Lecture notes

Lecture Note 1

Basic Aspects of Management Accounting

Definition of a cost

…………………………………………..........................................................................
…......................................................................................................................................

Classifications

• …………………………………….
• …………………………………….
• ……………………………………..

Measures of ‘activity level'

• …………………………………….
• …………………………………….

• ……………………………………..

Variable costs and fixed costs

• Variable costs ………………………………….. to the increased level of activity.

• Fixed costs ………………………………. whatever the level of activity.

Variable costs

Output (number of vases) 100 200 300

Cost (£s) 1,000 2,000 3,000

Total cost increases by £10 for every vase produced.

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Graph of total cost against activity

Graph of total cost per unit against activity

Non Linear Variable Costs

PO Lecture Note 1 Akila Gunarathna Wisdom Business Academy

Examples of variable costs are:

………………….…………………………………………………………
…………………………………………………………………………….
……………………………………………………………………………
……………………………………………………………………………..

Definition
A variable cost is cost which …………………………… with a measure of activity.

Fixed costs
Output (number of vases) 100 200 300
Cost (£s) 3,000 3,000 3,000

Total cost remains fixed at £3,000.

Unit cost is decreasing as output increases, because the fixed cost is spread over more
vases:

Output (number of vases) Unit cost

100
200
300

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 Graph of total cost

6000
5000

total cost in £s
4000
3000
2000
1000
0
0 100 200 300
activity in units

Examples of fixed costs are:

………………….…………………………………………………………
…………………………………………………………………………….
……………………………………………………………………………
……………………………………………………………………………..

Definition

A fixed cost is cost incurred for an accounting period, that, within certain output or
turnover limits, tends to be ……................................... by the …...............................
in the levels of activity.

Stepped Fixed Cost.

Suppose we can produce maximum 200 items per machine, 1 machine costs £3000, if
we buy another machine the marginal cost would be £2500
Output (number of items) 100 200 300
Cost (£s) 3,000 3000 5,500

PO Lecture Note 1 Akila Gunarathna Wisdom Business Academy

 ▪ The cost is constant within the relevant range for each activity
level but when a critical

level of activity is reached, the total cost incurred increases to the next step.

Semi-variable costs

Activity (number of calls) 100 200 300

Cost (£s) 2,100 2,200 2,300

Graph of semi-variable cost

Examples of semi-variable costs are:

………………….…………………………………………………………
…………………………………………………………………………….
Analysing semi-variable costs
(a)The high – low method
(b) The scatter graph method
(c)The least squares method of regression analysis

PO Lecture Note 1 Akila Gunarathna Wisdom Business Academy

(a)The high – low method

This method picks out the ……………. and ……………. activity levels from the
available data and investigates the change in cost which has occurred between them.
Example

Month Activity Level Cost Incurred £

January 1800 36600
February 2450 41150
March 2100 38700
April 2000 38000
May 1750 36250
June 1950 37650

Solution.

Activity Level Cost Incurred £

High --------------------------
Low -------------------------
Increase

Variable Cost =

Fixed Cost, take high point

£
Total Cost …...........................
Variable Cost (….............................)
Fixed Cost …..............................

(b)The scatter graph method.

This method takes account of all available historical data and its very simple to use.
Steps.
1. Draw a scatter graph plotting all available pairs of data on a graph.
2. Draw a line of best fit by eye

PO Lecture Note 1 Akila Gunarathna Wisdom Business Academy

 3. Interpret the graph
Fixed Cost =

Cost for 0 units =

Cost fr 150 units =

Gradient = = variable cost

A draw back: Prone to inaccuracies that arises due to the subjectivity and likelihood
of human error

(c)The least squares method.

Learned under Business Mathematics

The least square method, like the high -low method is used to predict linear
relationship between two
variables but unlike the high-low method, it uses all past data to calculate the line of
best fit.

Steps.
1. Create the table with columns x, y, x2, xy
2. Find b (variable cost)
3. Find a (fixed cost)
Example
Step 1
Month Activity Level Cost Incurred £ X2 XY
X Y

January 1800 36600

February 2450 41150
March 2100 38700
April 2000 38000
May 1750 36250
June 1950 37650
Total

Step 2

b=

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Step 3

a=

Calculator approach for regression analysis.

Direct costs and indirect costs

Direct cost - Expenditure that can be attributed to a specific cost unit, for exaple
material that forms part of the product.

Indirect costs -Expenditure on labour, materials or services that cannot be indentified

with a specific saleable cost unit. This is known as “Overheads”

PO Lecture Note 1 Akila Gunarathna Wisdom Business Academy

Use of Cost Behaviour Patterns

Costs for planning

Planning question
What is the cost impact of a change in levels of production over a
period of time?
What is the cost effect of planning operations in a particular location?

Costs for decision making

Decision-making question
Should the company produce components in this country or produce
them overseas?
Should the company continue to provide a service when demand is
falling?

Costs for control

Control question
Are the costs of each product within the targets set?
Is the value of stock stated correctly?

The main drawback in determination of cost behaviour.

The estimates
are usually based on data collected in the past. Events in the past may not be
representative
of the future and managers should be aware of this if they are using the information
for
planning and decision-making purposes.

PO Lecture Note 1 Akila Gunarathna Wisdom Business Academy