‭Section C Decision-making Techniques‬

‭Relevant costs and revenues are :‬

‭1.‬ ‭In the future‬
‭2.‬ ‭Cash only‬
‭3.‬ ‭Incremental only‬

‭Decision-making should be based on relevant costs and revenues:‬

‭1.‬ ‭Future cost‬
‭2.‬ ‭Cashflows‬
‭3.‬ ‭Incremental cost‬
‭4.‬ ‭Avoidable costs‬

*‭ Committed costs‬‭* are future costs that cannot be‬‭avoided because of decisions that have‬
‭already been made. These are non-relevant costs.‬

‭Opportunity Costs - Only arise when resources are scarce and have alternative uses.‬

‭*Original cost is a sunk cost, therefore irrelevant.*‬

‭By‬‭‘break-even’‬‭we mean simply covering all our costs‬‭without making profit.‬

‭This type of analysis is known as‬‭‘cost-volume-profit‬‭analysis’ (CVP analysis).‬

‭ VP looks primarily at the effects of differing levels of activity on the financial results of a‬
C
‭business‬

‭-‬ ‭ ocuses on sales volume because, in the short-run, sales price, and the cost of‬
F
‭materials and labour, are usually known with a degree of accuracy‬

‭ reak-even units‬
B
‭= Fixed costs/Contributions‬

‭ reak-even unit‬
B
‭=Fixed cost / Contribution to sales revenue‬

‭ argin of Safety‬
M
‭= Predicted Sales - Break even (units)‬

‭ chieve a required profit‬

A
‭= Fixed cost + required profit / c/s ratio‬
‭Planning with one limiting factor‬

‭Three steps in key factor analysis‬

‭1.‬ ‭Determine the limiting factor‬
‭2.‬ ‭Rank the options using the contribution earned per unit of the scarce resource‬
‭3.‬ ‭Allocate resources‬

‭Linear programming‬
‭1.‬ ‭Maximise contribution and/or‬
‭2.‬ ‭Minimise costs‬

‭ rice of elasticity of demand - The degree of sensitivity of demand for a product to change in‬
P
‭respect of the price of that product‬

‭%change in sales demand/ % change in selling price‬

‭If the % change in demand > the % change in price then price elasticity > 1 Demand is ‘elastic’‬

‭If the % change in demand < the % change in price elasticity < 1 Demand ‘inelastic’‬

‭Equation of a striaght- line‬

‭ raph of linear function‬

G
‭y= a +bx‬
‭ arginal Revenue‬‭is the extra revenue that an additional‬‭unit of product will bring. It is the‬
M
‭additional income from selling one more unit of a good.‬

‭ arginal cost‬‭is the change in total cost that arises‬‭when the aunty produced changes by one‬
M
‭unit. That is, it is the cost of producing one more unit of good.‬

‭Cost-plus pricing involves establishing the unit cost and adding a‬‭mark-up‬‭or sales‬‭margin‬

‭ ull cost-plus pricing‬‭is a method of determining‬‭the sales price by calculating the full cost of‬
F
‭the product and adding a percentage markup for profit.‬
‭Different Price Strategies‬
‭1.‬ ‭Cost-plus pricing - Involves establishing the unit cost and adding a mark-up or margin‬

‭2.‬ ‭Marginal Cost-Plus Pricing - Adding a profit margin to the marginal cost of production‬

‭3.‬ M
‭ arket Skimming- For high unit profits in the early stages of a product’s life cycle. ( For‬
‭New, short life cycle, High initial cash inflows and Barriers to entry)‬

‭4.‬ P
‭ enetration Pricing - Initial price is low ( To build a large market share, demand is elastic,‬
‭which discourages new entrants to the market. Will shorten the initial period of a‬
‭product’s life cycle to the growth and maturity stages quickly)‬

‭5.‬ C
‭ omplementary Product Pricing Strategy - Is one that used in conjunction with another‬
‭product.‬

‭6.‬ ‭Product-line Pricing - A range of products for different target audiences.‬

‭7.‬ V
‭ olume Discounting - The more you buy the cheaper the unit price. ( Quantity discounts‬
‭or Cumulative quantity discounts)‬

‭8.‬ P
‭ rice discrimination occurs when a company sells the‬‭same products‬‭at‬‭different‬
‭prices‬‭in‬‭different markets‬‭.‬

‭ ensitivity Analysis‬
S
‭This calculates the maximum percentage in a variable before a decision would change.‬
‭The lower % variables are therefore the most important for the decision under review.‬

‭ aximax‬‭applies to an optimist (risk-seeker) who seeks‬‭to maximise the maximum‬

M
‭possible gain of possible outcomes.‬

‭ he‬‭maximin‬‭rule looks at the worst possible outcome‬‭at each supply level and then‬
T
‭selects the highest one of these.‬
 ‭ ecision Tree - A diagram that looks at alternative courses of action and their possible‬
D
‭outcomes.‬
‭●‬ ‭Draw the tree from left to right‬
‭●‬ ‭A square represents a decision‬
‭●‬ ‭A circle represents an outcome‬
‭●‬ ‭At a decision square- a branch from it represents a potential outcome‬

‭Perfect information is available when a 100% accurate prediction can be ,ade about the future.‬

I‭mperfect information- the concept of perfect information is somewhat artificial since, in the real‬
‭world, such perfect certainty rarely, if ever, exist. The approach to calculate the value of perfect‬
‭and imperfect information is the same :‬

‭-‬ ‭Expected value of the decision with imperfect information - Expected value without it.‬
‭Section E Performance Measurement and Control‬

‭Measuring Profitability‬
‭Measuring Liquidity‬
‭Measuring risk‬
‭Non financial factors‬
‭ riotising long-term sustainability over short-term gains is crucial for preserving value and‬
P
‭mitigating potential risks.‬
‭ he balanced scorecard approach emphasises the need to provide management with a set of‬
T
‭information that covers all relevant areas of performance in an objective and unbiased fashion.‬

‭ .‬
1 ‭ he Financial perspective‬
T
‭2.‬ ‭The Customer perspective‬
‭3.‬ ‭The internal business perspective‬
‭4.‬ ‭In the learning and growth perspective‬

‭Advantages‬
‭1.‬ ‭It measures performance in a variety of ways‬
‭2.‬ ‭Managers are unlikely to be able to distort the performance measure‬
‭3.‬ ‭It takes a long-term perspective of business performance‬
‭4.‬ ‭Success in the four key areas should lead to the long-term success of the organisation‬
‭5.‬ ‭It is flexible‬
‭6.‬ ‭‘What gets measured gets done’‬

‭The Building Block Model‬

I‭nseparability / Simultaneity (Production and consumption of the service coinciding)‬
‭Perishability‬
‭Heterogeneity (Lack of consistency)‬
‭Intangibility (what is provided to and valued by individual customers)‬
‭Ownership‬

‭1.‬ ‭Standards‬
‭a)‬ ‭Employees need to participate in the budget and standard-setting processes.‬
‭They are then more likely to accept the standards.‬
‭b)‬ ‭Standards need to be set high enough to ensure that there in some sense of‬
‭achievement in attaining them, but not so high that there is a demotivating effect‬
‭because they are unachievable.‬
‭c)‬ ‭Equity is seen to occur when applying standards for performance measurement‬
‭purposes.‬

‭2. Rewards‬
‭1.‬ ‭Objectives need to be clearly understood by those whose performance is being‬
‭appraised.‬
‭2.‬ ‭Individuals should be motivated to work in pursuit of the organisation’s strategic‬
‭objectives‬
‭3.‬ ‭Managers should be accountable for their areas of responsibility. For example, they‬
‭should not be held responsible for costs over which they have no control.‬
‭Transfer Pricing‬
‭1.‬ ‭External Sales Revenue‬
‭2.‬ ‭Internal Sales Revenue‬

‭Aims for a Good Transfer Price‬

‭1.‬ ‭Division A and B have some autonomy‬
‭2.‬ ‭A and B Managers are Motivated‬
‭3.‬ ‭Ensure Goal Congruence‬

‭Practical Transfer Pricing‬

‭1.‬ ‭Market Prices‬
‭2.‬ ‭Production Cost (of Division A) - this can be based on variable or full cost including a‬
‭mark-up‬
‭3.‬ ‭Negotiation‬
‭Measures of divisional performance‬
‭ bjectives of Not-For-Profit organisations‬
O
‭Not-for-profit organisations have multiple stakeholders. This gives rise to multiple objectives.‬
‭Organisations will need to prioritise/compromise as, very often, it is impossible to say which is‬
‭the overriding objective.‬

‭Problems‬‭of Not-For-Profit Organisations‬

‭1.‬ ‭Measuring outputs‬
‭2.‬ ‭Lack of profit measures‬
‭3.‬ ‭Nature of service provided‬
‭4.‬ ‭Financial Constraints‬
‭5.‬ ‭Political, social and legal influences‬
‭Performance Measure‬
‭➔‬ ‭Effectiveness is the relationship between an organisation’s outputs and its objectives‬
‭➔‬ ‭Efficiency is the relationship between inputs and outputs‬
‭➔‬ ‭The economy is attaining the appropriate quantity and quality of inputs at the lowest‬
‭cost.‬

‭Indicators to assess overall performance‬

‭1.‬ ‭Effectiveness‬
‭●‬ ‭Financial indicators‬
‭-‬ ‭Quality of service/output measures‬
‭-‬ ‭Utilization of resources‬
‭-‬ ‭Flexibility‬

‭●‬ N
‭ on-financial indicators‬
‭-Workplace morale‬
‭- Staff attitude to dealing with the public‬
‭- Client satisfaction in the service being provided‬

‭2.‬ ‭Efficiency‬
‭-‬ ‭Cost per unit of activity‬
‭-‬ ‭Variance analysis‬
‭-‬ ‭Comparisons with benchmark information‬

‭ .‬ ‭Economy‬
3
‭A value-for-money audit will looks also at the economy of the use of resources.‬
‭Section B - Specialist Cost and Management Accounting Techniques‬

‭Costing Methods‬
‭-‬ ‭Absorption costing‬
‭-‬ ‭Marginal Costing‬

‭ bsorption costing‬
A
‭Overheads were allocated to products using a three-stage procedure‬
‭1.‬ ‭Overheads are allocated or apportioned to cost centres (usually production and service‬
‭departments) using a suitable basis‬
‭2.‬ ‭Service centre costs are reapportioned to production centres‬
‭3.‬ ‭Overheads are absorbed into units of production using an overhead absorption rate‬

‭ ow to find OAR‬
H
‭OAR = Budgeted overheads/ Budgeted activity level‬

‭ bsorption costing focuses on the product in the costing process.‬

A
‭Cost are traced to the product because each product item is assumed to consume the‬
‭resources.‬

‭Cost drives such as ordering cost, set up cost and packing cost‬

‭ arginal Costing‬
M
‭Variable Indirect Costs are treated as Product Costs‬

‭Steps in establishing and applying ABC‬

‭1.‬ ‭Identify activities that consume resources and incur overhead costs‬
‭2.‬ ‭Allocate overhead cost to the activities that incur them‬
‭3.‬ ‭Determine the cost driver for each activity or cost pull‬
‭4.‬ ‭Collect data about actual activity for the cost driver in each cost pool‬
‭5.‬ ‭Calculate the overhead cost of products or services.‬

‭Advantages of ABC‬
‭1.‬ ‭More accurate cost information is obtained. It identifies ways of reducing overhead costs‬
‭in the longer term.‬
‭2.‬ ‭As a result in selling price will be less than is required to fully recover overheads and‬
‭yield a satisfactory profit.‬
‭3.‬ ‭It provides much better insights.‬
‭4.‬ ‭ABC can be applied to all overhead costs‬
‭Disadvantages of ABC‬
‭1.‬ ‭Cost vs Benefit‬
‭2.‬ ‭Need for informed application‬
‭3.‬ ‭Difficulty in identifying cost drivers‬
‭4.‬ ‭Lack of appropriate accounting records.‬

‭ arget Costing‬
T
‭A target cost is what’s left over after you’ve subtracted your desired profit from your competitive‬
‭selling price‬

‭Steps in Target Costing‬

‭1.‬ ‭Choose an appropriate Selling Price‬
‭2.‬ ‭Choose a desired Profit Margin‬
‭3.‬ ‭This leaves the Cost Target‬
‭4.‬ ‭Calculate the Cost Gap ( Current costs - Target Cost)‬

‭ arget costing was introduced by major Japanese manufacturing companies to use when a new‬
T
‭product was to be designed to meet the target cost and a substantial part of the production cost‬
‭consisted of bought-in material‬‭s.‬
‭The difficulties of using target cost‬
‭1.‬ ‭It is very difficult to determine a market-driven price for services provided‬
‭2.‬ ‭The introduction of new service occurs far less frequently than in a manufacturing‬
‭company‬
‭3.‬ ‭The major cost in the service industry is salaries. Bought-in materials are usually low‬
‭when compared to salaries.‬

‭Suggest how a target cost gap might be closed‬

‭1.‬ ‭Review the product features‬
‭2.‬ ‭Remove features that add cost but do not significantly ass value to the product when‬
‭viewed by the customer. (This should reduce cost but not achievable selling price (value‬
‭engineering/value analysis).‬
‭3.‬ ‭Team approach - cost reduction works best when a team approach is adopted.‬
‭4.‬ ‭Review the whole supplier chain - each step in the supply chain should be reviewed,‬
‭possibly with the aid of staff questionnaires, to identify areas of likely cost savings.‬
‭5.‬ ‭Efficiency improvements should also be possible by reducing waste or idle time that‬
‭might exist.‬

‭ ife-cycle costing - Tracks and accumulates the actual costs and revenues attributable to each‬
L
‭product from inception to abandonment.‬

‭Every product goes through a life cycle‬

‭1.‬ ‭Development‬
‭2.‬ ‭Introduction‬
‭3.‬ ‭Growth‬
‭4.‬ ‭Maturity‬
‭5.‬ ‭Decline‬
‭The benefits of product life cycle costing are:‬
‭a)‬ ‭All costs (production & non-production) will be traced to individual products over their‬
‭complete life cycles and hence individual product profitability can be more accurately‬
‭measured.‬
‭b)‬ ‭The product life cycle costing results in earlier actions to generate revenue or to lower‬
‭costs that might be considered‬
‭c)‬ ‭Better decisions‬
‭d)‬ ‭Promote long-term rewarding‬
‭e)‬ ‭Understand the cost consequence. Cost reduction efforts‬
‭f)‬ ‭Understanding and managing the total costs incurred‬
‭g)‬ ‭More accurate feedback on the success and failure of new products available‬

‭To maximise a product’s return over its lifecycle, several factors need to be considered:‬
‭●‬ ‭Design cost‬
‭●‬ ‭Minimise the time to market‬
‭●‬ ‭Maximise the length of the life cycle itself‬
‭●‬ ‭Minimise break-even time‬
‭ hat is throughput?‬
W
‭Is the rate of converting raw materials and purchased components into products sold to‬
‭customers.‬

‭Throughput = Revenue - Raw material cost‬

‭What is throughput accounting‬

‭1.‬ ‭In the short run, most factories (with the exception of materials costs) are fixed. These‬
‭fixed costs are called Total Factory Cost (TFC)‬
‭2.‬ ‭In a JIT environment, the ideal inventory level is 0‬
‭3.‬ ‭Profitability is determined by the rate at which sales are made at the end, in a JIT‬
‭environment, this depends on how quickly goods can be produced to satisfy customer‬
‭orders.‬

‭Throughput accounting and the theory of constraints‬

‭1.‬ ‭Identify the system’s bottlenecks‬
‭2.‬ ‭Decide how to exploit the system’s bottlenecks‬
‭3.‬ ‭Subordinate everything else to the decisions made in Step 2‬
‭4.‬ ‭Elevate the system’s bottlenecks‬
‭5.‬ ‭If a new constraints is broken in Step 4, go back to Step 1‬

‭The Throughput Accounting Ratio‬

‭Criticisms of TPAR‬
‭1.‬ ‭It concentrates on the short-term‬
‭2.‬ ‭It is more difficult to apply throughput accounting concepts to the longer term when all‬
‭costs are variable‬
‭3.‬ ‭In the long run, ABC might be more appropriate for measuring and controlling‬
‭performance.‬

‭How to improve TPAR?‬

‭1.‬ ‭Increase the selling price‬
‭2.‬ ‭Reduce material costs per unit‬
‭3.‬ ‭Reduce total operating expenses - this will reduce the total factory costs‬
‭4.‬ ‭Improve productivity so throughput will increase.‬
‭Sustainability Strategy Perspective‬
‭1.‬ ‭Value Creation from different capitals‬
‭2.‬ ‭Stakeholder perspectives.‬
‭3.‬ ‭Megatrends influencing opportunities and threats.‬
‭4.‬ ‭Customer preferences.‬
‭Role of accountants in developing sustainable practices.‬

‭These actions can be seen in 3 main areas:‬

‭1.‬ ‭Leadership and Business Strategy‬
‭2.‬ ‭Management, Operations and Accounting‬
‭3.‬ ‭Communications, Reporting and Disclosure‬