to function; Production, Selling and Distribution, Administration, Finance and those
that relate to the organisation as a whole, General OH.

Production Function sub divided into production cost centres (directly involved with production process eg
cutting dept or finishing dept) and service cost centres (eg maintenance or materials stores)

In OH analysis no direct costs are included but apportionment of wage related costs includes Direct wages
11
 Item Basis of Dept1 Dept2 Total
apportionment

Different basis OAR = different results, selected method must offer most realistic results (and with
consideration of practical applicability/the ease of collecting data required to use the selected rate)

Generally time based methods to be used as many OH increase with time (rent, rates ID labour). Therefore
logical to absorb based on time, as the longer it takes to produce, more OH would be incurred during the
time.

Rate PU + easy - Only suitable when all cost units

produced in the period ar identical.
DL hr rate + favoured as time based Lab intensive CC are rarer nowadays,
+most appropriate in labour intensive cost so less frequently used.
centres
Machine + Favoured as time based
hr rate + Appropriate where Machine activity
predominates.
+ most appropriate for absorbing OH relating
time AND to machine based activitiy eg
power, dpn, R&M.
Direct + may be acceptable as to some extent it is - Will not produce equitable OH
wage cost time based. charges if different rates are paid to
%age different employees, as there may not
be a direct relationship between wages
paid and the time taken to complete a
cost unit.
DM cost Only used if more suitable method is too Not logical, higher material cost not
%age costly and inconvenient to produce. necessarily incur greater production
OH cost.
Prime cost Not recommended as suffered
%age combined disadvantage of DL cost and
DM cost.

Reciprocal servicing
1. Repeated distribution method (reapportion)
Final apportionment is adjusted for rounding once it is a small value.
2. Equation method (p 126)
e.g.

000s Stores Maint %

%
Machining 400 40 55
Finishing 200 30 20
Assembly 100 20 20
Stores 100 - 5
Inspection 50 10 -

12
Stores = 100,000 + 5% Inspection
Inspection = 50,000 + 10% Stores

S = 100,000 + 0.05I I = 50,000 + 0.1S

S = 100,000 + (0.05 x I) I = 50,000 + (0.1 x 103,015)
S = 100,000 + (0.05 x 50,000) + (0.05 x 0.1S) I = 50,000 + 10,301
S = 100,000 + 2,500 + 0.005S I = 60,301
S = 102,500 + 0.005S
S – 0.005S = 102,500
0.995S = 102,500
S = 103,015
M = 400k + (0.3xS) + (0.2xI) F = 200k + (0.25xS) + (0.3xI) A = 100k + (0.35xS) + (0.45xI)

Predetermined OAR. Uses expected cost and activity levels. Actual monthly costs and production levels
can vary. If actual OAR was used, product cost would also fluctuate widely, which would pose difficulties
for planning and control. It is impractical to regularly change prices in line with production costs.

Another advantage is that the OAR is readialy available to managers which they can use with product
costing, quotations etc. Actuals would not be known until period end.

Under or Over absorption (under recovery or over recovery)

Actual OH more or less than budget
Quantity of absorption base (units, hrs) were more or less than budget.
Overhead absorbed = Budgeted OAR x actual (units or hrs)

N.B Standard Costing OH is not absorbed using actual hrs, but is absorbed using standard hrs for actual
levels of production. See standard costing and variance analysis, and under/over abs of stnd costing is
cover ding intergrated accounting systems chapter.

Under Abs Over Abs

OAR too low, prices have been set too low or Selling prices may have been unnecessarily high
decidions made based on inaccurate decisions. If which could lead to a oss in sales.
significant can adversely impact reported profit

OAR could be reviewed periodically, is it still appropriate or does it need to be adjusted to reflect more
recent estimates of activity and expenditure.

13
Ch 5: Marginal and Absorption costing.

Two different ways of valuing the cost if goods sold and the value of inventory, which affect the profit on
the SPL. The choice effects
1. Inventory valuation (and therefore cost of sales in a period)
2. Format of SPL

Cost need to classified as either product of period cost.

Product costs are charged to the individual product and matched against the sale revenue they generate.
Period costs are charged in full to SPL in the period in which they occur.
Main difference is the treatment of the fixed production costs
Absorption costing Marginal costing
Variable production cost Product cost Product cost
Fixed production cost Product cost Period cost
Variable non production cost Period cost Period cost

Fixed non production cost Period cost Period cost

Marginal Costing (incremental) (VC)

VC of a product or service which would be produced if the unit was not produced or provided. Only VC are
charged as COS and a contribution is calculated. CI of WIP and FG are valued at marginal (variable)
production cost. FC are treated at period costs.

Cost card
£ £ Unit
Unit
DM X DM X
DL X DL X
VOH X VOH (prod and non-prod) X
FOH X Marginal Cost X
Absorption Costing X

CONTRIBUTION = SALES £ – VC
14
Contribution remains consistent at varying levels of output and sales, whereas profit varies, because fixed
costs are shared over more/less units. Therefore profit per unit depends on the number of units sold so not
as helpful with DM.
Contribution can be used to calc profit.
TOTAL CONT = Cont PU x sales volume.
Profit = Total cont – Fixed costs.

Absorption costing builds a full product cost, inc DC and proportion of Prod OH costs. FOH are added to
the cost of each unit. i.e. treated as a product cost. However, different methods of absorption produce
different results. This obviously is not an issue with marginal costing as Prod OH are treated a period costs.

MC highlights contribution PU and treats FOH from total contribution. AC

Calculationg Profit

Abs Cos Marginal Costing

Selling £ Selling £
DM DM
DL DL
VOH VOH
FOH Cont PU
Profit per unit X Units
X Units Total Cont
Gross Profit Less F OH
Less under/over abs OH (OH – (OARxPrdn) Total Profit
Total Profit

1. Total CPU
Total profit PU x prdn
Gross Profit
2. Less UA/OA
Net Profit

Where more/less is made than sold in a period, inventory levels will change and profit under MC and
Abs C will differ.

MC values inv at total VPC of a unit. Abs C values inv at full production cost. This causes:
1. Inv vals to differ at beginning and end of a period.
2. Different inv vals causes different profit reported in SPL.

Abs Costing SPL

 Valuation of OI and CI at full production cost.
 Under/over abs OH adjustment necessary in SPL.

£ £
Sales X
Less COS:
OI X
V Cost of Production X
F OH Abs X
15
 Less CI (X)
(X)
X
Under/Over Abs. OH (X)/X
Gross Profit X
Less Non Production Costs (fixed and v selling distr admin etc) (X)
P/L X

MC SPL
 Valuation of OI and CI at marginal (VC) cost.
 FC actually incurred deducted from contribution earnt to determine P/L for period.

£ £
Sales X
Less COS:
OI X
V Cost of Production X
Less CI (X)
(X)
X
Less other VC (X)
Contribution X
Less Fixed Costs (X)
P/L X

Abs MC
Increase inv level Higher profit as FOH held in CI LOWER
carried over to next period,
I A>M instead of wo
Decrease inv level LOWER Hi profit as FOH BF in OI is
released
D M>A

Constant Inv level Equal P/L Equal P/L

If at P end OI < CI, then MC profit < AC profit

Reconciling profits reported under the different methods 

When inventory levels increase or decrease during a period then profits differ under absorption
and marginal costing.

 If inventory levels increase, absorption costing gives the higher profit. 

This is because fixed overheads held in closing inventory are carried forward (thereby reducing cost of
sales) to the next accounting period instead of being written off in the current accounting period (as a
period cost, as in marginal costing).
16
  If inventory levels decrease, marginal costing gives the higher profit. 

This is because fixed overhead brought forward in opening inventory is released, thereby increasing cost of
sales and reducing profits.

 If inventory levels are constant, both methods give the same profit.  

Advantages of marginal costing Advantages of (full) absorption costing

 Contribution per unit is constant unlike  Absorption costing includes an element of
profit per unit which varies with changes in fixed overheads in inventory values (in
sales volumes  accordance with SSAP 9). 
 There is no under or over absorption of  Analysing under/over absorption of
overheads, and no adjustment in SPL.  overheads is a useful exercise in controlling
 Fixed costs are a period cost and are costs of an organisation 
charged in full to the period under  In small organisations, absorbing overheads
consideration  into the costs of products is the best way of
 Marginal costing is useful in the decision- estimating job costs and profits on jobs 
making process 
 It is simple to operate 

 The main disadvantages of marginal  The main disadvantages of absorption

costing are that closing inventory is not
valued in accordance with accounting
standards and that fixed production
overheads are not 'shared' out between
units of production, but written off in full
instead. 
costing are that it is more complex to
operate than marginal costing and it does
not provide any useful information
for decision making (like marginal
costing does).

Use of costing information in pricing decisions  OAR can be used to trace indirect cost to
Marginal cost (VC) pricing, considers price of one cost units.
additional unit.  Full cost of prod used to determine selling
Useful when deciding the selling price on a special price
order.
Additional VC incurred, but FC may not change if it
still falls between relevant range.
No OH absorbed into product cost so easier to calc
but difficult to determine the £ to add to the
marginal cost to cover the cost of production and
admin OH are covered and that the org makes a
profit.

Useful with one off editions but not routine

product pricing decisions, which need to faction in
all costs.

Difference between abs costing and MC profit can be analysed as the FOH “held” in the closing inventory.

To reconcile or calc the alternative p/l: A-O-C-M

Marginal Abs cost profit: 18750
Plus change in inv (CI – OI) x OAR Plus change in inv (OI – CI) x OAR: (2500)

17
 Abs cost profit Marginal cost profit: 16250

ACTIVITY BASED COSTING ABC – not tested in this module, add AAT notes.
Cost Pools, Cost drivers (eg no of set ups), cost driver rate

Calculating selling price: Mark-up and Margin

Mark-up
%age of cost (aka cost plus)
Selling £ = Total cost + 20%
Margin
% rtn on sales/investment
Rtn on sales/sales revenue =
Profit = total cost x (required margin/ 1- required margin)
e.g. 15% rtn = P = TC x (15/(100-15))
P = TC x (15/(85)

Sales price = TC / 1 - required margin

Rtn on investment = invest x %age rtn = xy

Target rtn pu = xy/production units = rtn pu

Required annual rtn = invst x %age = yz

Rtn as % of total cost = yz/TC = RTC%
Required cost-plus selling price = Unit cost + RTC%

Practices on p177 NEED TO TRY THESE AGAIN

18
Ch 6: Budgeting
LO:
1. Why orgs prep forecast and plans
2. Prep functional budgets
3. Explain budget statements
4. Identify impact of budgeted cash surplus and shortfall on business ops
5. Prep flex budget
6. Calculate variances

Main purpose of management accounts is PLANNING, CONTROL and DECISION MAKING.

PLANNING: looking ahead and trying to forecast what is likely to happen or what the company would
like to happen.

CONTROL: reviewing performance against plan.

Purpose:

Planning – forces management to look ahead, set targets anticipate issues before they arise and give
purpose and direction. Long term strategies term into shorter term action.

Control – the budget provide the plan against which actuals can be compared. Out of line results can be
investigated and rectified. This comparison and corrective action is “FEEDBACK CONTROL”

Coordination – Sound budget system helps coordinate the different activities of the business, harmony.
Budgeting forces managers to appreciate how their activities relate to other managers.

Communication – budget communicate targets to managers.

Motivation – Influence and motivate managers to perform in line with organisational objectives

Performance Evaluation – by success in achieving the budget

Authorisation – Budgets act as authority to spend. Eg headcount is contained in the budget,

19
Budget “a quantative expression of a plan for a defined period of time.”

Budgets can be set for sales volume, revenue, resource quantities , cost, expense, asset liability and cash
flow e.g. Budgeted x for y department for the year to z is £.

Budget period – the time it is prepared and used. Usually a year ut depends on the nature of the org and
the type of item being considered. Each budget period can be sub divided into control periods, depending
on the level of control which management wants to exercise, usually a month.

Level of budgeting (3 different types of planning) which are interrelated, but differing time spans (which
differs depending on the org/activity
1. Strategic (corporate/LT) – attaining org objectives
2. Budgetary (ST/MT) carried out within the framework of the plan, could be viewed as an
intrim step to meet long term strategic plan.
3. Operational = ST/day-to-day. Planning and utilising resources and carried out withing the
framework set by the budgetary plan

Process differs with org but key requirements are:

Budget committee across dept/functions – ensures coordination, meet regularly to review progress and
resolve problems that arise . Bring together the whole organisation and ensure a coordinated approach to
budget prep.
Budget Manual could include:
Budget process; introductory explanation of the budget planning and control processed and including
Statement of Budgetary Objective and Desired results.
Organisational Chart to show who is responsible for which functionary budget.
Budget timetable, prevents bottleneck (late prep of one budget preventing progression.
Poformas and explanations for their completion
Account Codes and explanations of how to use them
Key assumptions – information concerning key assumptions made by managers, FX rate and rate of
inflation.
Budget officer – usually senior accountant and usually chairs the committee. The POC for any concerning
problems encountered when preparing the budget.

The principle budget factor (key factor/limiting factor) which limits the activities of the organisation.
Identification of limiting factor indicates which budget should be prepared first, e.g. sales volume (often
suales but this should not ne assumed). Identifying this at an early stage ensures time isn’t spend working
on a budget that is not feesable, as the sales volume would form the basis of the other budgets. (The
interrelationship of budgets).

Master Budget – summery of the departmental or activity budgets of all the departments of responsibility
centres within an organisation. – submitted to SM for approval.

Budget Prep expanded on p203

20
 1. SB considers how many unit can be sold. Expressed in revenue or possibly in terms of units
of sale.
2. How many units can be produced to meet budgeted sales levels N.B. the difference between
sales and the production budgets is the Inv of Finished Goods. Will consider inventory
policy. Subsidiary budgets for
3. Material (two parts – quantity of mat for prod and quant of mat required to be purch. The
difference is Inventory of Raw Mat. Consider Material Losses ) Lab (consider Idle time). and
OH established based on Prdn.
4. Non prd budgets
5. 6. and 7. MASTER BUDGET collative the individual budgets.

The Cash Budget

Inventory, selling and credit policy and so on… Insufficient cash finance plans, they need to be modified, or
action taken to alleviate the constraint. A cash budget can give forwarding of potential problems, so
managers can prepare or avoid.

Cash budgets ST Arrange OD, reduce receivables and are prepared for each period.
Deficit inventories, increase payables
LT Raise LT finx LT loan capital or share capital
Deficit
ST Invest in ST inv, receivables and invs to boost
21 Surplus sales, pay suppliers early to obtain a cash
discount.
LT Expand or diversify operations, replace or
Surplus update NCA
Cash budgets include:
1. Clear distinction btwn cash receipts and cash payments for each period.
2. Net figure for cash flow for each period (helps draw attention to CF inplications of their actions
during a period.
3. Closing cash balance for each period
- Dpn is not included in cash budgets (inc in OH instead)
- Allowances must be made for Bad (never) or Doubtful (might) Debts (reduce receipts)
- Include all CF not just sales revenue and production costs. Not just sales and production cost, ALL
movements of cash eg; inflow - sales of shares, grants rcd, or outflow – purchase of NCA and the
repayment of a loan.
- Look at the detail and consider timing of receipts and payments, payments at the beginning of the
moth and receipts at the end of the month, deficit may be greater.

Approaches to budgeting
- Rolling and Periodic Budgets continuously updates by adding a further accounting period when the
earliest account period has expired. Useful when future cost and/or activities cannot be forecast
accurately. Full budget always availiableand forces managers to always plan ahead. ‘Continuous
Budgeting’
+Budgeting accurate
+uncertainities reduced.
+managers forced to reconsider budgets on a more regulate basis
+planning and control based on a more recent & realistic budget
+Theres always a budget extending 9-12 months into the future.
.- Time. Consuming, therefore expensing to prepare
.- questionable benefit of preparing
- Incremental and Zero Based Budgeting (ZBB)
- Participative and Imposed Budgeting

Rolling
In practice most orgs update their budget in some for as the year progresses, so that the budget is remains
a realistic target for planning and control.
Formalize budget planning would still be coordinated on a regular basis.
Periodic/Incremental cost and revenue for one period at a time and updated on a periodic basis.
“method of budgeting based on pervious budget or actual results, adjusted for known changes such as
inflation.”
Traditionally, prior year +% to allow for inflation and other cost increases, or other adjustments for known
items such as increased headcount or fixed asset purchases. In a recession -%.
+ Easy, even for non Fx - Activities won’t be justified, undertaken
+ Relatively quick to calculate because they have been previously.
+ less likely to miss required items - Past inefficiencies continue – budget
slack (unnecessary spend built into the
22
 budget).
- Managers know that if they fail to use
their budget, it will be reduced the
following year

ZBB this is not required in detail for the exam.

“all cost to be specifically justified by the benefits expected”
- Each budget is prepared and justified from zero.
- Incremental levels of expenditure on each activity is evaluated, depending on the resulting incremental
benefits. Resources are allocated to where they will be the most effective.

+Forces Mngmt to consider alternative - Time taken

ways of achieving objectives & Mngmnt req
to justify current activities, which reduces
Budget Slack
+Inefficient/obsolete activities can be
discontinued
+Create inquisitorial attitude, rather than
the assumption current practices represent
good value for money
+ Reduces wasteful expenditure
+ forces mngmnt to consider alternative
methods for achieving objectives.
+ improves knowledge and behaviour
patterns
+resources allocated efficiently and
economically
- Emphasis on ST benefits
- Difficult to compare and rank
completely different activities.
- The necessary skills may be missing
from the mngmnt team
- Budget process could become too rigid,
and the company may not be able to
react to unforeseen opportunities or
threats.
- Incremental cost and benefit of
alternatives are difficult to quantify
accurately.

Participative/bottom up budgeting – Not in exam

All budget holders have the opportunity to participate in setting their own budgets.
+ Improved quality of forecasts as the basis - Extended and complex process to get
for the for the budget. Mngmnt doing a job every managers input
on a day to day basis will have a better idea - Slack may be built into the budget, as
of what is achievable, what is upcoming mngrs may be tempted to make
and local trading conditions. budgets easier to achieve.
+Improved motivation, as involved in
budget rather than imposed on them

Imposed/top down budget – Not in exam

Budget set with without input from the ultimate budget holder having opportunity to participate in budget
setting.
+ SM imposing budgets is less time - Lack of ownership of the budget.
consuming than involving other managers. Managers may resent it being imposed.
+ Mngrs may not have the skill or desire to - Lack of knowledge of each business
participate. area may result in an unrealistic budget.
+ SM may have a better overall view of the
org and it’s resources. May by a mor
objective and fresher perspective

Incrementa A method of budgeting based on the previous budget or actual

23
 l results, adjusted for any anticipated changes.
Zero-based A method of budgeting requiring all costs to be specifically justified
by the benefits expected.
Periodic A budget prepared for a fixed period of time.
Rolling A system of budgeting whereby the budget is continuously updated
by adding a further accounting period when the earliest accounting
period has expired.

Budgetary control – comparing actual with budget and determining if they are favourable or adverse
costs > budget = adverse revenues < budget = adverse
costs < budget = favourable revenues < budget = favourable
Budget Centres/Responsibility Centre – section of an entity for which control may be exercised with a
budget. Regular budgetary controls are sent to the manager, aka budget holder for the area
Cost centre Manager is responsible for operating costs.
Revenue centre Manager is responsible for revenue.
Profit centre Manager is responsible for operating costs and revenue and profit.
Investment Manager is responsible for profit and the return on any investment
centre made.

Budgetary reports should be:

Timely
Accurate
Relevant to the recipient (concise for SM)
Communicated to the correct manager
Many control reports also segregate controllable and non-controllable costs and revenue.
Fixed unchanged with level of activity
Flex Budgets more valid comparison. Useful for control but no planning.

Reconciling actual contribution with budget contribution

24
Ch 7: Standard Costing and Variance

LO:

Standard control technique that reports variances by comparing actual costs to pre-
costing determined standards/target, facilitating action through management by
exception
Produces a target against which we can measure actual results, but in standard
costing the targets are set at a unit level.
Standard Product X
cost card £ per unit
DM 30kg @ £4.30 129.00
DL 12 @ 11.80 141.60
Prime cost 270.60
Variable POH 12 @ £0.75 9 .
Variable Production Cost 279.60 .
Not that the stnd hr for labour and production OH is assumed to be the same
uless otherwise stated.
For each variable cost the stnd amount and stnd price are given.
Could also include FOH
Measurabl Can be a unit of product or service. Must be capable of being standardised
e cost unit The cost units themselves do not necessarily have to be identical. For example,
25
 standard costing can be applied in situations such as costing plumbing jobs for
customers where every job is unique. However, the plumbing jobs must include
standardised tasks for which a standard time and cost can be determined
for monitoring purposes.

Types of standards
Standard benchmark measurement of resource usage or revenue or profit generation,
set in defined conditions, against which actual performance can be monitored.
Ideal No allowance for inefficiencies such as losses, waste and machine down time
(idle time). Only achievable under the most favourable conditions.
Useful if managers wish to highlight losses. Always results in adverse variances.
Attainable Assume efficient levels of operation, include allowances for losses, waste and
machine downtime etc. Des not have the negative motivational impact that can
arise with an ideal standard because it makes some allowance for unavoidable
inefficiencies. Adverse variances will reveal whether inefficiencies have
exceeded this unavoidable amount.
Current Standards based on current performance levels (current wastage, current
inefficiencies) are known as current standards. Their disadvantage is that they
do not encourage any attempt to improve on current levels of efficiency.
Basic Standards set for the long term and remain unchanged over a period of years.
This standard is often retained as a minimum standard and can be used for long
term comparisons of performance.
Bases for Prior year level of performance by the same organisation. Mngmnt feel prior
setting prd acceptable.
standards Level of performance achieved by comparable organisations. Outward looking,
perhaps in comparison to “the best of the rest’
Level of performance required to meet organisational objectives.

In modern business
Developed when environments were more stable. In dynamic environments, stable conditions cannot be
assumed and it is difficult to set standard costs over a period of time.
Attainment of stnd no longer satisfactory and CI must be aimed for in order to remain competitive.
Labour variances no longer appropriate with the increasing use of automated methods.

Variance Analysis
Learn 6 variable cost variances and may just
have to calculate 2 in the exam. Remember to
include if it is adverse or (favourable).
DM (cal on mat Amount produced should cost should cost.
quantity) cost Did cost. .
variance DM cost variance adverse (favourable)
Also DL (calc on
hours)
DM (or DL) Amount produced should have used cost
Price usage Did use. .
variance Variance in kg adverse (favourable)
‘quantity’ x stnd price per kg
variances are DM useage variance in £ adverse (favourable)
always valued at
the
26
 standard
price.

Usage = Units
Check:
$8,569 adverse + $595 favourable = $7,974 adverse (the correct total
variance). P260
Variable OH Variable OH total variance:
Should
Did
Variance
variable Actual hrs should have cost @ VOH absorption rate
overhead Actual VOH
expenditure V OH expenditure variance adverse (favourable)
variance (price)
variable Variance in hours (from labour efficiency variance) adverse (favourable)
overhead × standard variable overhead rate per hour
efficiency Variable overhead efficiency variance adverse (favourable)
variance
(quantity)

Standard selling price = Stnd cost card shows total unit cost plus mark-up or margin.
Contribution = Selling price – unit cost

full set of standard data can be produced for a product or service showing standard selling price, standard
costs, standard contribution and budgeted production and sales volumes.

Sales variance
Sales price variance Quantity sold should sell for
Did sell for
Sales price variance adverse (favourable)
Sales volume Actual sale volume
contribution variance Bud sales volume
Variance units adverse (favourable)
X Stnd CONTRIBUTION
Sales volume contribution variance adverse (favourable)

Might have to calculate Variances Backwards in the exam

Operating Statement Reconcile act contribution with bud contribution.

Original budgeted contribution X

Sales volume contribution variance X
Standard contribution from actual sales volume X
Sales price variance X
X
Cost variances: Fav Adv
Direct material price X
Direct material usage X
27
 Direct labour rate X
Direct labour efficiency X
Variable overhead expenditure X
Variable overhead efficiency X _

Total cost variances X/(X)

Actual contribution X

Eg on pg 271

Reconcile Bud Profit with Act Profit. As before but start with bud profit.
Bud profit
Bud fixed OH
Original budgeted contribution
…. As before
Act Cont
(Act FOH)
Actual Profit

Interpreting variances
Understanding causes allows organisations to take appropriate corrective action.
First consider if the stnd was too high/low to begin with.
Remember variances are inter-related. One issue could effect a number of variances.

28
Standard Hour
To do
Sometimes it can be difficult to measure the output of an organisation which manufactures a variety of
dissimilar items. It is likely that each of the items takes a different amount of time to produce and utilises
a different amount of resource.
A standard hour is a useful way of measuring output when a number of dissimilar items are
manufactured. A standard hour is the amount of work achievable, at standard efficiency levels, in an
hour.
Example
A company manufactures tables, chairs and shelf units. The standard labour times allowed to
manufacture one unit of each of these are as follows:
Standard labour hours per unit
Table 3
Chair 1
Shelf unit 5

Production output during the first two periods of this year was as follows:
Units produced
Period 1 Period 2
Table 7 4
Chair 5 2
Shelf unit 3 5

It would be difficult to monitor the trend in total production output based on the number of units
produced. We can see that 15 units were produced in total in period 1 and 11 units in period 2.
However, it is not particularly meaningful to add together tables, chairs and shelf units because they are
such dissimilar items. You can see that the mix of the three products changed over the two periods and
the effect of this is not revealed by simply monitoring the total number of units produced.
Standard hours present a useful output measure which is not affected by the mix of products. The
standard hours of output for the two periods can be calculated as follows:

29
Expressing the output in terms of standard labour hours shows that in fact the output level for period 2
was very similar to that for period 1. It is important to realise that the actual labour hours worked during
each of these periods was probably different from the standard labour hours produced. The standard
hours figure is simply an expression of how long the output should have taken to produce, to provide a
common basis for measuring output.
The difference between the actual labour hours worked and the standard labour hours produced will
be evaluated as the labour efficiency variance.

30
Ch 8 Integrated Accounting Systems
• explain the integration of the cost accounts with the financial
accounting system
• prepare a set of integrated accounts, showing standard cost
variances.

Integrated accounts: a ‘set of accounting records that integrates both financial and cost accounts using a
common input of data for all accounting purposes.’

Accounts required for an integrated accounting system:

– Raw materials control account
– Wages control account
– Production overhead control account
– Administration overhead control account
– Selling and distribution overhead control account
– Work in progress control account
– Finished goods control account
– Cost of sales control account
Other accounts:
– Sales account
– Under-/over-absorption account
– Statement of profit or loss.
Control accounts are total or summary accounts. For example, the raw materials control account records
the total materials received and the total materials issued
+ Less work involved as work is not duplicated + No - need to provide information for statutory
need for periodic reconciliations purposes, which may influence the quality of
+ One set of accs avoids confusion (i.e, with information which can be made available for
different profit figures). management purposes
Wages Net wage = Gross wage – Deductions
Direct Indirect
Overtime Due to specific General OT & cannot be attributed to a single cost unit
premium customer request
Bonus If paid on individual Accumulated total standard time
earnings task bases
Idle time Available for work & being paid, but is not carrying out any
31
 productive work e.g. due to
machine breakdown, lack of orders or unavailability of materials.
Idle time payments = indirect costs in analysis
The balances end up in the Statement of financial position (SOFP) or the Statement of profit or loss (SOPL).
A debit is an asset (in the SOFP) or an expense (in the SOPL) and
A credit is a liability (in the SOFP) or an income (in the SOPL).

DEAD CLIC

Wages Control
Cash/Bank WIP control (direct)
EE deductions payable (tax etc) Prod OH control (indirect)

Wages control is debited with the net amount of wages actually paid, after deductions and the EE
deduction (so the full amount).
Prdn OH Control
Raw materials control WIP Control (to transfer accumulated OH
Wages cntl (indirect) and absorbed into WIP @ OAR)
Payables control (prdn elec) Under absorption
Provision for Dpn
Over absorption
OAR = Bud OH / Bud machine hrs
Prdn Overhead Over Absorbtion Acc
(not an essential acc and could be taken straight to the P&L)
SPL Prd OH Control
SP&L
Cost of Sales (Admin OH poss inc in COS Sales
figure) Prdn OH OA Acc
Admin OH
WIP Control
Raw Mat Control Finished Goods
Wages control (direct)
Prdn OH Control
The summary statement of profit or loss is prepared for the month.

General rules for recording variances

Variances are entered in the accounts at the point at which they arise.

32
 Debit for an adverse variance and credit for a favourable variance.

materials price materials control account

labour rate wages control account
‘quantity’ variances i.e. WIP control account
material usage, labour
efficiency and variable
production overhead
efficiency
variable production production overhead control account
overhead expenditure
Sales values variances are not shown in the ledger accounts

SPL
All variances are eliminated before any entries are made in the finished goods inventory account. The
finished goods inventory is held at standard cost and the transfer to the cost of sales account and to the
statement of profit or loss will be made at standard cost.
At the end of the period the variance accounts are totalled and transferred to the statement of profit or
loss.
In this way the actual cost (standard cost, plus or minus the variances) is charged against the sales value in
the statement of profit or loss for the period.

33
Ch 9: Performance Measurement
• explain the need for appropriate performance measures
• calculate appropriate financial and non-financial performance measures in a variety of contexts.

Performance measurement.
MA; setting targets, measuring actual performance against targets and providing info to mngmnt.
Can affect behaviour, so consider behaviour that wants to be encouraged. Poor performance targets 
dysfunctional behaviour i.e. not in the interests of the org as a whole.
Can be measured as an indv, dept or org.
Responsibility accounting (above)
1. CC assessing cost
2. PC assessing profitability
3. Inv C assessing return
Different types of orgs require different performance measurements, e.g. Business/business areas
commercial (maximise shareholders wealth) and NFP (best service at lowest cost). And within
organisations, objectives and goals in prdn centre (maximise volume and reduce wastage) vs call centre
(calls answers/not dropped).
LT (strategic) goals or objectives  broken down into tactical and ops targets which need to be monitored,
which requires critical success factors to be identified, and KPIs will help asses if they have met KPIs.
Performance measures are particularly relevant if they are controllable.

N.B remember that an item that is uncontrollable for one manager

could be controllable by another. In the long term, all costs are controllable.

Financial Performance Measures (Indicators (FPI))

34
Used to monitor inflows (revenue) and outflows (costs) and overall management of money in the business.
(info from SPL and SFP).

Gross revenue But, sales rev more meaningful as includes deductions for rtns etc
Contribution Sales rev – vc
Gross Gp = sales rev – CO(G)S
profit/margin
This is a useful measure which shows how effective the company’s trading activity
is. It shows if the sales revenue is enough to cover the cost of the item sold.
o COS for retail = purchase cost of stock
o COS for manufacturing = total prdn cost of goods sold.
Gross margin more
useful if shown as
a %age of
turnover:
Highlights the relationship between sales revenue and production/COS
High GP margin = sales/volumes are high or prdn cost are under control. % enables
comparison between different areas of the business or different products.
Operating (net) Deducting all other expenses from the gross profit expenses will include
profit/margin/EBI administration and sales and distribution overheads. For a manufacturing
T company, this will be all non-production costs.

It shows if the sales revenue is enough to cover the cost of the item sold and all
expenses. High PM is desirable.

Return on capital Shows the net profit generated from assets employed (Capital Invested/capital
employed (ROCE) employed/total assets less current liabilities/Total equity + LT debt).

X 100 to calculate net profit generated for each £1 asset employed.

Could be calculated with PBIT instead of net profit

Helps to highlight the productivity of the capital employed.

35
The performance measurements used will depend on the needs of the individual manager. Not all of these
measures are suitable for all types of responsibility centre.
ROCE only suitable in investment centres where managers are responsible for the level of investment.
Cost centre managers are only responsible for costs, so are most likely to use variance analysis to measure
performance.
Measures suitable for each type of centre:

Problems with FPI

Do not convey the full picture i.e. factors that will drive LT profitability e.g. customer satisfaction and
profitability.
Historic data, so not the best indicator of future performance.

short-termism Linking rewards to financial performance  decisions that will improve short-term
financial performance but poss a negative impact on long-term profitability. e.g.
cut investment or to purchase cheaper but poorer quality materials to reduce
costs.
Any targets that are set at the different planning levels should all aim towards
achieving the overall aim or mission of the business. There should be goal
congruence to reduce the risk of a short-termist view being taken by the
managers.
Manipulating results in order to achieve the target financial performance and hence their reward,
managers may be tempted to manipulate results.
Accelerating Revenue earned in one year may be wrongly included in the previous year in order
revenue to improve the financial performance for the earlier year
Delaying costs Costs incurred in one year may be wrongly recorded in the next year's accounts in
order to improve performance and meet targets for the earlier year.
Understating a This would improve the financial
provision or performance and may result in the targets being achieved.
accrual
Manipulation of This could include overstating closing inventory values resulting in an increase in
accounting policies profits for the year.

Non - Financial Performance Measures (Indicators (FPI)) (Forward looking measures)

Best to consider a range of fin and non fin KPIs to obtain a balance and holistic view.
Not distorted by inflation
Often grouped together into the broad headings of productivity or quality. Should be expressed in terms of
deviation from target or industry standard or trend analysis from a comparable period.
If performance in these non-financial measures begins to fall, it will not be long before the financial
measures deteriorate as well. e.g.
 resource utilisation - machines being operated for all the available hours and producing output as
efficiently as possible?
36
 measurement of quality - reduction in production losses or number of rejected unit
 measurements of customer satisfaction - returning customers or reduction in complaints
eg:

Call centre
• Average length of time of calls
• Staff absences
• Number of abandoned calls.
Distribution centre
• Speed of delivery
• Accuracy of delivery
• Customer complaint
Production department
• Wastage levels
• Internal re-working of finished products
• Meeting government targets on emissions.
Sales department
• Repeat sales
• Number of new customers
• Staff cost per customer
The Balanced Scorecard

Not in exam:
Financial traditional financial measures. 1. Operating ,margin
2. return on capital employed
3. return on shareholders’ funds
Customer attempt to measure customers’ 1. number of customer complaints
view of the organisation by 2. % of returning customers
measuring 3. new customers as a % of total customers.
customer satisfaction
Internal business Aims to measure the 1. unit costs
process organisation’s output in terms of2. capacity utilisation %
technical excellence 3. number of units rejected
and consumer needs.
Learning and grown focuses on CI improvement of 1. % of revenue attributable to new products

37
 perspective aka existing products and techniques2. number of new products launched in the
Innovation and and developing new ones to meet period
learning customers’ changing needs. 3. number of staff training days undertaken.

PM in service industries
Services have four main features:
Intangibility They often have few, if any, physical aspects activities. undertaken by the organisation
on behalf of its customers and therefore cannot be packaged for the customer to take
away with them.
Variability Unique and cannot usually be repeated in exactly the same way, making offering a
standardised service to customers very difficult.
Simultaneous problems of planning and control but it does mean that the incidence of work in
production progress is very low, that is, it is rarely necessary to value part-finished units of service
and at the end of an accounting period.
consumption
Perishability Services cannot be stored for later. For example, if a
cinema seat is vacant when a film is showing it cannot be stored in
inventory for a later sale. Therefore, capacity utilisation becomes a very
important issue for managers in many service organisations

Composite cost units useful when difficulties establishing a suitable cost unit.
Hotel — bed-night or room-night
Hospital — in-patient day
Haulage contractor — tonne-kilometre.

Eg

Financial performance Service quality Internal quality measurement

Can be useful if compared to
past trends of competitor’s
ratios
gross revenue
revenue per 'service'
revenue per 'principal' or
partner in, say, a management
consultancy
Critical in a service company as
there is no
tangible product, the company
will be judged on that service.
Customer service is difficult to
measure, could use the following
to assess customer satisfaction.
the length of time to be served at
reception
Inspection and monitoring of the
inputs to the service process
The quality of the service may be
measured after the event by
measuring the output of the
service against the target output
for the period.

38
 staff costs as a % of revenue
space costs as a % of revenue
training costs as a % of
revenue
operating (net) margin
the availability of facilities in the
hotel
the cleanliness of the rooms
the quality of the food
the helpfulness of its staff

Ch 10: Prepping acc and reports for mngmnt

Costing systems provide the basic information required for PLANNING, CONTROL
and DECISION MAKING. Information provided by costing system: Actual CU, Act CU
for Op dept, forecast costs incurred with different levels of activity.

Job costing undertaken with specific order/job from customer.

Performance measurements
1. Cost control
2. Time management

Job cost sheet/job card with specific job number costs are allocated to this
number, also the sales value of each job can be separately identified so it is possible
to determine a p/l on each job.

Includes:
1. job number
2. description of the job; specifications, etc.
3. customer details
4. estimated cost, analysed by cost
element
5. selling price, and hence estimated
profit
6. delivery date promised
7. actual costs to date, analysed by cost
element
8. actual delivery date, once the
job is completed
9. sales details, for example delivery note
no., invoice no

The 3Es concept

39
The 3Es concept is also known as the value for money (VFM) concept. Assesses the performance of a NFP
org. VFM still focuses on financial performance. Not-for-profit organisations will also need to consider non-
financial performance measurements, particularly quality.
Economy (an input measure). This measures the relationship between money spent and the
inputs. Are the resources used the cheapest possible for the quality required?
Efficiency (link inputs with outputs). This measures whether the maximum output is being achieved
from the resources used.
Effectiveness links outputs with objectives). This measures to what extent the outputs generated
achieve the objectives of the organisation.

Ch 11: Risk 1 – Summarising and Analysing Data (Decision Making).

- explain the concepts of risk and uncertainty
- ungrouped data.

'Risk' is quantifiable. Used to describe a scenario when we know the different possible outcomes and can
estimate their associated probabilities.

‘Uncertainty' is quantifiable. Used when we do not know the possible outcomes and/or their associated
probabilities.
Tabulating data. (Tallying (usually between 4 and 12 groups)/Frequency distributions) present raw
data in a
way which makes it easier to understand and therefore more useful for decision making.
Charts and diagrams (Pie charts/Bar charts/Histograms and ogives)
Averaging (Arithmetic mean (N.B. skewed distribution)/Median/Mode)
Measures of spread (Range/Variance/Standard deviation/Coefficient of variation). Spread give us
more information relating to the averages we have calculated
Mode

40
The range High – Low
the standard How far the highest and lowest observations are from the mean i.e. Data set 10,
deviation (σ) and 30. Mean = 20, σ = 10.
variance Variance = σ2 Square root σ2 = σ

Measures of spread Ratio of standard deviation to the Mean, useful in comparing degree of variation
AKA the form one data series to another, Given as a %age to aid comparison.
coefficient of
variation. In practice allows comparison of risk and return from inversment.. Lower ratio =
better.

N.B 0 or -x numbers do not work.

41
Ch 12: Risk 2 - Probability

Standard Deviation = σ
Mean = μ
Probability: Certain = 1, unlikely = 0, 40% = 0.4
Notation: the probability of event ;A: occurring is written as P(A)
Complementary rule: P(NOT A) = 1 – P(NOT A)

Exact Can be applied to the population of outcomes, e.g. the probability of a certain
card being drawn from a pack of cards.
Empirical Calculated from samples of observations from the past, e.g. the probability of a
certain level of sales occurring in a day. Primary (not focus groups must be
representative) and secondary research.
Subjective Based on judgement, e.g. the probability of winning a new order, or finding oil
in a new drilling area.

Expected Values (EV) EV = ∑PX Where X is the outcome and P is the probability of the outcome. (Long run
average, weighted average of a probability distribution).
Payoff tables
Each unit is bought for $8 and sold for $20, giving
a profit of $12.
Probability trees – work through e.g.

42
financial outcomes are shown at the end of the branches
Joint probabilities
If considering the joint probability of two independent variables, multiply probabilities together.
Normal distribution – Bell Curve. Mean = Median = Mode. 50% of the values will be below the mean and
50% of the values will be above the mean
μ for mean and
σ for standard deviation.

A & B = equal spread so stnd dev is the same.

C < A stnd dev (C is taller and narrower than A)
Note:
To be able to use the normal distribution the
distribution must be:
 Continuous
 Symmetrical
 Shaped as a bell curve.

68% of values are between 1 stnd dev ie -1 to

1
95% fall -2 to 2
99.7 between -3 to 3
LOOK AT NORMAL DISTRIBUTION TABLES WHICH ARE
ALWAYS IN +ve Values.
To use the tables

1. Convert normal distribution – stnd normal distribution (stnd normal

distribution: μ mean = 0 and σ std dev = 1)

2. Once we have calculated our ‘z score’ we can look this up on the

normal distribution table to find the area under the curve, which
equates to the percentage chance (probability) of that value occurring. So if we have calculated a z
score of 1.00. From the table the value is 0.3413. This means that (0.3413 ÷ 1.0) or 34.13% is the
area shown from 0 – 1 on the diagram.
43
 3. 34.13% would be the area shown from 0 to –1 on the
diagram. So we can say that 68.26% values will fall within one
standard deviation (–1 to 1).

44
Ch 13: ST DM

Eg ST DM
 Pricing decisions for a one-off product or job.
Only relevant CF which are:
- Only future incremental cashflows (i.e. those affected but the DM).
- Opportunity costs (that s the value of the benefit sacrificed, when one option is chosen
in preference to the other).
o Materials = Contribution from alternative use.
o Labour - contribution from alternative products which must be abandoned to
create spare capacity. (loss of cont/hr and add the direct labour rate per hour i.e.
Relevant cost = Contribution forgone from alternative product per hour PLUS
o direct labour cost per hour.).
- Sunk costs and committed costs are not included
- Non cash flows eg dpn, provisions and allocated fixed costs are excluded.
- Notional costs – excluded

45
46
Where there is a choice between selling an asset, or using the asset, the higher of the net realisable value
and the cash flows from the use of the asset (the economic value) should be selected as the relevant cost.

 How many units to produce and sell – this is known as breakeven analysis.
Cost–volume–profit (CVP) or Breakeven analysis (or CVP analysis)
Calculations:
1. Breakeven point (units) = FC/contribution PU
Breakeven point (£ of revenue) = FC/(C/S ratio)
Also: BEP x Selling price
2. Margin of safety units = Projected sales – breakeven sales
Margin of safety % (or ratio) = (Projected sales – breakeven sales)/Projected sales
3. C/S ratio = Contribution/Sales (aka profit/volume)
higher contribution to sales ratio means that contribution grows more quickly as sales levels
increase i.e. Profit accumulates quickly.
4. Sales units requires for profit x = (FC+x)/CPU
Sales revenue requires for profit x = (FC+x)/(C/S ratio)

Charts:
1. Breakeven charts

2. P-V chart aka Profit graph or contribution-volume graph.

47
AT zero activity the loss is equal to FC. The second point used to draw the line could be the calculated breakeven point
or the calculated profit for budgeted sales.

Profit-Volume chart depicting alternative scenario. <30k units more

profit/lower gains with scenario A.

 Limiting factor Analysis – maximising the contribution per unit of limiting factor.’
= Cont PU/ Amount of limiting factor PU

 Make or buy decisions – where a company decides whether to make components in house, or buy
them from an external supplier.
Buy = Wholly direct cost
Make = comparative cost = Variable production cost (DM, DL and Variable factory OH)

48
Ch 12: LT DM
- Explain the time value of money
- Apply financial mathematics
- Calculate the net present value, internal rate of return and
- Payback for an investment or project.

Capital Investment Decisions

To appraise a potential capital project:
- Estimate the costs and benefits from the investment (aka RELEVANT cash flows)
- Select an appraisal method and use it to assess if the investment is financially worthwhile
- Decide whether or not to go ahead with the project.

Payback
- Company must set a payback period (target return). If project is quicker, it should be accepted.

Payback usually Yrs and Mnts

cumulative cash flow becomes positive in year 5, so

payback is 4 years plus (130/160 × 12) months = 4
years 10 month
prior yr cumulative CF/year settled CF x
12

Constant Annual CF N.B. if CF estimated

for each year is the same then PP = Initial
Invest / Annual CF.

49
Time Value of Money
Compounding (finding future value if Discounting Considered future receivable and revalues
invested) it at its Present Value.

Net Present Value NPV

Surplus funds, after funding the investment, earnt on the project
+ve = viable
best project X > rejected project

50
In theory, this is the preferred method.

Annuities and perpetuities

Where projects have equal annual CF, two types:
Annuities (for a set number of years) Discount in the same way as cumulative present value.

Perpetuities (indefinitely/foreseeable future)

r could also = interest rate
Remember to deduct initial investment if
calculating the opportunity.

Advanced annuity +1 to the cumulative value.

Delayed = - cumulative for the years delayed
e.g. If 5 yr, paying from 3, deduct 1&2.

51
Internal Rate of Return
If NPV is 0 calculate IRR
IRR is compared to the company’s cost of capital.
If IIR > the cost of capital = accept
If choosing between 2, accept the one with the highest IRR

52
EXAM INFO

53
54
55
56
57