Advanced Cost

&
Management Control Systems
ACFN 622

Alpha University College

Teklu K.(Ph.D)
March,2016
 Course Description:

This advanced cost and management accounting

course primarily uses cost and managerial
accounting foundation materials covered in the
under graduate level to expand upon the
concepts fundamental to management
accounting from an entity’s strategic perspective
 Course Objective
The objective of the course is to equip
participants with the cost and management
accounting tools, and techniques and methods of
modern cost management information for
analyzing the various costs and their influence on
the performance of the organization to enable
efficient decision making and control.
 Course contents
1. Fundamentals of cost and management accounting
2. Cost Planning
3. Multi-product CVP Analysis
4. Activity Based Costing (ABC)
5. Cost Analysis and Pricing Decisions
6. Performance Measurement
7. Management Control Systems
 Course delivery:

Introductory lectures and topic presentations

are made by the course instructor. Students
will be assigned to work on exercises, reading
and presentations of journal articles, business
cases and projects both on individual and
group basis.
 Course assessment

Evaluation on the course will be as follows:

• Review of journal articles……………….. 20%

• Business cases and group projects…. 40%

• Final Exam…………………………..………… 40%

• Total ……………………………………………………
100%
 Text books:
Horngren, Datan, Rajan, 2012, Cost
Accounting: a managerial emphasis, 14th
edition Pearson Education, Inc., publishing as
Pearson Prentice Hall
Blocher, Stout and Cokins, 2010,Cost
Management: a strategic emphasis, 5thedition
The McGraw-Hill Companies, Inc. New York, NY,
•  
 Advanced Cost
&
Management Control Systems
ACFN 622

Alpha University College

Teklu K.(Ph.D)
March,2016
 Contents
1.General Introduction

2. Cost and management accounting:

subject matter, scope and issues in
modern cost and management
accounting

9
 Introduction
Essence
Cost accounting a branch of accounting
that measures and reports financial and
non financial information related to the
cost of acquiring or utilizing resources in
an organization.
 Cost concepts and classifications
 Cost: is a resource sacrificed or forgone to achieve a
specific objective. A cost is usually measured as the
monetary amount that must be paid to acquire goods and
services.
 A Cost object: is anything for which a separate
measurement of costs is desired. Example; product,
department, customer, geographical area, process etc.
 Cost pool: A cost pool is a grouping of individual cost
items possessing identical nature. Cost pools can range
from broad, such as all costs within a manufacturing
plant, to narrow, such as the costs of operating machine.
 Cost accumulation: is the collection of costs in
some organized way by means of an accounting
system, i.e., by some natural or self descriptive
classification.
Eg. material cost, labor cost, fuel, Advertisement
cost etc.
 Cost assignment: is a general term that includes:
 Tracing accumulated costs: For direct costs
 Allocating accumulated costs: For indirect costs
 Cost Classification
 Costs are classified into different categories on the basis
of different reasons:
 Based on their traceability to a particular cost object
a. Direct Costs: costs that have a relationship with the
cost object and can be traced to that cost object in an
economically feasible (cost effective) way.
Example:
i. The cost of bottle is a direct cost to Pepsi-Cola because
the cost of it can be easily traced to or identified with
the drink.
ii. Cost of paper is a direct cost for a sport magazines
because it can be conveniently traced to a magazine.
b. Indirect Costs: costs that have a relationship
with the cost object but cannot be traced to
that cost object in an economically feasible
way.

Example: Salary of supervisors who oversee

production of different soft drink products.
Unlike the cost of bottles of Pepsi-cola, it is so
difficult to trace supervisors cost s to Pepsi-
cola line. Such costs are allocated to products
based on some cost allocation base.
 Thus, the term cost tracing is used to describe the
assignment of direct costs to a particular cost object
and the term cost allocation is used to describe the
assignment of indirect costs to a particular cost
object.
 The distinction between a direct cost and indirect
cost depends on units of products, activities,
departments, organization etc.
 So, a cost could be direct cost for one cost object
and an indirect cost to the other.
 Example: A supervisors’ salary may be a direct
cost to the production department but an indirect
cost for the product being produced
  Based on their behavior pattern
a. Variable costs: are total costs that changes in
direct proportion to changes in the level of
activity but unit costs remain constant.
Example: Cost of bottles for Pepsi-cola.
b. Fixed Costs: are total costs that remain
constant regardless of the level of activity up to
a certain relevant range but unit costs vary
according to the level of activity.
Example: Monthly salary of employees of a
company for a year.
  Based on
function/operation/purpose
a. Manufacturing costs are those costs that are
directly involved in manufacturing of
products and services. Manufacturing cost is
divided into three broad categories by most
companies.
• Direct materials cost
• Direct labor cost
• Manufacturing overhead cost.
 Direct Material costs: are those materials that
become an integral part of the finished product and
that can be physically and conveniently traced to it.
The cost incurred in acquiring these direct materials
are called direct material costs.
 Direct Labor Cost: those labor costs that can be
essentially traced to individual units of products.
 Manufacturing Overhead Costs: includes all costs
of manufacturing except direct material and direct
labor. Examples include indirect material, indirect
labor, maintenance and repairs, heat and light,
property taxes, depreciation, and insurance on
manufacturing facilities etc.
b. Non-manufacturing Costs
i. Administrative costs: include all executive,
organizational, and clerical costs associated with
general management of an organization rather than
with manufacturing, marketing, or selling.
Example: Salary of managers, clerical staffs, office
rents etc.
ii. Marketing or selling costs: are costs related to selling
and distribution of goods and services. Includes all
costs necessary to secure customer orders and get the
finished product into the hands of the customers.
Example: Transportation Costs, advertising costs,
Shipping costs, Sales commission and Sales salary.
  Based on timing they are charged against
revenue
a. Product costs: are costs that are necessary and integral
part of producing (acquiring) the finished product.
They are considered as an asset/inventory when they
are incurred. Under the matching principle, these
costs do not become expenses until the finished goods
inventory is sold.
Example: Cost of direct material
b. Period Costs: are costs of income statement other than
cost of goods sold. They are treated as expense of the
period in which they are incurred because they are
expected to benefit revenue in the current period.
Example: Advertising costs
 Exercise
• Daily PLC produce and sale products A and B. It uses three
different kind of direct materials D.M. X,Y and Z respectively.
The materials costs br. 10,12 and 14 per unit respectively. 6,4 and
2 k.g of material X,Y and Z are required to produce a unit of
product A. The material requirement increase by 100 % to
produce a unit of B. 4 labor hour at rate of 25 per hour is required
to completely produce A. To produce B, it needs 3 labor hour at a
rate of 30 per hour. MOH is applied to the products at 50 % of
prime cost. Operating expenses are equal to 80% of cost of
goods manufactured. The ratio b/n selling and administrative
expense is 3:1. During the period just ended 60 A and 40 B were
produced and sold for 100% profit on CoGS. The firm is subject to
30 percent income tax rate.
Required : Compute the following for product A,Y and the co. As a
whole in unit and total base. 1.DMC 2. DLC 3. MOH 4. CGM
5 G.P 6 PC 7.CC 8.Op.Expenses 9. Op. income 10. Net Income
 Introduction MCS
• MCS: A system which gathers and uses
information to evaluate the performance
of different organizational resources like
human, physical, financial and the
organization as a whole in light of the
organizational strategies pursued

22
Three underlying sub processes of MCS
Management control process has three
underlying sub processes
Target setting ( budgeting), also known
as attention directing
Performance measurement
 Reward and compensation

23
 Strategic planning and budgeting

Strategic planning is the process of deciding

on the programs that the organization will
undertake and on the approximate amount
of resources that will be allocated to each
program over the next several years.

24
 The nature of strategic planning
 Strategic planning include:
–Thinking about the future
–Deciding on the future direction
of the entity
–Leading to formal statement of
plans about the future
–Plan how to get there
25
Strategy formulation and strategic planning
Strategy formulation involves :
– an overall drawing of road map
– Defining strategic direction

Strategic planning involves:

– the quantification and specification of
programs
– the quantification and specification of
recourses required
26
 Budget
• Budget: a quantitative expression of the
inflows and outflows to determine whether
a financial plan will meet organizational goal
.
– Plans consists of
• Physical plan/ Programming and
• Financial plan= budget
Budgeting is an instrument of
planning and monitoring operations
over short-term and medium term
27
 What does budgeting involve/significance
• Express objective: where do we want to go
• Diagnosis/assess position: where are we ?
• Prognosis: where are we heading/how can we recover ?
• Strategies: how to go
• Tactics : how to implement the strategy
»Mid term corrections
• Control: how to keep on truck
– Difference between corporate planning/
strategic planning and budget
28
Planning , control and the role of
budgets

Identify organizational objectives

and short term goals

Planning
Develop long-term strategy
And short term plans

Develop master budget

Measure and assess performance

against budgets

control
Reevaluate objectives, goals strategy and plans

29
 Budget setting process
Important issues to be settled before
detailed budget setting.
• Corporate objectives : major, growth and
profitability, broken down into products
• Corporate profit planning: summary plan
• Nature of market- buyers’ or sellers’
• Principal budget factor: identify key factor,
limiting factor, critical factor, or governing
factor
30
 Cont’d
• Sales forecasting: (starting point, factors
to consider, demand analysis, general
business conditions, production capacity,
sales mix analysis
• Spending for the future (spending on
items that affect the future, but no
contribution for the current
sales/revenue (non expense items)

31
 Budgeting under uncertainty
• Scenario analysis- Optimistic /pessimistic
• Sensitivity analysis – what if technique
• Probability analysis- how big the chance?
• limiting factor analysis-(multi constraints

32
 The master budget: interrelationship of
functional budget components

1. Organizational goals 3. Capital spending plan

2. Sales forecast and plan

5. Production plan 6.Productive capacity

4. Inventory policy
plan
8. Labor hiring and 9. Administrative and
7. Materials purchasing plan
training plan Discretionary spending plan

10. Expected financial results

11.projected Statement of cash flows 12. Projected financial statements

33
 Sales budget and the sales forecast
• Sales budget :
– Forecast of price and quantity (market size, market
share, growth and expansion considered)
– Forecast of total ales expressed in monetary terms
– It is generally starting point for other budgets and
budgetary control system
– May be prepared under variety of classifications as
• By Product or product groups
• By Areas or sales territories
• By Salespersons or agent
• By type of customer
• local market and export etc
34
Factors influencing sales budget
External factors
• Demographic factor – population, gender
mix, age group and other characteristics of
the target customer
• Government policy and regulations
• Income distribution
• Trends in economic conditions
• Global events and economic conditions
• Competition
• Seasonal and cyclical fluctuations of
production/demand
 Factors influencing sales budget
Internal factors
– Past trend in sales
– Demand analysis supported by market
research
– Analysis of various internal reports
– review of general business conditions
– Production capacity analysis
– Profitability analysis including optimal sales
mix
– Effect of promotions
36
 Methods of sales forecast
• Financial and semi financial tools
– Historical analogy (similar economy, similar industry)
– Period comparison (last year vs. this year)
– End user or consumer expectation based
• Quantitative and statistical
– Time series
– Trend or regression analysis
– Multivariate analysis
– Probabilistic model etc

37
 Cont’d
• Qualitative method
– Opinion from experts
– Brain-storming
– Delphi techniques
– Scenario building
• field survey data etc

38
 Example
• The following is actual revenue of Addis Ababa
City administration during the last five years.
What will be forecasted revenue at higher case
and lower case scenario based on the
philosophy of trend analysis.
Year Revenue Growth Rate

2004 10,000,000 BY HGR=70%

2005 17,000,000 0.7 LGR=17.6

2006 20,000,000 17.6% H.C=52,700,000

2007 24,000,000 20% LC=36,456,000

2008 31,000,000 29
39
 Exercise
• Tax and none tax revenue of Akaki kality
Sub city in 2004 E.C was 20,000,000.
During the subsequent four years,
revenue were growing at 100,000 plus 20
% of the preceding year. What will be
revenue of 2009 E.C assuming higher
case, lower case and average growth rate
principles of trend method?

40
 Components of master budget
• Sales budget
• Selling and distribution expense
• Advertising
• Production budget
• Plant utilisation budget
• Repairs and maintenance
• Personnel
• Purchase budget
41
 Cont’d
• Purchase budget depends on
– Production budget
– Capital expenditure budget
– R & D budget
– Policy of subcontracting
– Stock levels (inventory policy)
– Availability of finance
– Storage space and source of supply
42
 Framework for performance
measurement system
• Purpose of measurement:
– tool to help managers control the results of their
organizations,
– Helps organizations to gain insight into, and make
judgments about the effectiveness and efficiency of
their programs, process and people.
• Choice of the right metrics important
• Prioritize indicators
• Choose appropriate measurement methods
– Achieve understanding and acceptance
43
 Types of metrics
• Hard vs soft (Both have their strength and weakness)
– Hard
• Pure facts that are possible to measure ( input,
production, net profit etc)
– Objective reference
– Accurately known
– Hierarchical
– Soft
• Measure the intangible (customer satisfaction,
brand loyalty, employee satisfaction, etc
– Observer bias
– Surrogate indicator
– Multi variable situations
44
 Performance cont’d
• Financial Vs Non financial
– Integration of the two is important to achieve best
results
– financial metrics example
• Budget vs actual variance analysis
• Product and product group (cost, contribution
margin)
• Profitability, Cash flow analysis, ROI, EPS
• Customer profitability, ets
– Non financial metrics example
• Inventory turnover, labor efficiency, capacity
utilization, defect ratio, lead time, market share
analysis, market penetration, new product sales

45
 Cont’d
• Financial performance targets ( for control)
a. Model based vs historical vs negotiated targets
. Model based
» Deterministic casual relationship
between output and inputs (engineered
targets)
• Historical targets
» Derived from past
• Negotiated
» Mutual agreement between superior and
subordinate

46
 Requirements for PMS
• Establishing and updating performance
measures
• Establishing accountability for
performance
• Gathering and analyzing performance
data
• Reporting and using performance
information
47
 Cont’d
b. Internally vs externally derived targets
• Target costing derived from selling prices
• Benchmarking ( study of best practice and
implement process and system to enhance
performance)
(internal bench mark, external bench mark)
C. Fixed vs flexible targets
– (changing and non changing)

48
 Single Vs. multiple performance indicator
• Drawback of single indicator
– Single indicator may apply to a given situation but
not to all.
– Single indicator such as profitability may apply well
to macro situations but not to micro situations
– single indicator ignores underlying process
– It also fails to link with strategic plans
– It is also able to only measure one aspect of business
performance
• The G.E measurement project
• Balanced scorecard 49
 Cont’d
• The G.E measurement project
– Divided into three projects
• those designed to measure overall
performance of department as an
economic entity
• Those designed to measure performance of
functional organizations such as finance,
marketing, production human resource, etc
• Those designed to measure performance of
the departments’ management
50
 Continued
– Core principles:
– 1. Measures designed to provide factual knowledge to
support judgments in performance appraisals
2. Measures designed to provide information regarding
short term objectives and long term goals
3. Minimum number of indicators used at each level
The following key success factors were selected for each
department:
a. Short term profitability (ROI, profit contribution/NI to
sales ratio, and residual income /net income minus
capital charge/)
b.Market share (degree of attaining market leadership)
51
 Cont’d
c. Productivity ( department productivity =value
added /(labor inputs + capital inputs)
d. Product leadership (long run goal, company
originated product, research and development
effort that led to product development,
comparative analysis of competitors and
company positions)
e. Personnel development (demand for human
resources by type and supply of talented
personnel, effectiveness of training programs etc)
f. Employee attitude , (measured by turnover, rate of
absenteeism, tardiness, punctuality etc)
52
 Cont’d
g. Public responsibility [good corporate
citizenship, well being of all stakeholders,
including employees, vendors (suppliers),
customers environment, community at large]
h. Balance between short term and long range
objectives (the measures mentioned are
combinations of short term profitability and
growth and long term goals)

53
 The Balanced Scorecard as measure of
performance
• Traditional performance report focus on cost
control
• In modern business companies compete in terms
of product quality, terms of delivery, reliability,
after sales services, customer satisfaction etc
• These variables are not captured in traditional
measures
• Traditional measure do not include information
needed for planning since they are based on
historical facts/records/accounts
54
 Cont’d
• BSC was developed to link financial and
nonfinancial measures of performance and to
identify key performance measures (Kaplan
and Norton,1992)
• BSC is a set of financial and non financial
measure related to company’s critical success
factors
• It provides information to management to
assist in strategic policy formulation
• As a tool, helps to assess over all performance
55
 Cont’d
• The general objective of the BSC is to provide
comprehensive framework for translating a
firm’s strategic objectives into coherent set of
performance measures
• There are four perspectives from which
company performance is to be measured in
the BSC
• companies need to articulate objectives for
each of the for perspectives
• Performance measures are then set for each
goal
56
 Major components of BSC
• Customer perspective / how do customers
see us/
• Internal perspective/ what must we excel
at/
• Innovation and learning perspective/
ability to continue to improve and create
value/
• Financial perspective / how do we look to
our share holders/
57
 Reward/ incentive and compensations
‘One of the primary principles of effective
management is that rewards should be the
third thing you work on, measurement
should come second, and both reward and
measurements should be subordinated to
performance definition; i.e. clear
unambiguous articulation of what needs to
be done’ ( Kerr, 2004, Quoted in Merchant and van der Stede 2007 p. 393 )

58
 Examples of positive and negative rewards
• Positive rewards
– Autonomy
– Power
– Oppurtunity to participate in important decision process
– Salary increases
– Bonuses
– Stock options
– Restricted stock
– Praise
– Recognitions
– Promotions
– Titles
– Job assignment
– Office assignment
– Reserved parking place
– Country club membership
– Job security
– Merchandise prizes
– Vacation trips
– Participation in executive development programs
– Time off 59
 Cont’d
• Negative rewards
– Interference in job from superiors
– Loss of job
– Zero salary increase
– Assignment to un important tasks
– Chastisement (public or private)
– No promotion
– Demotion
– Public humiliation

60
 Purpose of incentives
• Performance-dependent rewards or incentives,
provide the drive for alignment of employees’
natural self-interests with organization’s
objectives.
• They provide three types of management
control benefits
– Information : inform the employees or remind them
of the importance of result areas (cost control,
quality customer handling, asset management etc) –
effort directing purpose

61
 Cont’d
– Motivational : effort inducing,
employees need rewards/ incentive to
exert extra effort to accomplish tasks
– Personnel related to improve
employment, (salary plus incentive
package, or low salary plus incentive-
performance dependent pay, variable
pay etc)

62
 Environment of MCS
application of MCS in :
• service organizations
– eg Financial institutions, airlines, transport
services
• No for profit organizations
• or government entities
• Projects/ long term construction projects …
• Multinational firms

63