1 Costing 1 Dr. Clive Vlieland-Boddy FCA FCCA MBA
Mar 26, 2015
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Costing 1
Dr. Clive Vlieland-Boddy
FCA FCCA MBA
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Functions of Management
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Strategy of
Management
The Past
Annual Report
Annual Report
Annual Report
The Present
EnvironmentalScanning of current product/service mix
BudgetsForecasts
The Future
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Strategy Evaluation
Feedback
Planning
The Functions of Management
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Decentralised Operations
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© 2000 Colin Drury
Functional organizational structure
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Companies decentralize as they growSplit operations into different divisions or
operating unitsTop management delegates decision-making
to unit managersDecentralization may be based on:
Geographic areaProduct lineCustomer baseBusiness function
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Decentralization in Organizations
Benefits ofDecentralization Top management
freed to concentrateon strategy.
Top managementfreed to concentrate
on strategy.Lower-level managers
gain experience indecision-making.
Lower-level managersgain experience indecision-making. Decision-making
authority leads tojob satisfaction.
Decision-makingauthority leads tojob satisfaction.
Lower-level decisionoften based on
better information.
Lower-level decisionoften based on
better information.
Improves ability toevaluate managers.
Improves ability toevaluate managers.
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Decentralization and Segment Reporting
A segmentsegment is any part or activity of an
organization about which a manager
seeks cost, revenue, or profit data. A
segment can be . . .
Canadian TireCanadian Tire
An Individual Store
A Sales Territory
A Service Centre
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Advantages of Decentralization
Better information leading to superior decisions
Managers can respond quicker to changing circumstances
Increased motivation of managers Provides excellent training for future top-level
executives Frees top management time
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Disadvantages of Decentralization
Costly duplication of activities Lack of goal congruence
Management pursues personal goals Personal goals are incompatible with the
company’s goals To control goal congruence, companies evaluate
the performance of subunit managers
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Copyright (c) 2009 Prentice Hall. All rights reserved.
Advantages of decentralization
Disadvantages of decentralization
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Why Companies Evaluate the Performance of Subunits and Subunit Managers
A company evaluates subunits in order to decide if it should expand or contract them or change their operations
A company evaluates subunit managers in order to motivate them to take actions that maximize the value of the firm
Reasons for evaluating subunit managers: Identifies successful operations and areas
needing improvement Influences the behavior of managers
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Responsibility Accounting and Performance Evaluation
Responsibility accounting is a technique that holds managers responsible only for costs and revenues that they can control
To implement responsibility accounting in a decentralized organization, costs and revenues are traced to the organizational level where they can be controlled
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Responsibility Centres
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Cost, Profit, and Investment Centres
ResponsibilityCentre
ResponsibilityCentre
CostCentreCost
CentreProfit
CentreProfit
CentreInvestment
CentreInvestment
Centre
Cost, profit,and investmentcentres are allknown asresponsibilitycentres.
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Cost Centre A segment whose manager has control
over costs, but not over revenues
or investment funds.
CostCost
Cost
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Profit Centre A segment whose manager has control over both costs and
revenues, but no control over
investment funds.
RevenuesSalesInterestOther
CostsMfg. costsCommissionsSalariesOther
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Investment Centre
A segment whose manager has control
over costs, revenues, and investments in
operating assets.
Corporate Headquarters
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Cost Centres
Parts of the business to which particular costs can be attributed
In large businesses this can be a particular location, section of the business, capital asset or human resource/s
Enable a business to identify where costs are arising and to manage those costs more effectively
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Subunit of an organization whose manager is accountable for specific activities
Copyright (c) 2009 Prentice Hall. All rights reserved.
Responsibility Center
Manager is responsible for:
Cost center Controlling costs
Revenue center Generating sales revenue
Profit center Producing profit by generating sales and controlling costs
Investment center
Producing profit and managing the division’s invested capital
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© 2000 Colin Drury
Functional organizational structure
IC= Investment Centre CC = Cost Centre RC = Revenue Centre
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Performance Management
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When companies decentralize, top management needs a system to communicate goals to subunit managers
Primary goals:Promoting goal congruence and coordinationCommunicating expectationsMotivating unit managersProviding feedbackBenchmarking
Copyright (c) 2009 Prentice Hall. All rights reserved. 24
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Financial Accounting measures tend to be lag indicators
“After the fact”
Management Accounting are lead indicators“Before the fact”
Copyright (c) 2009 Prentice Hall. All rights reserved. 25
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Trading Statement
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Total Revenue
Total Revenue = Price x Quantity Sold Price can be raised or lowered to change revenue –
price elasticity of demand important here Different pricing strategies can be used – penetration,
psychological, etc.
Quantity Sold can be influenced by amending the elements of the marketing mix
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Manufacturing Companies: Income Statement
Sales
- Cost of goods sold
Gross profit
- Operating expenses
Operating income
Opening Inventories
Add Purchases
Less Closing Inventories
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Manufacturing (Product) Costs
Direct Manufacturing Costs are easily traced to the product. These include: Direct Materials Direct Labor
Indirect Manufacturing Costs are not as easily traced to the product and are usually pooled together in Manufacturing Overhead (MOH)
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What is Contribution
Contribution is the management accounting term for gross profit.
In other words, sales less the cost of goods sold.
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Contribution
Contribution Margin Per Unit This is Gross Profit that each unit contributes
towards the general overheads and net income Contribution Margin Ratio
The contribution margin as a % of sales. (Same as Gross Profit Margin %.
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Costs and Budgeting
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Cost Behaviour
Costs can be a function of units of production or time.
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There are several different types of costs:
Fixed Costs
Variable Costs
Stepped Costs
Semi Variable Costs
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Fixed Costs
These costs do not vary with production levels.
Example: Property costs like rent Municipal taxes and insurance have to be paid even if you only produce one ice cream.
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Variable Costs
These are as it says, costs that will vary with production.
Example: A manufacture of Ice Cream will have costs of milk that are directly proportionate to the production. Ie say 10 gallons of milk to11 gallons of ice cream.
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Stepped Costs
These are costs that are variable but not directly proportionate to production.
Example:
Rental of a warehouse. Once full, another is required so costs step up
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Semi Variable Costs
Include a variable and fixed cost elements.
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Budgeting & Forecasting
Strategy needs to be taken and developed into a financial plan.
There needs to be objective for the future. Benchmarks need to be created so as to be
able to evaluate the business against its planned path
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Chapter 10
Operating Budget
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Chapter 10
Financial Budget
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Chapter 10
Budget Objectives
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Chapter 10
Budget Cycle
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COSTING Cost accounting system provides
information about cost Aim : best use of resources and
maximization of returns
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Costs
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Costs Anything incurred during the production of the
good or service to get the output into the hands of the customer
The customer could be the public (the final consumer) or another business
Controlling costs is essential to business success
Not always easy to pin down where costs are arising!
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Common Types Of Cost Behavior
Fixed Costs: Costs that fundamentally are not driven by changes in volume
Variable Costs: Costs that change directly and proportionately with the volume of activity
Semi Variable Costs: Costs that contain both a fixed and a variable component. Also called Semi Variable or stepped.
Others
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Traceable and Common Fixed Costs
FixedCosts
TraceableTraceable CommonCommon
Costs arise becauseCosts arise becauseof the existence ofof the existence of
a particular a particular segment.segment.
Costs arise becauseCosts arise becauseof overall operatingof overall operating
activities.activities.
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Traceable and Common Fixed Costs
FixedCosts
TraceableTraceable CommonCommon
Costs arise becauseCosts arise becauseof the existence ofof the existence of
a particular segment.a particular segment.
Costs arise becauseCosts arise becauseof overall operatingof overall operating
activities.activities.
Don’t allocateDon’t allocatecommon costs.common costs.
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U.S. Sales Foreign Sales
Regular
U.S . Sales Foreign Sales
Big Screen
T elevisionDivision
Traceable Costs Can Become Common Costs
ProductProductLinesLines
SalesSalesTerritoriesTerritories
Webber’s Television Division
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Inappropriate Methods of Allocating Costs Among Segments
Segment3
Segment4
Failure to traceFailure to tracecosts directlycosts directly
Arbitrarily dividingArbitrarily dividingcommon costscommon costs
among segmentsamong segmentsInappropriateInappropriate
allocation baseallocation base
Segment2
Segment1
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Costing Methods
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Standard Costing
The forecasted expected cost per unit.
Example: A ball point pen manufacturer:Cost of Plastic case 0.07pCost of Cartridge 0.04pLabour to assemble 0.15pPackaging
0.01pStandard Cost 0.27p
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benchmarks formeasuring performance.
the expected levelof performance.
used for planning labourand material requirements.Standard
costs are
based on carefullypredetermined amounts.
Using Standard-Costing Systems for Control
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STANDARD COSTa budget for the
production of one unit of product or
service
STANDARD COSTa budget for the
production of one unit of product or
service
ACTUAL COSTincurred and
recorded in the production of the product or service
ACTUAL COSTincurred and
recorded in the production of the product or service
COST VARIANCE the differencebetween the
actual cost andthe standard cost
COST VARIANCE the differencebetween the
actual cost andthe standard cost
Using Standard-Costing Systems for Control
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Pro
du
ct c
ost
Standard
A standard cost varianceis the amount by which
an actual cost differs fromthe standard cost.
This variance is unfavorable because the actual cost
exceeds the standard cost.
Using Standard-Costing Systems for Control
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Directmaterials
Managers focus on quantities and coststhat deviate significantly from standards
(a practice known as management by exception).
Type of Product Cost
Am
ou
nt
Directlabor
Standard
Management by Exception
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Take the time to investigate only significant cost variances.
Take the time to investigate only significant cost variances.
What is significant?What is significant?
Depends on the size of theorganization
Depends on the size of theorganization
Depends on the type of the organization
Depends on the type of the organization
Depends on the production
process
Depends on the production
process
Management by Exception
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Prepare standard cost performance
report
Conduct next period’s
operations
Analyze variances
Identifyquestions
Receive explanations
Takecorrective
actions
Begin
Variance Analysis Cycle
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Analysis ofhistorical
data
Analysis ofhistorical
data
Taskanalysis
Taskanalysis
Used in a mature production process
Used in a mature production process
Analyze the processof manufacturing
the product
Analyze the processof manufacturing
the product
What DIDthe product
cost?
What DIDthe product
cost?
What SHOULD the
product cost?
What SHOULD the
product cost?
Combinedapproach
Combinedapproach
Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed
Analyze the process for the step thathas changed, but use historical datafor the steps that have not changed
Setting Standards
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Marginal Costing
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The layman’s language
The only cost of driving my caron a 200 mile trip today is
$12 for gasoline.
MarginalCosting
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Marginal or Variable Costing
Used for internal planning and decision making
Does not include fixed factory overhead as a product cost
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Advantages of variable/marginal costing Variable costing is simple to understand It provides more useful information for decision-making Avoids fixed overheads being incorporated into the costs
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Disadvantages of variable/marginal costing
The separation of costs into fixed and variable is difficult and sometimes gives misleading results
It underestimates the importance of fixed costs Application of fixed overhead depends on estimates. There may be
under or over absorption of the same A system which ignores fixed costs is less effective since a major
portion of fixed cost is not taken care of under marginal costing In practice, sales price, fixed cost and variable cost per unit may vary.
Thus, the assumptions underlying the theory of variable/marginal costing sometimes becomes unrealistic. For long term profit planning, absorption costing is the only answer
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Absorption Costing
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No! You must consider these costs too!
AbsorptionCosting
Cost Per month Per day
Car Leasing 300.00$ 10.00$
Insurance 60.00 2.00
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Absorption/Costing
Includes direct materials, direct labour, variable factory overhead, and allocates fixed factory overhead as part of total product cost
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Absorption costing
Costing method which involves or “absorbs” all the costs necessary to produce the product into its saleable form.
It is both the marginal and the fixed costs Also known as “Full costing”
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Absorbing Overheads
Having fixed the overhead consumption rate based on forecast.
If we under produce we recover insufficient overheads.
If we overproduce we recover excessive overheads.
In essence we under or over absorb the overheads.
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Overview of Absorption and Marginal Costing
Direct Materials
Direct Labor
Variable Manufacturing Overhead
Fixed Manufacturing Overhead
Variable Selling and Administrative Expenses
Fixed Selling and Administrative Expenses
MarginalCosting
AbsorptionCosting
ProductCosts
PeriodCosts
ProductCosts
PeriodCosts
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Summary
Variable/Marginal Costing Solves the Forecasting Problem in Pricing
Variable/Marginal Costing focuses on Variable and Incremental Costs
With Variable/Marginal Costing you will be able to calculate: Floor Price Out of Pocket Price Break Even Price Target Profit Price Most profitable sales mix Profitable Sales Strategies
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Managements Use of Costing
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MANAGEMENT
DECISIONS
Controlling Controlling CostsCosts
PricingPricingPlanning Planning
ProductionProduction
Analyzing Analyzing Market Market
SegmentsSegments
Analyzing Analyzing Contribution Contribution
MarginsMargins
ACTUAL PLANNED
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Question 1
An investment center is responsible for:a. Investing in long term assets
b. Controlling costs
c. Generating revenues
d. All of the above
Answer:
d. All of the above
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Question 2
An cost center is responsible for:a. Investing in long term assets
b. Controlling costs
c. Generating revenues
d. All of the above
Answer:
b Controlling Costs
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Question 3
An profit center is responsible for:a. Investing in long term assets
b. Controlling costs
c. Generating revenues
d. B and C
Answer:
d. Controlling revenues and costs
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Question 4
An investment center is responsible for:a. Investing in long term assets
b. Controlling costs
c. Generating revenues
d. All of the above
Answer:
d. All of the above
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Question 5
Absorption Costing:a. Ignores all fixed costs
b. Is a better way to evaluate cost centres.
c. Includes variable and fixed manufacturing costs
d. B and c are correct.
Answer:
d.
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Question 6
Gross Profit is defined asa. Sales less cost of sales
b. Sales less purchases
c. Sales less overheads
Answer:
a.
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Question 7
Contribution is another expression of?:a. Net Profit
b. EBIT
c. Gross Profit
Answer:
c. It is the management accounting expression for gross profit
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Question 8
Why should be distinguish between Traceable and non traceable costs?:
a. To ensure we can correctly allocate costsb. To divide up Variable costsc. To divide up fixed costsd. All above are correct
Answer:d.
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Question 9
Standard Costing is creating?:a. A forecasted summary of expected costsb. A tool for evaluating performancec. Reveals a variance when actual is compared to
forecasted.d. All the above are correct
Answer:d.
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Question 10
A variance shows?:a. Either a Favourable or Unfavourable departure
from Budgeted activity.b. A tool for evaluating performancec. Enables management by exception.d. All the above are correct
Answer:d.
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Question 11
Marginal Costing?:a. Takes only the costs that vary with production.
b. Takes the variable and fixed costs that are traceable to production.
c. Only takes the Fixed costs.
Answer:
b.
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Question 12
Absorption Costing?:a. Takes all costs both variable and fixed.
b. Is a good management tool as it allocates all costs to the product.
c. Both a and b are correct
Answer:
c.