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Mgmt. Accounting

Classification of costs Direct Costs Easily pinned to an individual product Total = PRIME COSTS Indirect Costs Not easily pinned to an individual product aka OVERHEADS
Manufacturing costs vs Non-manufacturing costs Manufacturing costs Direct costs e.g. raw mat Production overheads e.g. factory rent Non-manufacturing costs Distribution costs e.g. petrol for delivery vans Administrative expenses e.g. office salaries Financing costs e.g. interest payable
Contribution p.u. formula = SP - VC
BEP formula & explanation BEP = FC/Contribution p.u. When activity is above BEP the business will make a PROFIT & below = a LOSS.
MoS formula and explanation Current Output – BE Output MoS = the amount by which sales could fall & we still BE
Budgeting: 7 stages in planning process 1. Establish objectives 2. Identify possible alternative strategies 3. Evaluate alternative strategies 4. Select strategy 5. Implement long-tern plan in the form of annual budget 6. Monitor actual results 7. Respond to differences from plan
Purpose of budgets (also 7) Planning annual operations Co-ordinating activities Communicating plans Providing a system of authorisation Motivating managers Controlling activities Evaluating performance
Standard costs = Target costs for each operation that are built up to give a total cost of production for each product/service.
6 Purposes of Standard costing 1. A control device 2. To help setting budgets 3. For motivation 4. To identify efficiencies 5. For decision-making 6. To simplify book-keeping
Two main approaches to establishing standards: Past historical records Engineering studies
Flexed Budgets Master Budget (prepared in advance) is important for planning, but limited use for control/evaluation purposes After period ends, a Flxd Budget based on actual activity must be prepd to compare it with actual figures, and calc cost variances.
Variance Analysis Involves a series of calculations to analyse how actual differed from standard If the difference led to an increase in profit, it is said to be a ‘favourable’ variance If the difference led to a decrease in profit, it is known as an ‘adverse’ variance
Materials Variances Material Price Variance - (SP – AP) x AQ Material Usage Variance (SQ – AQ) x SP
Labour Variances Labour Rate Variance (SR – AR) x AH Labour Efficiency Variance (SH – AH) x SR
VOH Variances Variable Overhead Expenditure Variance (usually based on labour hours) (Standard VOH rate – Actual VOH rate) x AH Variable Overhead Efficiency Variance (SH – AH) x Standard VOH rate
Fixed Overhead Expenditure Variance NB:For the purposes of variance analysis on this module, we are assuming that fixed overheads are not being absorbed Actual fixed overheads – Budgeted fixed overheads
Sales variance Sales Price Variance (Actual price – standard price) x actual volume sold Sales Margin Volume Variance (Actual volume – budgeted volume) x standard contribution per unit
Adverse materials usage variance reasons Poor wastage/pilferage control? Staff training needed? Poor quality of materials? Quality of finished goods?
Favourable materials price variance reasons Efficient purchasing department? Or uncontrollable market forces? Bulk buying? BUT note stock holding costs New supplier? BUT note reliability of supply? Inferior quality of materials?
Adverse labour efficiency variance reasons Use of lower skilled labour? Poor control by production foreman? Need for better working practices/training? Need for productivity bonuses? Need better equipment? Quality – has this improved by taking more time?
Adverse labour rate variance reasons Use of higher grade of labour? – leading to higher quality, less waste? Increased production leading to increased overtime? Increase in rates of pay? – need to revise standards
Investment decisions & the management accountant Wherever there is a significant period of time between the initial outlay and future benefits The importance of such decisions: Resources involved Difficulty of bailing out Mgmt Accountant therefore must appraise capital investment opportunities caref
Accounting Rate of Return (ARR) Least-commonly used of the four methods Only one to use forecast profits rather than cash flows Corresponds to ROI/ROCE in financial statement analysis
ARR Method of calculation: 1. Calculate the average annual profit (= Total profits over life of project/Project life) 2. Calculate the average investment (= (Initial investment + Residual value)/2) 3. Calculate the ARR = Average annual profit/Average investment
Advantages of ARR - Straightforward calculation - Readily understood by accountants; corresponds with ROCE/ROI - Managers are familiar with the concept of a % return - Superior to payback in that it at least takes account of whole project life
Disadvantages of ARR - Ignores pattern of returns and time value of money - Uses profits rather than cash flows, therefore more subjective - Expressed as a percentage only and does not reveal size of project
Payback Period Simply calculates ‘how long will it take to get our money back on this investment?’ Despite its limitations, payback is widely used in practice Can be effective as a quick filter for ‘bad’ projects ‘Discounted payback’ is an alternative
Advantages of Payback - Straightforward calculation - Quick & simple - May be significant if company has cash flow problems - Early cash flows are easier to forecast than later ones
Disadvantages of Payback - Ignores time value of money - Ignores cash flows over full life of project - Expressed as no. of years only: does not reveal size of project - Target payback periods are arbitrary - Leads to ‘short-termism’
NPV decision rule Where NPV of project is positive, accept the project Where NPV of project is negative, reject it If there are two or more mutually exclusive projects, the project with the highest NPV should be selected
Advantages of NPV - Takes full account of amount & timing of all cash flows over project life - Consistent with goal of shareholder value-maximisation - Theoretically the most sound approach
Disadvantages of NPV - May be little-understood by non-financial managers - Identification of appropriate cost of capital may be difficult
IRR decision rule IRR is simply the discount rate that results in a 0 NPV. Where the IRR > cost of capital, accept the project Where the IRR < cost of capital, reject the project Where the are mutually exclusive projects, accept the one with the highest IRR
Advantages of IRR - Some managers prefer a ‘rate’ to an NPV - No need to specify a cost of capital in order to calculate (but ‘hurdle rate’ still required
Disadvantages of IRR - Ignores overall size of project - Cannot cope with changes in cost of capital during life of project - Mathematical problems: e.g. can be more than one IRR if negative cash flows forecast during life of project
Investment appraisal: 6 other considerations 1. Query accuracy of forecasts 2. Consider non-financial factors 3. Risk assessment of projects 4. Impact of taxation 5. Effect of inflation 6. Need to identify relevant cash flows
Working capital AKA NCAs = current assets – current liabilities
Reasons for holding inventories: Transaction motive – for day to day (predictable) activities Precautionary motive – just in case - precautionary Speculative motive – prediction of price (inc) means firm want to wait until the price increases.
Costs of ordering & holding inventories: Costs of ordering inventories: Preparing orders, receiving deliveries, paying invoices Costs of holding inventories: Warehouse storage and handling costs Insurance Deterioration, pilferage (stealing) and obsolescence Opportunity cost
Costs of not holding inventories: Loss of sales Loss of customer goodwill Interruptions/stoppages to production Extra cost of emergency deliveries Higher price of emergency purchases Effective techniques for inventory management are therefore essential
Assumptions of EOQ model Demand can be predicted with accuracy Holding cost per unit is constant Demand is constant over period No buffer inventories No discounts for bulk-buying Note EOQ model can be modified to overcome some of these assumptions
Created by: wguate
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