(Janet Walker) CIMA Revision Cards Management Acc (BookFi)

CIMA REVISION CARDS
Management Accounting
Fundamentals
Janet Walker
Certificate Level Paper C1
AMSTERDAM l BOSTON l HEIDELBERG l LONDON l NEW YORK l OXFORD

PARIS l SAN DIEGO l SAN FRANCISCO l SINGAPORE l SYDNEY l TOKYO
Elsevier Butterworth-Heinemann
Linacre House, Jordan Hill, Oxford OX2 8DP
30, Corporate Drive, Burlington, MA 01803
First published 2005
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Welcome to CIMA’s Official Revision Cards. These cards have been designed to:
. Save you time by summarising the syllabus in a concise form
. Jog your memory through the use of diagrams and bullet points
. Follow the structure of the CIMA Official Study Systems
. Refer to relevant questions found within the Preparing for the Assessment section of the study system
. Provide you with plenty of assessment tips and hints
Ensure assessment success by revising with the only revision cards endorsed by CIMA.
TABLE OF CONTENTS
1. Basic aspects of cost accounting .................................................. 1
2. Materials .............................................................................. 11
3. Labour ................................................................................. 19
4. Overhead .............................................................................. 25
5. Specific order costing ............................................................... 31
6. Continuous operation costing ....................................................... 37
7. Bookkeeping systems ............................................................... 55
8. Absorption costing and marginal costing.......................................... 63
9. Breakeven analysis and decision-making ......................................... 71
10. Budgetary planning and control .................................................... 87
11. Standard costing and variance analysis ........................................... 101
Basic Aspects of
Cost Accounting
The fundamental concepts of the framework of cost accounting
Topics
. Cost units and cost centres
. The classification of costs
Key study system questions . The coding of costs
. The elements of cost
1 Cost behaviour . Cost behaviour patterns
3 High-low method . Analysing semi-variable costs
1
Basic Aspects of Cost Accounting
Cost units and cost centres
Definitions
Cost unit – a unit of product or service in relation Cost unit examples

to which costs are ascertained Product: litre of paint, batch of cakes
Cost centre – a production or service location, Service: restaurant meal, tonne-mile
function, activity or item of equipment for which
costs are accumulated

The link between cost centres and Cost centre examples
cost units Location: production department A
Function: administration
A cost centre acts as a collecting place for costs. Activity: invoice processing
The total cost centre cost may then be related to
the cost units which have passed through the cost Item of equipment: stamping machine
centre to determine a cost per unit
2
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The classification of costs
Costs are classified so that they can be arranged

into logical groups for further analysis
Types of cost classifications
KKK
Nature of cost: material, labour or expense

Direct or indirect
Indirect costs are also referred to as
overheads
Functional analysis: production, selling,
distribution, administration
Semi-fixed, semi-variable or mixed costs
KK
Fixed or variable are partly fixed and partly variable

Controllable and non-controllable: important
when preparing management information
K
Normal and abnormal: highlighting abnormal

events draws them to managers’ attention
K
Relevant and non-relevant: in respect of

a particular decision
3
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The coding of costs
Definition Requirements for efficient coding

system
Code – a system of symbols designed to be
KK
applied to a classified set of items to give a brief Each code should be unique and certain
accurate reference, facilitating entry, collation and Coding system should be comprehensive and
analysis capable of expanding to include new items
KKK
Code numbers should be as brief as possible
Incorporate check digits in computerised codes
Advantages of a coding system Only authorised personnel permitted to add new
codes to system
K
Code numbers should all be of the same length
KKK
A code is usually briefer than a description

Reduces ambiguity
Assists computerised processing of data
4
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The elements of cost
Study tip
Remember this!
A sound understanding of the difference between Direct costs are those that can be specifically
total direct cost, total production cost and total identified with a particular cost unit
cost will help you in assessment questions on a
variety of different topics
Direct materials
þ Direct labour
þ Direct expenses
¼ Total direct cost Total direct cost is also referred to as
þ Indirect materials
prime cost
þ Indirect labour Indirect materials, indirect labour and indirect
þ Indirect expenses expenses associated with production are
¼ Total production cost also referred to as production overhead
þ Other overhead Other overhead includes selling,
¼ Total cost distribution and administration overhead
5
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Cost behaviour patterns
Cost behaviour patterns describe the way that costs behave in relation to changes in the level of activity.
Definition
Fixed cost – a cost which, within certain activity

limits, is not affected by fluctuations in the level of
activity
Examples of fixed costs

KK
Rent of the factory

Accountant’s salary
Definition
Stepped fixed cost – a cost which remains constant

for a range of activities, but which increases to the
next step when a critical level of activity is reached
Examples of stepped fixed costs

KK
Supervisors’ salaries
Machine rentals
6
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Cost behaviour patterns
Definition
Variable cost – a cost which varies in relation to

the level of activity
Examples of variable costs

KK
Packaging material costs

Royalties
Definition
Semi-variable cost – a cost containing both

fixed and variable components and which is thus
partly affected by a change in the level of activity
Examples of semi-variable costs Semi-variable costs are also referred to as

semi-fixed or mixed costs
KK
Telephone expenses
Gas and electricity bills
7
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Analysing semi-variable costs
The high-low method Example

Activity level Cost
KK
Uses historical data on costs and activity levels

Selects the highest and lowest activity levels and 450 units £ 4,675
assumes that the change in cost between the 220 units £ 4,330
levels is caused by the change in variable cost 800 units £ 5,200
K
Variable cost per unit of activity is determined by Analyse the cost into its fixed and variable components.
dividing change in total cost by change in activity
level
Solution
K
Fixed cost determined by substituting variable

cost per unit into either of the activity levels
£ ð5;200 4;330Þ
Variable cost per unit ¼
ð800 220Þ
Study tip
¼ £ 1:50
This is a very important technique. It is vital Fixed cost ¼ £ 5;200 £ ð1:50 800Þ
that you are able to apply it to a wide variety of ¼ £ 4;000
data. The activity measure will vary but the
technique remains the same
8
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Analysing semi-variable costs
Scattergraph
KKK
Uses historical data on costs and activity levels

All available pairs of data plotted on graph
Line of best fit is drawn by eye
Example
Fixed cost ¼ vertical axis intercept ¼ £ 200
Variable cost per unit ¼ gradient of line of best fit
£ ð500 200Þ
¼
ð150 0Þ
¼ £ 2 per unit
Variable cost per unit is given by gradient

of line
Fixed cost is given by intercept on vertical
axis, i.e., cost at zero activity 9
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Materials
Materials accounting and control procedures
Key study system questions Topics

8 Stock level calculations . Recording stock movements
11 Stock control . Stock control levels
12 Stock valuation methods . Stock valuation
11
Materials
Recording stock movements
Ordering and receiving stock Alternatively, a special order item might be

required
1 Stockholding falls to reorder level
2 Storekeeper raises purchase requisition

Details goods required. Copy sent to buying
department
Copy sent to supplier, to accounts

3 Buying department completes purchase order
department and to storekeeper to confirm
goods are on order
Supplier may also leave a delivery note

4 Goods received from supplier and goods Copy of GRN sent to accounts department
received note (GRN) completed and to buying department
Invoice checked against purchase order

5 Supplier’s invoice received and GRN before being authorised for
payment
12
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Materials
Issuing stock from stores

1 Department requiring materials raises material
Details materials required and correct cost
requisition centre, or cost, unit to be charged with use
of materials
Ensures that cost of unused material is

2 Excess materials returned to stores are credited to relevant cost centre, or cost unit,
recorded on a materials returned note and stock records are updated
3 Excess materials transferred to another job

Ensures that cost of material is charged to
without first returning to stores are recorded correct cost centre or cost unit
on a materials transfer note
13
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Materials
Recording and checking stock

balances
K
Bin cards and/or stores ledger cards record all

transactions and show continual record of stock
This is known as a perpetual inventory
system
balance
K
Stock may be counted and checked against stock

records annually on a particular date
K
Alternatively, a number of items may be counted Continuous stocktaking cannot be carried

and checked against records each day. This is
out unless a perpetual inventory system
continuous stocktaking. Each item is checked
exists
at least once a year
14
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Materials
Stock control levels
Stock kept at optimum level to minimise risk of Study tip

stock-outs and the costs of ordering and storing
stock. Usually achieved by monitoring free stock You must memorize all the formulae on this card.
balance ¼ physical stock þ stock on order with They will not be provided in the assessment
suppliers outstanding requirements unfulfilled
Reorder level ¼ maximum usage maximum lead time

Reorder level ¼ level of free stock at
which an order should be placed for
replenishment stock
Minimum level ¼ reorder level (average
usage average lead time)

Minimum and maximum are warning
Maximum level ¼ reorder level þ reorder levels
quantity (minimum
usage minimum lead time)
Average stock ¼ safety stock þ ½ reorder quantity Minimum stock often used as safety stock
in this formula
15
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Materials
Stock control levels
Definition
As carrying costs increase the ordering costs
Economic order quantity – the order size which reduce
minimises the sum of stock ordering costs and

stockholding
qffiffiffiffiffiffifficosts
2Co D
EOQ ¼ Ch
Study tip
The EOQ formula will be provided in the

assessment if you need it. But make sure that you
know the meaning of each of the terms in the

formula
EOQ ¼ when total cost is

minimised ¼ point at which carrying cost is
EOQ theory assumes average stock
equal to ordering cost
¼ order quantity/2, i.e. no safety stock is held
16
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Materials
Stock valuation
FIFO method
Stock valuation methods
Value of issues 7th March ¼ (200 units £ 2.00)
þ (100 units £ 2.35)
K
First In First Out (FIFO) – prices issues at the

price of the oldest items in stock ¼ £ 635
Value of closing stock ¼ 400 units £ 2.35 ¼ £ 940
K
Last In First Out (LIFO) – prices issues at the

price of the latest items received into stock
LIFO method
K
Weighted average (AVCO) – prices issues at the

weighted average price of items in stock Value of issues 7th March ¼ 300 units £ 2.35 ¼ £ 705
Value of closing stock ¼ (200 units £ 2.00)
Example data þ (200 units £ 2.35) ¼ £ 870
Opening stock 1st March 200 units at £ 2.00 per unit AVCO method
Purchases 5th March 500 units at £ 2.35 per unit Average price ¼ ((200 £ 2.00) þ (500 £ 2.35))/700
Issues 7th March 300 units ¼ £ 2.25 per unit
Value of issues 7th March ¼ 300 units £ 2.25 ¼ £ 675
Value of closing stock ¼ 400 units £ 2.25 ¼ £ 900
17
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Materials
Stock valuation
When prices are rising FIFO LIFO AVCO

Closing stock valuation Highest Lowest Between FIFO and LIFO
Charge to cost of sales Lowest Highest Between FIFO and LIFO
Reported profit Highest Lowest Between FIFO and LIFO
Calculating the weighted average price

Revised average price usually calculated
whenever new batch received into stock ¼
cumulative weighted average
If single average calculated at period end based
on total purchases for period ¼ periodic moving
average
18
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Labour
Labour accounting and control procedures
Topics
Key study system questions . Remuneration systems

. Labour turnover
14 Labour remuneration . Time and activity recording systems
15 Labour remuneration . Classification of labour costs
19
Labour
Remuneration systems
Time-based systems Piecework systems Bonus schemes

K
K
Employee paid for hours Employee paid for output Employee paid a bonus for
attended: hours attended achieved: output time saved against agreed
agreed hourly rate achieved piecework rate per target
K
K
Wages not dependent on unit Benefit of efficiency shared
K
output achieved May include guaranteed between employee and
K
Overtime hours usually paid at minimum wage employer

K
KK
premium above basic rate Differential system pays Many different schemes
K
Suitable where: output difficult increasing rates for higher May be applied to groups
to measure, activities output: important to state if where: operations carried out
undertaken vary widely, higher rates apply to additional in groups, not possible to
quality of output important units only measure individual
KK
Important to check quality performance, whole group

Suitable where quantity of must work faster to exceed
output is important targets
20
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Labour
Labour turnover
Benefits
Definition
May help to reduce turnover and encourage higher
Labour turnover – a measure of the number of morale among workforce. For example:
KKKKKK
leavers relative to the size of the workforce. company cars
Usually expressed as a percentage staff discounts
subsidised canteen
health insurance
number of leavers replaced pension scheme
Labour turnover ¼ crèche facilities
average number of employees
100%
Study tip
Learn this formula. It will not be provided in the

exam
21
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Labour
Time and activity recording systems
Time recording systems Activity recording systems

KK
K
Important for time-based employees Important for employees who are paid according
Also important for reconciling analysis of total to output
KKKK
time in jobbing environment Also important in a jobbing environment
K
Clock cards: record starting and finishing times. Piecework/bonus ticket

May be mechanical or electronic Time sheets: daily or weekly
K
Important, with flexible time working for Important to record and report on idle time ¼
employees, to know cumulative hours worked when employee is being paid but not doing
in current period productive work
22
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Labour
Classification of labour costs
Usually treated as direct labour Usually treated as indirect labour

KKK
KK
Basic pay of direct workers All payments to indirect workers
Basic rate of direct overtime hours worked Overtime premium and bonus payments unless
Overtime premium and bonus payments which directly attributable to specific job
KK
can be identified with specific customer or job Idle time payments
Holiday pay, sick pay, etc.
Example data
Direct employees Indirect employees Solution
Basic pay £ 37,800 £22,300
Direct wages ¼ £ 37;800 þ ð2=3 £ 3;900Þ
O/time pay
(time þ ½) £ 3,900 £5,100 ¼ £ 40;400
Idle time £ 400 Indirect wages ¼ £ 30;800 þ ð1=3 £ 3;900Þ þ £ 400
Bonuses paid £ 2,700 £ 3,400 þ £ 2;700
Total £ 44,800 £ 30,800 ¼ £ 35; 200
23
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Overhead
The analysis of overhead
Topics
Key study system questions
. Overhead analysis
17 Overhead absorption . Overhead apportionment
18 Overhead absorption rates . Overhead absorption
21 Overhead analysis . Under/over absorption
25
Overhead
Overhead analysis
Definitions
Remember
Overhead – expenditure on labour, materials or Overhead costs are also called indirect costs
services which cannot be economically identified
with a specific saleable cost unit
Absorption costing – a method of costing that, in
addition to direct costs, assigns production Three stages in overhead analysis
overhead costs to cost units by means of
overhead absorption rates
K
Allocation. Allot whole items of overhead to
Production cost centre – a cost centre that is individual cost centres, e.g., allocate
directly involved with the production of the storekeeper’s wages to stores cost centre
K
organisation’s output Apportionment. Apportion remaining overhead
Service cost centre – a cost centre that provides between cost centres on an equitable basis,
support services to the production cost centres, e.g., apportion factory rent over several cost
e.g., maintenance, stores, canteen centres on basis of floor area
K
Absorption. Absorb total cost centre production
overhead costs into cost units
26
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Overhead
Overhead apportionment
Apportionment and re-apportionment Reciprocal servicing

K
K
Once all possible direct allocations have been Occurs when service cost centres provide service
made, apportion the remaining production to each other
K
overhead costs to production and service cost Take account of reciprocal servicing by repeated
centres on an equitable basis distribution of service cost centre total
K
Then re-apportion the total of the service cost overheads to production cost centres and to other
centre costs to production cost centres service cost centres until amounts involved
become negligible
Remember
After the apportionment stage you should end
up with overheads attributed to production cost
centres only
27
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Overhead
Overhead absorption
Total overhead of production cost centre is absorbed into Main bases of overhead absorption
unit costs, using pre-determined overhead absorption
rate (OAR):
K
Rate per unit – only suitable if identical units
budgeted production overhead for cost centre produced
OAR ¼
K
Direct labour hour rate – suitable for
budgeted units of absorption base
labour-intensive cost centres
K
Machine hour rate – suitable for
machine-intensive cost centres
Reasons for pre-determined OARs
Study tip
K
Overhead not incurred evenly over period: actual

rates per unit subject to wide fluctuation
A common error is to use the actual
K
Activity levels may fluctuate during period: OAR

overhead and activity figures to determine the
would also fluctuate
OAR. Remember that OARs are pre-determined,
K
Managers have an overhead rate available for

based on budgeted figures for the period.
use in product costing, price quotations, etc.
28
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Overhead
Under/over absorption
Pre-determined OARs result in under or over absorption Example

due to either or both of the following: Machining department results for latest period:
Actual Budget
KK
actual overhead is different from budget

actual activity level is different from budget Machine hours 23,800 22,700
Production overhead £ 8,330 £ 9,080
Actual overhead > absorbed overhead ¼ under absorbed
Actual overhead < absorbed overhead ¼ over absorbed Solution
Pre-determined OAR ¼ £ 9,080/22,700
¼ £ 0.40 per machine hour
Overhead absorbed ¼ 23,800 hr £ 0.40 ¼ £ 9,520
Overhead incurred £ 8,330
Over-absorbed overhead £ 1,190
29
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Specific Order Costing
Job, batch and contract costing systems

Topics
22 Specific order costing
25 Job/batch costing . Job and batch costing
26 Specific order costing . Contract costing
31
Job and batch costing
Definition Characteristics of batch costing
KK
Similar to job costing
Specific order costing – the basic cost
Each batch is a group of similar articles, which
accounting method applicable where work
is separately identifiable from all other batches
consists of separately identifiable contracts, jobs
K
Cost per item within batch ¼
or batches
total batch cost
number of items in batch
Characteristics of job costing

K
Customer-driven production. Jobs are

undertaken as the result of a customer request
Relatively short duration
KKK
Each job is a separately identifiable unit

Jobs are of relatively short duration

Compared with those to which contract
Each job has a unique number. Costs are costing is applied
accumulated against the number on a job card
32
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Job and batch costing
Example
Data for job no. 9364 is as follows: Solution
Direct material £ 465.00
Direct material cost £ 465
Direct labour £ 790.00
Direct labour cost £ 790
Direct expense £ 250.00
Hire of special machine £ 250
Prime cost £ 1,505.00
Production overheads are absorbed at a rate of 30 per Production o’head (£ 790 30%) £ 237.00
cent of direct labour cost. Other overheads are added at Total production cost £ 1,742.00
a rate of 10 per cent of total production cost. The required Other overhead (£ 1,742 10%) £ 174.20
profit margin for each job is 15 per cent of the sales price. Total cost £ 1,916.20
Profit margin (£ 1,916.20 15/85) £ 338.15
Calculate the selling price of job no. 9364, to the nearest
Selling price £ 2,254.35
penny. Show separate subtotals for prime cost, total
production cost and total cost
Study tip
Be careful! Sometimes the required profit is

expressed as a percentage of the total job cost
33
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Contract costing
Characteristics of contract costing The contract account

K
K
Customer-driven production. Contracts are Acts as a collecting place for costs incurred on
undertaken as the result of a customer request contract
K
K
Each contract is a separately identifiable unit, Debit all costs incurred during period,
usually constructional in nature e.g., materials issued to contract, wages paid,
K
Contracts are of relatively long duration and plant delivered to site, head office charges
K
often span more than one accounting period Credit value of plant or material returned or
K
Costs accumulated in separate account for transferred from site during period
K
each contract Credit value of plant and material on site at end of
K
Architect’s certificates state the value of work period
KK
completed to date. Progress payments are made Credit cost of work not yet certified
by customer according to value of work certified, Balance on account ¼ cost of work certified
less any retention money during period
34
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Contract costing
Recognising profits on contracts Study tip

K
Profit recognised in stages as contract

Many different methods exist for calculating the
progresses. Otherwise wild fluctuations in profits
profit to be recognised on an incomplete contract.
reported year on year
In the assessment you should assess the
K
Requirements of prudence concept must be

information available and follow any instructions
adhered to
concerning the calculation of profit
K
No profit recognised if contract in early stages

and final outcome cannot be foreseen with
reasonable certainty
K
If difficulties or a loss are foreseen the whole

of the final estimated loss on contract should
be recognised immediately
35
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Contract costing
Example Solution
Agreed contract price £ 380,000 (a) Profit to be recognised ¼ notional profit to
Value of work certified to date £ 340,000 date (cash received/value of work certified)
Progress payments received from ¼ £ (340,000 275,000) £ (289,000/340,000)
customer £ 289,000 ¼ £ 55,250
Cost of work certified to date £ 275,000 (b) Profit to be recognised ¼ estimated final
Cost of work to complete contract £ 35,000 profit (cost incurred to date/estimated final
contract cost)
(a) Profit to be recognised is a percentage of the
notional profit to date, based on the proportion of Estimated final contract cost ¼ £ ð275;000 þ 35;000Þ
the certified value received from the customer ¼ £ 310;000
(b) Profit to be recognised is a percentage of the
Profit to be recognised ¼ £ ð380;000 310;000Þ
estimated final contract profit, based on the
proportion of total contract costs incurred to date £ ð275;000=310;000Þ
¼ £ 62;100
36
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Continuous Operation
Costing
Service costing and process costing systems
Topics
Key study system questions . Introduction to continuous operation costing

. Service costing
27 Process costing . Fundamentals of process costing
28 Joint products . Work in progress
29 Process costing . Process losses
32 Service costing . Joint products and by-products
37
Continuous Operation Costing
Introduction to continuous operation costing
Costs cannot be identified with individual cost units,

Definition
therefore an averaging process is necessary to derive
a unit cost
Continuous operation costing – the costing
method applicable where goods or services result total costs incurred
from a sequence of continuous or repetitive Average cost per unit ¼
number of units produced
operations or processes. Costs are averaged over
the units produced during the period, being initially
charged to the operation or process
Unlike specific order costing, which is applicable
when each cost unit can be separately identified
from all others, continuous operation costing is
used in situations where operations result in
a continuous flow of identical units
38
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Service costing
Characteristics of service costing Composite cost units

Often used in services because of problem of
K
High levels of indirect cost as a proportion of total comparability of unit costs, e.g., cost per tonne
costs transported will depend on distance travelled.
K
Can be difficult to establish a measurable cost Comparison easier for control purposes with cost
unit per tonne-kilometre
K
‘Output’ is often intangible, i.e., cannot be

physically seen and touched total costs incurred
Cost per service unit ¼
K
Often provided instantaneously, rather than for number of units supplied

stock, e.g., office cleaning service
K
Many services ‘perish’ immediately. Cannot be

stored for later use, e.g., seat on coach journey.
Capacity utilisation is therefore an important
issue
K
May be provided for external customer, e.g., hotel

service, or for internal use, e.g., canteen
39
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Service costing
Example Solution
A hotel’s records for last period include the following No. of guests Length of stay Guest-
information: (nights) nights
150 1 150
No. of guests Length of stay
230 2 460
(nights)
76 4 304
150 1
460 7 3,220
230 2
334 14 4,676
76 4
8,810
460 7
334 14 Laundry cost per guest-night ¼ £ 18,530/8,810 ¼ £ 2.10
Laundry cost £ 18,530
Calculate the laundry cost per guest-night
40
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Fundamentals of process costing
Characteristics of process costing Preparing process accounts

K
K
Production consists of a continuous flow of Include a column for units as well as value on
identical units, e.g., food manufacture both sides of account
K
KK
Usually a sequence of processes, where output Debit units and value of any opening WIP
from one process becomes input of next If not first process in sequence, debit units and
KK
Separate account maintained for each process value of transfer from previous process
K
Work in progress (WIP) at period end may be Debit all costs incurred, including absorbed
complete to different degree for each cost overhead if appropriate
KK
element Credit units of normal loss and any scrap value
K
Losses may occur in process. The losses may Credit abnormal loss/debit abnormal gain units
have a scrap value and full cost value (not scrap value)
K
K
Joint products or by-products may be produced Credit units and value of finished output and
closing WIP
41
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Work in progress
Closing work in progress (WIP) Solution

If closing WIP is complete to a different degree for Equivalent units
each cost element, it is necessary to calculate Output units Materials Conv. costs
equivalent units of production for each cost element F. Goods 900 900 900
Closing WIP 100(100%) 100(60%) 60
1,000 1,000 960
Costs £ 4,000 £ 2,400
Cost per
equiv. unit £ 6.50 £4 £ 2.50
Example Valuation:
Opening WIP nil Finished
Input materials 1,000 units @ £ 4 per unit goods £ 5,850
Conversion cost £ 2,400 Closing WIP £ 550 £ 400 £ 150
Outputs: Finished goods: 900 units (100 £ 4) (60 £ 2.50)
Closing WIP: 100 units
WIP is completed: 100% as to material cost Conversion cost ¼ labour and overhead
60% as to conversion cost cost
42
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Work in progress
Opening work in progress (average Solution

cost method) Equivalent units
Output units Materials Conv. costs
F. Goods 1,050 1,050 1,050
KK
Cost of opening WIP added to costs incurred

Cost per equivalent unit calculated as before Closing WIP 100(100%) 100(60%) 60
1,150 1,150 1,110
Opening WIP cost £ 830 £ 264
Example
Costs this period £ 4,000 £ 2,400
Using data from last example, assume that finished
£ 4,830 £ 2,664
output was 1,050 units and that opening WIP was as
Cost per
follows:
equiv. unit £ 6.60 £ 4.20 £ 2.40
Opening WIP 150 units, valued:
Material cost £ 830 Valuation:
Conversion cost £ 264 Finished
goods £ 6,930
Closing WIP £ 564 £ 420 £ 144
(100 £ 4.20) (60 £ 2.40)
43
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Process losses
Definitions Determining the amount of losses
K
Normal loss – the level of loss expected in a Sum the total volume of input (opening
process for a given volume of input WIP þ input during period)
K
Abnormal loss – if the actual loss is greater than Sum the total volume of output
the normal loss the difference is an abnormal loss (completed units þ closing WIP)
K
Reconcile input with output and difference is
Abnormal gain – if the actual loss is lower than
number of units of total loss
the normal loss the difference is an abnormal gain
K
Deduct normal loss from total loss. Positive
difference ¼ abnormal loss. Negative
difference ¼ abnormal gain
Remember this!
The scrap value of only the normal loss units
reduces the process costs. Abnormal losses
and gains are valued at full production cost and
their scrap value is not entered in the process
account
44
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––––––––––––––––––––––––––––––––––––––––
Process losses
Normal loss Abnormal loss

K
K
Does not absorb any process costs. Do not Value at full cost per unit. Debit: Abnormal loss
include as output in equivalent units calculations a/c; Credit: Process a/c
K
K
Value at scrap value only. Debit: Scrap stock a/c; Scrap value of abnormal loss ¼ Debit: Scrap
Credit: Process a/c stock a/c; Credit: Abnormal loss a/c
K
K
When calculating cost per equivalent unit, deduct Transfer Abnormal loss account balance to P/L
scrap value of normal loss from first cost element
(either previous process cost or added materials Abnormal gain
cost)
K
Value at full cost per unit. Debit: Process a/c;
Credit: Abnormal gain a/c
K
Scrap value of abnormal gain ¼ Debit: Abnormal
gain a/c; Credit: Scrap stock a/c
K
Transfer Abnormal gain account balance to P/L
45
——————————————————————————————————————————
Process losses
Example: abnormal loss
Process account
kg £ kg £/kg £

Materials 500 6,000 Output 430 21.67 9,317
Conversion costs 4,000 Normal loss 50 5.00 250
Abnormal loss 20 21.67 433
500 10,000 500 10,000
Cost incurred scrap value of normal loss £ 10;000 £ 250

¼ ¼ £ 21:67
Expected output 450
The abnormal loss units are valued at the same rate per unit as the good output units. The normal loss is valued at its
scrap value only.
46
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––––––––––––––––––––––––––––––––––––––––
Process losses
Example (continued): abnormal loss
Abnormal loss account
£ £
Process 433 Scrap stock: 20 £ 5 100
Profit and loss 333
433 433
Scrap stock account
£ £
Process – normal loss 250 Debtor/cash: (50 þ 20) £ 5 350

Abnormal loss transfer 100
350 350
47
——————————————————————————————————————————
Process losses
Example: equivalent units/abnormal gain
Equivalent units
Materials Conversion cost
Input Units Output Units % %

O.WIP 100 F. goods 810 100 810 100 810
Materials 800 Normal loss 80
Abnormal gain (30) 100 (30) 100 (30)
C. WIP 40 100 40 60 24
900 900 820 804
48
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––––––––––––––––––––––––––––––––––––––––
Process losses
Example (continued): equivalent units/abnormal gain
Costs Total Materials Conversion cost

Opening WIP £ 280 £ 190
This period £ 3,900 £ 2,222
Scrap value n. loss (£ 80) —
£ 4,100/820* £ 2,412/804**
Cost per unit £8 £5 £3
*£4,100/820 ¼ £5
**£2,412/804 ¼ £3
49
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Process losses
Example (continued): equivalent units/abnormal gain
Total Materials Conversion cost

F. goods: 810 £ 8 ¼ £ 6,480 C. WIP £ 272 £ 200* £ 72**
A. gain: 30 £ 8 ¼ £ 240
Process account
Units £ Units £
Opening WIP 100 470 F. goods 810 6,480
Material 800 3,900 Normal loss 80 80
Conversion cost 2,222 Closing WIP 40 272
Abnormal gain 30 240
930 6,832 930 6,832
*40 £ 5 ¼ £200
**24 £ 3 ¼ £ 72
50
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––––––––––––––––––––––––––––––––––––––––
Joint products and by-products
Definition Study tip
Joint products – two or more products produced Your syllabus requires you to understand only
by the same process and separated in processing, general principles of joint and by-products. You
each having a sufficiently high saleable value to will not be required to perform any computations
merit recognition as a main product
Characteristics of joint products

Examples of joint products
KK
Accounted for separately as far as possible
K
In the manufacturing of blood products, the Products become individually recognisable at

process produces red cells, platelets and plasma separation point or split-off point
(which requires further processing) K Costs incurred before separation point ¼ joint
K
The output from oil refining is the various grades costs, common costs or pre-separation costs
K
of petrol, diesel, paraffin, and so on Common costs are apportioned to joint products
mainly for stock valuation
K
May require further processing after separation

51
——————————————————————————————————————————
Joint product and by-products
Accounting for joint products

The most common bases of apportioning pre-separation
point costs to joint products are as follows:
K
Weight or volume of output of each product at

separation point. Not suitable if products in Apparent gross margin
different form, e.g., solid, liquid, gas Note reference to ‘apparent’ gross
K
Sales value at separation point. Produces margin. Apportionment of common costs

same apparent gross margin for each product, results in arbitrary cost for each joint
but some products may not be saleable at product. Result is of limited use for
separation point. In this case use the third method decision making. Decisions should focus
K
Final sales value, net of the cost of any further on what happens to products after
processing beyond the separation point separation, e.g., incur further processing
costs?
52
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––––––––––––––––––––––––––––––––––––––––
Joint products and by-products
Example of by-product
Definition
Sawdust produced when timber is processed
By-product – output of some value produced
incidentally in manufacturing something else Characteristics of by-products
(main product)
K
Value is small and incidental compared with that
of main product or products
Accounting for by-products
K
Do not absorb any process costs
None of the costs of the main process are attributed
to the by-product. The value of the by-product is
usually used to reduce the net costs of the main
Point to notice
process, i.e., credit by-product value to main process Notice that a by-product is effectively
account. It is usually valued at its sales value, less treated in the same way as a normal loss,
any further processing costs required to put it into which has a scrap value
a saleable state
53
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Bookkeeping Systems
Integrated and non-integrated accounting systems
Topics
. Integrated and interlocking systems
33 Integrated and interlocking . Accounting for materials
accounts . Accounting for wages
35 Integrated accounts . Accounting for production overhead
36 Integrated accounts . Other accounts
37 Integrated accounting system . Interlocking accounts
55
Bookkeeping Systems
Integrated and interlocking systems
Definitions Advantages of integrated systems
K
Avoids duplication of effort involved in keeping
Integrated accounts – a set of accounting
two separate ledgers
records which provides both financial and cost
KK
No need for periodic reconciliations
accounts, using a common input of data for all
Avoids confusion that can arise by using two
accounting, purposes
different sets of accounts
Interlocking system – a system in which the cost
accounts are distinct from the financial accounts,
the two sets of accounts being kept continuously
Advantages of interlocking systems
in agreement by the use of control accounts or
K
Management attention can be focused on
reconciled by other means
operational aspects of business
Main disadvantage of integrated system is that a
K
Cost accounts can analyse information to be
single system has to provide information for both useful to managers, without need to conform
external and internal reporting. However, the to statutory requirements
information needs of each are very different
56
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––––––––––––
Bookkeeping Systems
Accounting for materials
(i) Purchase of raw materials on credit Material control account

Dr: Materials control; Cr: Creditors control
(ii) Issue of direct materials to production Balance b/d xx (ii) WIP – direct xx
Dr: Work in progress (WIP) control; Cr: Materials (i) Creditors xx (iii) Prodn.
control (iv) WIP – returns o/h-indirect xx
(iii) Issue of indirect materials to production from prodn. xx Balance c/d xx
Dr: Production overhead control; Cr: Materials xx xx
control
(iv) Return of unused direct materials to stores
Dr: Materials control; Cr: Work in progress (WIP)
control (i.e., the reverse of entry (ii) above)
57
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Bookkeeping Systems
Accounting for wages
(i) Payment of net wages The gross wages ((i) þ (ii)) are collected in the wages
Dr: Wages control; Cr: Bank control account before they are transferred to work in
(ii) Account for PAYE/NI progress, or to production overhead control, according
Dr: Wages control; Cr: PAYE/NI creditor to whether they are direct wages or indirect wages.
The gross wages are made up of two parts: the net
(iii) Transfer gross direct wages to WIP
wages that are paid from the bank, plus the PAYE/NI
Dr: Work in progress control; Cr: Wages control
deductions.
(iv) Transfer gross indirect production wages to
production overhead control Wages control account
Dr: Production overhead control; Cr: Wages
control (i) Bank – net wages xx (iii) WIP – direct xx
(ii) PAYE/NI creditor (iv) Prodn.
xx o/h – indirect xx
xx xx
58
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––––––––––––––––––––––––––––––––––––––––––––
Bookkeeping Systems
Accounting for production overhead
(i) Issue of indirect materials to production All production overheads are collected in the
Dr: Production overhead control; Cr: Materials production overhead control account before they are
control absorbed into work in progress, using a
(ii) Transfer of gross indirect production wages pre-determined overhead absorption rate
Dr: Production overhead control; Cr: Wages control
(iii) Payment of other production overhead costs Production overhead control account
Dr: Production overhead control; Cr: Bank/creditors
(iv) Absorb production overhead cost (i) Materials control xx (iv) WIP control xx
Dr: WIP control; Cr: Production o/head control (ii) Wages control xx (v) Under-absorbed
(v) Transfer under/over absorbed balance to P & L (iii) Bank/creditors xx to P&L* xx
Under-absorbed: Dr: P & L; Cr: Prodn. o/head xx xx
control
Over-absorbed: Dr: Prodn. o/head control; *Over-absorbed overhead would be debited in the
Cr: P & L overhead control account and credited to the profit and
loss account
59
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Bookkeeping Systems
Other accounts
(i) Expenses for selling/distribution/ Work in progress control account

administration
Dr: Selling/distn./admin. o/head control; Balance b/d xx (ii) Finished goods xx
Cr: Creditors Materials control xx Balance c/d xx
(ii) Transfer of cost of completed production Wages control xx
Dr: Finished goods control; Cr: WIP control Prodn. o/h control xx
(iii) Transfer of cost of goods sold xx xx
Dr: Cost of sales account; Cr: Finished goods
control Profit and loss account
(iv) Sale of goods on credit
Dr: Debtors control; Cr: Sales account (v) Cost of sales xx (v) Sales xx
(v) Complete summary profit and loss account (v) Selling o/h control xx
Dr: P & L account; Cr: Cost of sales account (v) Distn. o/h control xx
Dr: P & L account; Cr: Selling/distn./admin. o/head (v) Admin. o/h controlxx
control Under-absorbed o/h* xx
Dr: Sales account; Cr: P & L account Profit for period xx
xx xx
*Over-absorbed overhead is credited to P & L account
60
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––––––––––––––––––––––––––––––––––––––––––––
Bookkeeping Systems
Interlocking accounts
Interlocking accounting systems maintain two The need to reconcile cost ledger and
separate ledgers: one for financial accounts and one financial ledger profits
for cost accounts. Cost ledger operates in same way
as integrated system (i.e., materials control, work in
K
Some items affect financial accounts profit
progress control, etc.) but no accounts in cost ledger but not included in cost accounts. Examples:
for financial items (debtors, creditors, fixed assets, interest, loss on sale of fixed assets
dividends, etc.)
K
Some items affect cost accounts profit but not
included in financial accounts. Examples:
notional charges for rent or interest
Cost ledger control account
K
Some items treated differently in two ledgers.
Examples: stock value, depreciation
K
Used to record all information which is passed to

and from financial ledger Cost ledger control account may also be
K
Records entries for which there is no account in called general ledger control account or
cost ledger financial ledger control account
61
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Absorption Costing and
Marginal Costing
The principles of absorption costing and marginal costing
Topics
. Marginal costing and contribution
39 Marginal and absorption . Preparing profit statements
costing . Reconciling the profit figures
40 Marginal costing . Marginal costing or absorption costing?
63
Absorption Costing and Marginal Costing
Marginal costing and contribution
Marginal costing and absorption costing

Definition
Absorption costing values all stock items at full
production cost, including absorbed fixed production Marginal cost – the part of the cost of one unit of
overhead costs. Marginal costing values all stock product or service which would be avoided if that
items at variable or marginal production cost only. unit were not produced, or which would increase if
Fixed costs are treated as period costs and written one extra unit were produced
off in full against the profit for period
Contribution
Remember this! Contribution is so called because it literally does
The difference between the two systems is in contribute towards fixed cost and profit. Contribution
their treatment of fixed production overheads is calculated as:
only. Both systems treat other types of fixed Sales value variable/marginal* costs
overhead as period costs
*The terms marginal cost and variable cost tend to be
used interchangeably
64
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––––––––––––––––––––––––––––––––––
Preparing profit statements
Example data Marginal costing profit statement for June

£ £
Data concerning product X are as follows:
Sales revenue (2,600 £ 35) 91,000
Selling price per unit £ 35
Variable production cost Opening stock (1,200 £ 14) 16,800
per unit £ 14 Variable prodn. cost (2,800 £ 14) 39,200
Variable selling cost per unit £2 56,000
Closing stock (1,400 £ 14) 19,600
Fixed production overhead £ 30,000 per month 36,400
Other fixed overhead £ 12,000 per month Variable selling costs (2,600 £ 2) 5,200
Budgeted production and Variable cost of sales 41,600
sales 3,000 units per month Contribution 49,400
Opening stock for June 1,200 units Less fixed overhead:
Production in June 2,800 units Fixed production overhead 30,000
Sales for June 2,600 units Other fixed overhead 12,000
42,000
Profit 7,400
65
——————————————————————————————————————————
Preparing profit statements
Absorption costing profit statement for June

£ £
Sales revenue 91,000
Notes
Opening stock (1,200 £ 24) 28,800 1. Fixed production overhead per
Full prodn. cost (2,800 £ 24) 67,200 unit ¼ £ 30,000/3,000 ¼ £ 10 per unit
96,000 Full production cost per unit ¼ £ 14 þ £ 10
Closing stock (1,400 £ 24) 33,600 ¼ £ 24
62,400 2. Fixed production overhead absorbed
Under-absorbed o/head 2,000 ¼ 2,800 units produced
Full production cost of sales 64,400 £ 10 £ 28,000
Gross profit 26,600
Fixed production overhead incurred £ 30,000
Less other overhead:
Variable selling cost 5,200 Under-absorbed production
Other fixed overhead 12,000 overhead £ 2,000
17,200 This amount is added to the cost of sales for
Profit 9,400 the month. If the overhead had been over
absorbed the amount would have been
deducted
66
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––––––––––––––––––––––––––––––––––
Reconciling the profit figures
Profit differences Example

Using the data from the previous example, stocks
increased during the period, therefore absorption costing
K
Difference arises between profit reported under

marginal costing and under absorption costing will report a higher profit than marginal costing, because
only if stock volume changes during period of the extra fixed production overhead carried forward in
stock
K
If stocks increase, absorption costing profit is

greater than marginal costing profit, because
some fixed production overhead is carried forward Marginal costing profit £ 7,400
in stock to later periods Add: fixed production overhead carried
K
If stocks reduce, absorption costing profit is lower forward in stock increase (200 units £ 10)
than marginal costing profit, because some fixed £ 2,000
production overhead that had been carried Absorption costing profit £ 9,400
forward is now released from stock to be charged
against sales for the period
67
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Reconciling the profit figures
Summary Study tip

K
Profit difference ¼ change in stock units fixed

This type of reconciliation lends itself well to an
production overhead cost per unit
objective testing situation and has been a favourite
K
If stocks increase, absorption costing

topic in the multiple choice questions on past
profit > marginal costing profit
papers. Learn these four rules and ensure you can
K
If stocks reduce, absorption costing profit

apply them quickly in an assessment situation
< marginal costing profit
K
If stocks do not alter, absorption costing profit

¼ marginal costing profit
68
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––––––––––––––––––––––––––––––––––
Marginal costing or absorption costing?
Arguments in favour of absorption Arguments in favour of marginal

costing costing
K
K
Fixed production overheads are a necessary cost Provides better information for short-term
of production and therefore should be included in decision-making
K
unit valuation Focuses management attention on the more
K
Accounting standards require the use of controllable measure of contribution
K
absorption costing for external reporting Absorption of fixed production overhead done on
K
If stocks are accumulated for future sale, then arbitrary basis and result can be misleading for
absorption costing smooths profits by carrying decision-making
forward in stock the fixed production overheads,
to be matched against sales when they are made
69
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Breakeven Analysis and
Decision-Making
Using cost information to make decisions

41 Breakeven analysis
Topics
48 Cost behaviour/breakeven . Breakeven analysis
chart . Breakeven charts
50 Relevant costs . Limitations of breakeven analysis
52 Limiting factor . Relevant costs
decision-making . Limiting factor decision-making
71
Breakeven Analysis and Decision-Making
Breakeven analysis
Contribution per unit is usually assumed to be Example

constant. As sales volumes increase, the total Data for a product for one month are as follows:
contribution increases in a linear fashion until it just £ per unit £ per unit
covers fixed costs. This is the breakeven point, Selling price 65
where neither profits nor losses are made Direct material 22
Direct labour 12
fixed costs Variable overhead 8
Breakeven point in units ¼
contribution per unit Fixed overhead* 15 57
Profit per unit 8
*Based on budgeted production and sales of 2,300 units
Study tip
Solution
No breakeven formulae will be provided in the Total fixed overhead ¼ 2,300 units £ 15 ¼ £ 34,500
assessment. Therefore you will need to learn all of Contribution per unit ¼ £ 65 £ (22 þ 12 þ 8) ¼ £ 23
the formulae in this chapter
£ 34;500
Breakeven point ¼ ¼ 1;500 units per month
£ 23
72
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––––––––––––––––––––––––––––––––––
Breakeven analysis
Example
Definition
Using the data from the previous example:
Margin of safety – the difference between the MOS ¼ (2,300 1,500) units ¼ 800 units per month
projected level of sales and the breakeven point ¼ (800/2,300) 100%
¼ 35% of projected sales
Margin of safety ¼ projected sales breakeven point Projected profit ¼ 800 units £ 23 contribution per unit
¼ £ 18,400
The larger the margin of safety (MOS) the more likely it is
that a profit will be made. MOS should be expressed as a The projected profit can also be calculated as follows:
percentage of projected sales to put it in perspective
Projected contribution ¼ 2,300 units £ 23 ¼ £ 52,900
Forecast profit ¼ MOS contribution per unit Projected profit ¼ contribution fixed costs
¼ £ (52,900 34,500) ¼ £ 18,400
73
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Breakeven analysis
Contribution to sales ratio Example

contribution per unit
ðC=S ratioÞ ¼ 100% C/S ratio ¼ £ 23/£ 65 ¼ 35.4%
selling price per unit
Usually expressed as a percentage. Also referred to as £ 34;500
Breakeven point in sales value ¼
P/V (profit/volume) ratio. With higher C/S ratio the 0:354
profits grow more quickly as sales increase ¼ £ 97;458
fixed costs (check: 1,500 units £ 65 ¼ £ 97,500)
Breakeven point in sales value ¼
C/S ratio
74
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––––––––––––––––––––––––––––––––––
Breakeven analysis
To achieve a given level of profit the total contribution Solution

must cover the fixed overhead and leave sufficient
£ 34;500 þ £ 25;300
contribution to earn the required profit ðaÞ Required sales ¼
£ 23
Required sales for target profit ¼ 2; 600 units
fixed overhead þ target profit (b) Revised contribution per unit ¼ £ (23 1 2)
¼
contribution per unit ¼ £ 20
Example Revised C/S ratio ¼ 20/64 100% ¼ 31.25%
fixed costs
(a) Calculate the number of units to be sold to achieve Required monthly sales to break even ¼
C=S ratio
a monthly profit of £ 25,300
34;500
(b) If the selling price reduces to £ 64 per unit and the ¼
direct material cost increases to £ 24 per unit, 0:3125
calculate the revised sales revenue to break even ¼ £ 110;400
each month
75
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Breakeven charts
Traditional breakeven chart

K
Vertical axis ¼ costs and revenues; horizontal

axis ¼ level of activity
K
Includes straight lines for sales revenue, fixed

cost and total cost
K
Fixed cost line cuts vertical axis at cost at zero

activity ¼ total fixed cost ¼ £ 20,000 in example
K
Total cost line cuts vertical axis at fixed cost level.

Increases in straight line to total cost at maximum
activity
K
Sales revenue line passes through origin and

increases in straight line to total revenue at
maximum activity
K
Breakeven is where total cost ¼ sales revenue
76
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––––––––––––––––––––––––––––––––––
Breakeven charts
Contribution breakeven chart The advantage of the contribution breakeven chart is

that contribution can be read directly from the chart,
because the variable cost line is substituted for the
KK
Axes ¼ same as for traditional/basic chart

Includes straight lines for sales revenue, variable fixed cost line
cost and total cost
K
Total cost and revenue lines are same as for

traditional/basic breakeven chart
K
Variable cost line begins from origin and

increases in straight line to total variable
cost at maximum activity
K
Contribution can be read as difference between

sales revenue line and variable cost line
K
Breakeven is where total cost ¼ sales revenue
77
——————————————————————————————————————————
Breakeven charts
Profit-volume chart The main advantage of the profit volume chart is that
it can depict clearly the effect on profit and breakeven
point of any changes in the variables
K
Vertical axis ¼ profit or loss; horizontal

axis ¼ level of activity
K
Horizontal axis is drawn at zero profit/loss on

vertical axis
K
Straight line shows profit or loss for relevant

range of activity
K
Profit line cuts vertical axis at loss at zero

activity ¼ fixed costs ¼ £ 20,000 in example.
Increases in straight line to total profit at
maximum activity
K
Breakeven point ¼ where profit line cuts

horizontal axis
78
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––––––––––––––––––––––––––––––––––
Limitations of breakeven analysis
Limitations stem mostly from the

assumptions made Remember this!
It is unreliable to assume that cost and revenue
K
Assumes variable costs are linear, i.e., constant behaviour patterns are relevant across a wide
variable cost per unit range of activity. Managers must ensure that
KK
Assumes fixed costs are constant in total they work within the relevant range of activity,
Assumes sales revenue is linear, i.e., constant i.e., within the range over which the identified
sales revenue per unit cost and revenue relationships are reliable
KK
Assumes no changes in stocks

Assumes that activity is the only factor affecting
costs
K
Assumes a constant product mix, or a single

product only
79
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Relevant costs
A relevant cost is one which will be affected by the

decision being taken. If a cost will not alter as a result
of the decision then it is a non-relevant cost
Remember this!
Relevant costs and revenues are represented
by future cash flows, whose magnitude will
vary depending upon the outcome of the
Examples of non-relevant costs management decision made
K
Sunk or past costs. For example, the cost of

market research that has already been
undertaken
Study tip

KK
Absorbed fixed overhead

Committed costs. For example, the cost of staff In an assessment you should assume that
salaries where there is a policy of no fixed overheads are non-relevant costs,
redundancies unless you are given information to indicate
that they will alter; for example, if there is a
step in fixed costs at a specified activity level.
80
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––––––––––––––––––––––––––––––––––
Relevant costs
Example
Definition
Contract X is being considered, which requires 25 hours
Opportunity cost – the value of the benefit of skilled labour. The skilled employees are paid £ 18 per
sacrificed when one course of action is chosen, in hour and are currently working on product B, which earns
preference to an alternative. The opportunity cost a contribution of £ 14 per hour. If Contract X is
is represented by the foregone potential benefit undertaken the sales of product B would be foregone.
from the best rejected course of action
Solution
Relevant cost of skilled labour:
Opportunity costs and notional costs £ per hour
Are very similar in concept. A notional rent charge Hourly rate 18
could be made against an owned factory, to aid Opportunity cost: foregone
comparability with the costs incurred in a rented contribution from product B 14
factory. In effect, the notional rent represents the 32
foregone opportunity to rent the factory to a third
Total relevant skilled labour cost of
party, i.e., it represents the opportunity cost of
Contract X ¼ £ 32 25 hours ¼ £ 800
occupying the factory for the company’s own use
81
——————————————————————————————————————————
Relevant costs
Relevant cost of materials in stock Example

A contract requires 100 kg of material X and 50 kg of
K
If used regularly: relevant cost ¼ replacement material Y

cost 75 kg of material X are in stock, but have no other use.
K
If no other use: relevant cost ¼ zero or scrap The stock was originally purchased for £ 5 per kg. It could
value be sold for £ 5.50 per kg and the current replacement
K
If alternative use possible: relevant price is £ 6 per kg

cost ¼ opportunity cost, i.e., value of next best Material Y is used regularly and 45 kg are in stock, which
alternative use were originally purchased for £ 3 per kg. The current
The relevant cost of materials that are not yet in stock market price of material Y is £ 3.50 per kg
will always be the current replacement price of the
material Solution
Relevant cost of material
X ¼ (75 kg £ 5.50) þ (25 kg £ 6) ¼ £ 562.50
Relevant cost of material Y ¼ 50 kg £ 3.50 ¼ £ 175
82
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––––––––––––––––––––––––––––––––––
Relevant costs
Definitions
Avoidable costs – the specific costs of an activity Example of avoidable cost

or sector of a business which would be avoided if
that activity or sector did not exist The salaries of canteen staff if the
canteen is to be closed and vending
Differential/incremental cost – the difference in machines installed instead
total cost between alternatives; calculated to assist
in decision-making
Study tip
Differential costs are particularly useful for Always remember to consider the potential
highlighting the effect of sequential steps in a non-financial impact of a decision; for example,
decision, e.g., the incremental cost of employing the effect of department closure on labour morale
one supervisor, two supervisors, etc. or the potential loss of customer goodwill if a
decision is made to withdraw a product which is
unprofitable in the short term.
83
——————————————————————————————————————————
Limiting factor decision-making
Definition
Remember this!
Limiting factor – any factor which is in scarce The decision rule with a single limiting factor is
supply and which stops the organisation from to maximise the contribution per unit of limiting
expanding its activities further
factor
Example
Product A Product B Product C
per unit per unit per unit
Examples: machine capacity, labour hours Selling price £ 34 £ 23 £ 31
Variable cost £5 £ 11 £ 14
If an organisation is faced with a single limiting factor, Fixed overhead
e.g., machine capacity, the production plan must cost £ 19 £5 £7
maximise the profit from the available capacity. Profit £ 10 £7 £ 10
Assuming that total fixed costs remain constant, this Kg of material 3 2 5
can be achieved by maximising the contribution from Hours of labour 0.5 1 2
the limiting factor. Machine capacity must be allocated Monthly demand (units) 400 350 540
to products which earn the highest contribution per Maximum material available ¼ 4,300 kg
machine hour Maximum labour hours available ¼ 1,700 hours
84
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
First step: check for a limiting factor Second step: Rank products in order of contribution
Product A Product B Product C Total per kg of material
Demand Product A Product B Product C
(units) 400 350 540 £ per unit £ per unit £ per unit
Material Selling price 34 23 31
required 1,200 kg 700 kg 2,700 kg 4,600 kg Variable cost 5 11 14
Labour Contribution 29 12 17
required 200 hr 350 hr 1,080 hr 1,630 hr Kg of material 3 2 5
Contribution per kg £ 9.67 £ 6.00 £ 3.40
Labour supply is sufficient but the availability of material
Ranking 1 2 3
is a limiting factor
85
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Third step: allocate available material to products Fourth step (if required): calculate profit resulting
according to ranking from recommended plan
Product Recommended Material Assumption: unit fixed overhead costs are based on the
production utilised monthly demand for each product
(units) (kg) Monthly fixed overhead cost ¼ (£ 19 400) þ (£ 5 350)
A 400 1,200 þ (£ 7 540) ¼ £ 13,130
B 350 700
Product Units Contribution Total
C 480 2,400 (bal.)
A 400 (£ 29) £11,600
4,300 B 350 (£ 12) £ 4,200
Supply of product C will fall short of demand by 60 units C 480 (£ 17) £ 8,160 £ 23,960
Fixed overhead cost £ 13,130
Profit £ 10,830
86
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Budgetary Planning
and Control
Preparing and using budgets
Key study system questions Topics

58 Functional budgets . The purposes of budgeting
61 Functional budgets . The planning process
62 Cash budget . Preparing budgets
63 Flexible budgets . Budgetary control
87
Budgetary Planning and Control
The purposes of budgeting
Definition
Budget – a quantified plan of action relating to

To be useful the budget must be quantified
a given period of time
The purposes of budgeting

Planning process forces managers to think
K
Plan activities of all parts of organisation

ahead
Comparing actual results with budget

K
Provide a basis for monitoring current

enables control action to be taken if
performance necessary
KK
Delegate authority to budget holders Budget holders may incur expenditure on

Communicate targets and responsibilities to behalf of their part of the organisation
Managers will appreciate how their
individual managers

K
Coordinate activities of all parts of organisation activities relate to those of other managers
88
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–––––––––––––––––––––––––––––––––––––––
The planning process
Definitions Strategic planning

Preparing long-term action plans to achieve the
Budget period – the period for which a budget is organisation’s objectives. Also known as corporate
prepared and used, which may then be subdivided planning, or long-range planning
into control periods
Budget centre – a section of an entity for which Budgetary planning
control may be exercised and budgets prepared
Preparing short to medium term plans. Carried out
within the framework of the strategic plan. Each
The budget period can be any length to suit management annual budget is an interim step towards achievement
purposes, but is usually one year. Each separate control of the strategic plan
period may also be any length, depending on the level of Operational planning
control to be exercised, but is usually one month
Planning on a day-to-day basis. Carried out within the
framework of the budgetary plan. Also known as
tactical planning
89
——————————————————————————————————————————
Budget committee coordinates budgetary planning and Typical contents of budget manual
control process. Includes representative from every part
of organisation. Responsible for preparation of budget
K
Introductory explanation of budgetary planning
manual, which is a collection of documents containing and control process and budgetary objective
key information for those involved in planning process
K
Organisation chart to show responsibility for each
budget and how they are interrelated
KK
Timetable for budget preparation
Definition
Copies and explanations of all forms to be
completed by budget holders
Participative budgeting – a budgeting system in
KKK
Details of organisation’s account codes
which all budget holders are given the opportunity
Key planning assumptions, e.g., inflation rate
to participate in setting their own budgets
Name of budget officer to be consulted with any
problems or queries
Participative budgeting also called ‘bottom-up budgeting’,
to contrast with a system of imposed or top-down
budgets, where budget holder does not participate in the
planning process
90
——————————————————————————————————————————
–––––––––––––––––––––––––––––––––––––––
Definition Advantages of computerised budgeting

systems
Principal budget factor – a factor which will limit
K
the activities of an undertaking and which is often Computers can easily handle and store the large
the starting point in budget preparation volume of data involved
KK
Processes data more rapidly and accurately
Early identification of principal budget factor (PBF) Data can be quickly and accurately manipulated
indicates which budget should be prepared first, e.g., if and adjusted; for example, in carrying out
sales volume is PBF then sales budget must be prepared ‘what-if?’ analysis

first and all other budgets coordinated to this
Point to note ‘What-if?’ analysis involves adjusting the forecast

The PBF, and the limiting factor discussed in variables to assess the effect on the final
the last chapter, are effectively the same thing outcome
Computerised budgetary planning and control systems

have a number of advantages over a manual system
91
——————————————————————————————————————————
Preparing budgets
Assuming that sales volume is the PBF, the order

of budget preparation will usually be as follows: Production volume is not necessarily equal
1 Sales budget (units and value)
to sales volume because of budgeted
2 Finished goods stock budget changes in stock.
3 Production budget (units) Production ¼ sales þ closing stock
4 Production resource budgets, e.g., direct opening stock
labour, machine hours, material usage budget
5 Material stock budget Purchases ¼ usage þ closing stock
6 Material purchases budget (units and value)
opening stock
7 Other functional budgets, e.g., production
overheads, selling and administration costs
8 Cash budget and budgeted profit and loss These three budgets comprise the
account and balance sheet master budget, which is presented to
senior management for approval
92
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–––––––––––––––––––––––––––––––––––––––
Preparing budgets
Example Solution
A company manufactures and sells a single product. (a) Production budget Units
Extracts from the company’s budgetary planning data: Sales volume 2,000
Closing stock 250
Sales 2,000 units
2,250
Opening stocks Closing stocks
Less opening stock 300
Finished product 300 units 250 units
Budgeted production 1,950
Raw material 170 kg 155 kg
Material usage per unit 3 kg @ £ 4 per kg (b) Material purchases budget kg
Budgeted material usage (1,950 units 3 kg) 5,850
Prepare the following budgets: Closing stock 155
(a) Production budget 6,005
(b) Material purchases budget Less opening stock 170
Budgeted material purchases 5,835
Value @ £ 4 per kg £ 23,340
93
——————————————————————————————————————————
Preparing budgets
Cash budget shows cash effect of all decisions taken in Example

budgetary planning process. Decisions such as supplier
payment periods and stockholding policy affect cash flow. Extracts from a company’s budgetary planning data:
Managers need to be forewarned whether there will be May June July
cash deficits or surpluses and for how long the surpluses
Budgeted sales value £ 3,200 £ 4,000 £ 3,800
or deficits will last
50% of sales are for cash. Of the remaining customers,
40% pay during the month after sale and receive a 2%
Study tips discount; the remainder pay two months after the sale.
Calculate the budgeted cash receipts from sales in July
Things to watch out for in preparing cash budgets:
Depreciation is not a cash flow. Exclude from any Solution
figures before inclusion in a cash budget
Receipts from cash customers £ 3,800 50% £ 1,900
Bad and doubtful debts must be excluded before Receipts from credit customers:
calculating cash receipts from sales. June sales £ 4,000 50% 40% 98% £ 784
May sales £ 3,200 50% 60% £ 960
£ 3,644
94
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–––––––––––––––––––––––––––––––––––––––
Preparing budgets
Cash budgets are often prepared on a rolling basis

Example
Definition A rolling budget might be prepared every three months
Rolling budget – a budget continuously updated Year 1: budget prepared in detail for January to March
by adding a further accounting period (month or and in less detail for April to December
quarter) when the earliest accounting period has End of March Year 1: budget for first three months
expired. Its use is particularly beneficial where deleted and further three months added for January to
future costs and/or activities cannot be forecast March Year 2. Budget for remaining nine months of Year
accurately 1 updated, adding more detail for April to June Year 1

Advantages of rolling budgets

KKK A full year’s budget is always available
Note Managers forced to continually plan ahead
A system of rolling budgets is also known as Budget can adapt to changing circumstances
continuous budgeting
95
——————————————————————————————————————————
Preparing budgets
Definition
Incremental budgeting – a method of budget Problem

setting in which the prior period budget is used as Incremental approach tends to perpetuate
a base for the current budget, which is set by inefficient practices. Unnecessary
adjusting the prior period budget to take account expenditure built into the budget (budget
of any anticipated changes slack) will not be detected and eliminated
Definition One possible solution

Zero-based budgeting – a method of budgeting
to this problem
which requires each cost element to be specifically Zero-based budgeting developed as an
justified, as though the activities to which the alternative to the incremental approach.
budget relates were being undertaken for the Each budget is prepared from scratch
first time. Without approval, the budget allowance instead of using the previous year as
is zero a base
96
——————————————————————————————————————————
–––––––––––––––––––––––––––––––––––––––
Budgetary control
Budgetary control information Features of useful budget reports

K
K
A specific manager is responsible for managing Timely. Corrective action must be taken as soon
each budget centre and controlling the budget for as possible after the event
K
the centre Sufficiently accurate. May be a conflict between
K
Budgetary control achieved by comparing actual timeliness and accuracy
K
results with budget, flexed if necessary to actual Relevant. Ideally based on exception principle
level of activity and separating controllable and non-controllable
K
Actual budget ¼ variance. Action taken to items
K
correct variances if appropriate Communicated to appropriate manager.
K
Costs higher than budget, revenues lower than Individual budget holders’ responsibilities must be
budget ¼ adverse variance clearly defined
K
Costs lower than budget, revenues higher than

budget ¼ favourable variance
97
——————————————————————————————————————————
Budgetary control
Definitions Study tip
Fixed budget – a budget which is normally set Cost behaviour patterns are important in
prior to the start of an accounting period, and preparing flexible budgets
which is not changed in response to subsequent
K
A fixed cost is easily identified by looking at
changes in activity or costs/revenues. Fixed the absolute amounts
budgets are generally used for planning purposes
K
Identify variable or semi-variable costs by
Flexible budget – a budget which, by recognising dividing each cost by the activity level
different cost behaviour patterns, is designed to Constant unit rate ¼ variable cost; changing
change as volume of activity changes unit rate ¼ semi-variable cost
K
Analyse semi-variable costs using the
high-low method
Flexible budgets are appropriate where activity levels
fluctuate and variable costs are significant. In this
situation, a comparison of actual results with the original
Flexible budget cost allowance ¼ budgeted fixed
fixed budget will not produce useful control information
cost þ (variable cost per unit no. of units)
98
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–––––––––––––––––––––––––––––––––––––––
Budgetary control
Example: flexible budget Actual results for latest period:

Units 8,500
Summary budgets for two activity levels are as follows:
£
Units 7,000 9,000 Direct costs 2,580
£ £ Production overhead 9,109
Direct costs 2,100 2,700 Other overhead 3,611
Production overhead 8,900 9,300 15,300
Other overhead 3,480 3,480
14,480 15,480 Assuming that the fixed budget activity level is 9,000
units, prepare a budgetary control report for the period
and identify the volume variance and expenditure
Study tip
variances
Although direct costs are usually variable costs,
you must check this by testing the cost behaviour
pattern. It is possible that the cost will be
semi-variable
99
——————————————————————————————————————————
Budgetary control
Solution Budgetary control report

Variances in brackets are adverse
Direct cost: variable
Fixed Flexible Actual Expenditure
Cost per unit ¼ £ 2,100/7,000 ¼ £ 0.30 budget budget results variances
Budget cost allowance ¼ £ 0.30 8,500 ¼ £ 2,550 £ £ £ £
Production overhead: semi-variable Direct costs 2,700 2,550 2,580 (30)
Prod’n o/h 9,300 9,200 9,109 91
Variable cost per unit ¼ £ (9,300 8,900)/
(9,000 7,000)¼ £ 0.20 Other o/h 3,480 3,480 3,611 (131)
15,480 15,230 15,300 (70)
Fixed cost ¼ £ 9,300 (£ 0.20 9,000) ¼ £ 7,500
Budget cost allowance ¼ £ 7,500 þ (£ 0.20 8,500) Volume variance ¼ £ 15,480 £ 15,230
¼ £ 9,200 ¼ *£ 250 favourable
Total variance ¼ £ 15,480 £ 15,300
Other overhead cost: fixed ¼ £ 180 favourable
Budget cost allowance ¼ £ 3,480 ¼ £ 70 adverse þ £ 250 favourable
*Volume variance ¼ 500 fewer units
variable cost per unit
¼ 500 £ (0.30 þ 0.20)
¼ £ 250 favourable
100
——————————————————————————————————————————
Standard Costing and
Variance Analysis
Using standard costs to plan and control unit costs

Topics
66, 67, 68 Variance analysis
71 Fixed overhead . Standard costing
variances . Setting standard costs
72 Variance analysis . Standard costing in today’s environment
73 Profit reconciliation . Variance analysis
75 Standard cost . Interpreting variances
bookkeeping . Standard cost bookkeeping
101
Standard Costing and Variance Analysis
Standard costing
Definitions Example: standard cost card for product 456

£
Standard costing – a control technique which Direct material: standard quantity standard price xx
compares standard costs and revenues with
Direct labour: standard hours standard rate xx
actual results, to obtain variances which are used
Standard prime cost xx
to stimulate improved performance
Variable prod’n o/h: standard hours standard rate xx
Standard cost – the planned unit cost of the
Standard variable production cost xx
product, components or services produced in
Fixed prod’n o/h: standard hours standard rate xx
a period
Standard total production cost xx
Other overhead xx
Standard costs used in performance measurement, Standard total cost xx
control, stock valuation and establishing selling prices.
Standard costs and prices provide the basic unit For every production cost the standard amount and
information for valuing cost and revenue budgets standard price of resource is detailed. Standard selling
price might also be shown. Detail provides information for
variance analysis, as long as actual results are recorded
in same detail
102
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Setting standard costs
Performance levels Sources of information

Standard material cost
K
Ideal standard. Assumes ideal operating

conditions. Makes no allowance for losses, waste,
K
machine downtime, etc. Highlights cost of potential suppliers: quotations, discounts, delivery
inefficiencies, but can be demotivating charges, etc.
KK
K
Attainable standard. Assumes efficient operating historical trend in material prices

conditions. Includes allowances for normal loss, quality specifications
waste, machine downtime, etc.
K
Current standard. Based on current operating Standard material usage

conditions. Does not encourage improvement
from current levels of efficiency
KK
performance level: allowance for losses?
K
Basic standard. Kept unchanged and used for technical specifications

basis of preparing up-to-date standards
103
——————————————————————————————————————————
Setting standard costs
Sources of information The predetermined overhead absorption rate (OAR)

provides the standard rate for production overhead:
Standard labour rate budgeted production overhead
OAR ¼
budgeted standard hours
KK
personnel department
bonus scheme details Standard hour is a useful way of measuring output
when dissimilar items are manufactured. It must
Standard labour times always be used as an absorption base in standard
costing systems, unless a single product is
manufactured, in which case a rate per unit is suitable
KKK
performance level: allowance for downtime?

technical specifications Example: standard hour
results of work study exercises Product Units output Std hrs per unit
A 1,000 2
B 1,800 5
Std hrs of output ¼ (1,000 2) þ (1,800 5) ¼ 11,000
104
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Standard costing in today’s environment
Criticisms of standard costing

Addressing the criticisms
K
Developed when business environment was

K
stable. Not appropriate for control purposes in Standards can be updated regularly to
today’s dynamic environment ensure they reflect current operating
conditions and remain useful for control
K
Performance to standard used to be acceptable. purposes

Nowadays should strive for continuous
K
Use of demanding performance levels
improvement to compete effectively and ideal standards encourages
continuous improvement
K
Emphasis on labour variances not appropriate
K
with more automated production methods Standards can be developed for machine
times and hourly machine operating costs
K
Developed when products and services were
K
Possible to identify a number of standard
more standardised. Nowadays need to respond components and activities for which
to individual customer requirements standards can be set and used for control
105
——————————————————————————————————————————
Variance analysis
Example data Direct material price variance

Standard material cost per unit ¼ 4 kg @ £ 8 per kg ¼ £ 32 Measures how much of the total material variance was
Actual material cost for 500 units ¼ 2,100 kg £ 7 per kg due to paying a different price per kg of material.
¼ £ 14,700 2,100 kg should have cost ( £ 8) £ 16,800
Direct material total variance But did cost £ 14,700
Direct material price variance £ 2,100 favourable
500 units should cost ( £ 32) £ 16,000
But did cost £ 14,700 Direct material usage variance
Direct material total variance £ 1,300 favourable
Measures how much of the total material variance was
Direct material price variance £ 2,100 fav due to using a different quantity of material than the
þ Direct material usage variance £ 800 adv standard for the output achieved
¼ Direct material total variance £ 1,300 fav 500 units should have used ( 4 kg) 2,000 kg
But did use 2,100 kg
Variance in kg 100 kg adverse
Direct material usage variance ( £ 8 std) £ 800 adverse
106
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Variance analysis
Example data Direct labour rate variance

Standard labour cost per unit ¼ 3 hr @ £ 9 per hr ¼ £ 27 Measures how much of the total labour variance was due
Actual labour cost for 500 units ¼ 1,550 hr £ 8 per hr to paying a different rate per hour of labour
*150 of these hours were recorded as idle time 1,550 hr should have cost ( £ 9) £ 13,950
Direct labour total variance But did cost £ 12,400
Direct labour rate variance £ 1,550 favourable
Direct labour efficiency variance
But did cost (1,550 £ 8) £ 12,400
Direct labour total variance £ 1,100 favourable Measures how much of the total labour variance was due
Idle time variance ¼ 150 hrs £ 9 std ¼ £ 1,350 adv to using a different number of active labour hours than
the standard for the output achieved
Direct labour rate variance £ 1,550 fav
þ Direct labour efficiency variance £ 900 fav 500 units should have used ( 3 hr) 1,500 hr
þ Idle time variance £ 1,350 adv But did use (active hours only) 1,400 hr
¼ Direct labour total variance £ 1,100 fav Variance in hr 100 hr fav
Direct labour efficiency variance ( £ 9 std) £ 900 fav
107
——————————————————————————————————————————
Variance analysis
Example data Variable overhead expenditure variance

Std variable o/h cost per unit ¼ 3 hr @ £ 2 per hr ¼ £ 6 Measures how much of the total variable overhead
Actual variable o/h cost for 500 units ¼ £3,500. variance was due to paying a different rate per active hour
Labour hours as on previous card 1,400 active hrs should have cost
( £ 2) £ 2,800
Variable overhead total variance But did cost £ 3,500
Variable overhead expenditure variance £ 700 adverse
But did cost £ 3,500
Variable overhead efficiency variance
Variable overhead total variance £ 500 adverse
Variable o/h expenditure variance £ 700 adverse Measures how much of the total variable overhead
þ Variable o/h efficiency variance £ 200 favourable variance was due to using a different number of active
¼ Variable o/h total variance £ 500 adverse labour hours than the standard for the output achieved.
500 units should have used ( 3 hr) 1,500 hr
But did use (active hours only) 1,400 hr
Variance in hr 100 hr fav
Variable o/h efficiency variance ( £ 2 std) £ 200 fav
108
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Variance analysis
Remember this! Fixed production overhead total variance

The total fixed production overhead variance is Overhead absorbed ¼ 1,340 std hr £ 6 ¼ £ 8,040
equal to the under- or over-absorbed fixed Actual overhead incurred £ 7,370
production overhead for the period Fixed production o/head total variance £ 670 fav
Example data Overhead over absorbed ¼ favourable total variance

Overhead under absorbed ¼ adverse total variance
Budget Actual
Output (standard hours) 1,230 1,340
Fixed production overhead £ 7,380 £ 7,370 Reasons for under/over absorption
Predetermined o/head absorption rate ¼ £ 7,380/1,230
K
Overhead expenditure different from budget
¼ £ 6 per std hr (overhead expenditure variance)

K
Output different from budget (overhead volume
variance)
Production is measured in standard hours.
The approach would be the same if output
was measured in units
109
——————————————————————————————————————————
Variance analysis
Fixed production overhead expenditure Check:

variance Fixed production overhead:
expenditure variance £10 favourable
Measures the under/over absorption caused by the volume variance £660 favourable
overhead expenditure being different from budget
Fixed production overhead total variance £ 670 favourable
Budgeted expenditure £ 7,380
Actual expenditure £ 7,370
Fixed prodn. o/h expenditure variance £ 10 fav Remember this!
Fixed production overhead volume variance Always indicate whether a calculated variance
is adverse or favourable
Measures the under/over absorption caused by the
output being different from budget
Actual output 1,340 standard hours
Budget output 1,230 standard hours Favourable variance because output greater than
Difference 110 standard hours
budget ¼ potential over absorption of fixed
x overhead absorption rate (£ 6) production overhead
Fixed prodn. o/h volume variance £ 660 fav
110
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Variance analysis
Total sales margin variance Example

Budget Actual
Sales and production units 7,240 7,460
K
Measures difference between actual margin at

standard costs and budgeted margin Unit selling price £ 27 £ 25
K
Since analysis of cost variances explains Total unit cost £ 20 £ 19

differences caused by cost changes from
Solution
standard, sales margin variance is based on
Actual margin (based on standard unit costs)
standard cost, not on actual cost
Actual sales value (7,460 £ 25) £ 186,500
Std. cost of sales (7,460 £ 20) £ 149,200 £ 37,300
Total sales margin variance
¼ actual margin (based on standard unit costs) Budgeted margin
budgeted margin Budget sales value
¼ (actual sales value less standard cost of sales) (7,240 £ 27) £ 195,480
(budgeted sales value less budgeted cost of Budget cost of sales
sales) (7,240 £ 20) £ 144,800 £ 50,680
Total sales margin variance £ 13,380 adv
111
——————————————————————————————————————————
Variance analysis
A profit reconciliation statement summarises the Profit reconciliation statement for latest period
calculated variances, to demonstrate how they £ £
contribute to the difference between budgeted and Original budgeted profit xx
actual gross profit Total sales margin variance xx
xx
Cost variances
Direct material: price (xx)
Favourable variances are added to
budgeted profit Direct labour:
usage
rate
efficiency
xx
xx
(xx)
xx
(xx)
Variable overhead: expenditure xx
Adverse variances are deducted from
budgeted profit Fixed overhead:
efficiency
expenditure
volume
(xx)
xx
xx
xx
xx
Good practice to give a key. Actual gross profit xx
Alternatively, could use ‘A’ for adverse;
‘F’ for favourable Note: variances in brackets are adverse
112
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Variance analysis
Standard marginal costing

Remember this!
K
Compared with absorption costing variances, In a standard absorption costing system and in
differences only arise where fixed production a standard marginal costing system, all
overhead features ‘quantity’ variances (material usage, labour
K
Only one variance for fixed production efficiency, variable overhead efficiency) are
overhead ¼ fixed production overhead valued at the standard rate per kg, per hour, etc.
expenditure variance
K
No variance for fixed production overhead volume

variance In a marginal costing system, under/over
absorption of fixed overheads does not arise due
K
Total sales contribution variance replaces total

sales margin variance: contribution is used to volume changes
instead of margin; standard variable unit cost
is used instead of standard total unit cost
Study tip
Be prepared for assessment questions which
require you to work backwards from variance
information to derive the data for actual costs
113
——————————————————————————————————————————
Interpreting variances
Variance Possible cause of favourable Possible cause of adverse variance

variance
Direct material price Lower quality material Standard price too low
Direct material usage Standard usage too high High level of waste
Direct labour rate Less skilled employees used Standard rate too low
Direct labour and variable More skilled employees used Ideal performance standard
overhead efficiency
Idle time Machine breakdown
Variable overhead expenditure Standard hourly rate too high Higher variable power costs
Fixed overhead expenditure Lower cost for rent, salaries Budgeted expenditure too low
Fixed overhead volume Increased demand for output Budgeted volume too high
114
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Interpreting variances
Study tip It is probably not worth investigating every variance.

Factors which may be considered before conducting
On the last card we gave a single possible cause for
each type of variance. Many other causes are possible.
an investigation include the following
In the assessment you should study the information
available and select a cause which is consistent with
an adverse or favourable variance.
The significance of variances
A variance which exceeds, say, 5% of

K
Size of variance. Standards cannot be 100%
standard, might be investigated accurate and costs will tend to fluctuate
K
Likelihood of variance being controllable. For
example, labour rate variances may be caused by
For example higher quality material
uncontrollable market forces
¼ adverse price variance but favourable
usage variance
KK Possible interrelationship of variances
Likely cost of investigation. Cost of
investigation might outweigh saving from
Ideal performance standard tends to
correction of variance
K
produce adverse variances Type of standard set

115
——————————————————————————————————————————
Standard cost bookkeeping
Recording variances – general rules

K
Record all variances at the point at which they

arise
Note
These are general rules. Variations do
K
Materials price variance in materials control stock

account exist
K
Labour rate variance in wages control account

stock Record the actual variances as a debit (adverse
K
‘Quantity’ variances (material usage, efficiency variance) or a credit (favourable variance) in a

variances) in work in progress account separate variance account. Entries described in the
K
Overhead variances in production overhead list opposite ¼ ‘other side’ of each variance entry
control account
K
Sales values recorded at actual amounts. At period end, transfer all variance account
No accounts are kept for sales variances
balances to P & L to offset against standard
KK
Finished goods stock held at standard cost. cost of sales. Adverse ¼ debit to P & L;
Transfer to cost of sales and to P & L made favourable ¼ credit to P & L
at standard cost
116
——————————————————————————————————————————
––––––––––––––––––––––––––––––––––
Material control account Wages control account
Balance b/d xx WIP (actual usage Bank net wages xx WIP (actual hours
std. price) xx std. rate) xx
Creditors xx PAYE/NI creditor xx Labour rate variance# xx
Price variance* xx Balance c/d xx xx xx
xx xx
#This example shows an adverse rate variance, which is
*This example shows a favourable price variance, which debited to the labour rate variance account for later
is credited to the material price variance account for later transfer to P & L. For a favourable variance, the wages
transfer to P & L. For an adverse variance, the material control account would be debited and the labour rate
control account would be credited and the material price variance account would be credited
variance account would be debited
117
——————————————————————————————————————————
Production overhead control account Work in Progress control account
Expense creditors xx WIP (standard hours Balance b/d xx Finished goods (actual
Depreciation provn. xx std. rate) xx Material usage at production std. cost) xx
Expenditure std. price xx Usage variance# xx
variance* xx Volume variance# xx Labour hrs at
xx xx std. rate xx
Prodn. o/h at
*Favourable variance is credited to overhead std. rate xx
expenditure variance account. Entry reversed if variance Efficiency variance* xx Balance c/d xx
is adverse xx xx
# Adverse variance is debited to overhead volume
*Favourable labour efficiency variance is credited to
variance account. Entry reversed if variance is favourable
variance account for later transfer to P & L
# Adverse material usage variance is debited to variance
account for later transfer to P & L
118
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(Janet Walker) CIMA Revision Cards Management Acc (BookFi)

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(Janet Walker) CIMA Revision Cards Management Acc (BookFi)

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CIMA REVISION CARDS

AMSTERDAM l BOSTON l HEIDELBERG l LONDON l NEW YORK l OXFORD

First published 2005

Copyright ß 2005, Elsevier Ltd. All rights reserved

Printed and bound in Great Britain

Cost unit – a unit of product or service in relation Cost unit examples

Costs are classified so that they can be arranged

Nature of cost: material, labour or expense

Fixed or variable are partly fixed and partly variable

Normal and abnormal: highlighting abnormal

Relevant and non-relevant: in respect of

Definition Requirements for efficient coding

A code is usually briefer than a description

Fixed cost – a cost which, within certain activity

Examples of fixed costs

Rent of the factory

Stepped fixed cost – a cost which remains constant

Examples of stepped fixed costs

Variable cost – a cost which varies in relation to

Examples of variable costs

Packaging material costs

Semi-variable cost – a cost containing both

Examples of semi-variable costs Semi-variable costs are also referred to as

The high-low method Example

Uses historical data on costs and activity levels

Fixed cost determined by substituting variable

Uses historical data on costs and activity levels

Variable cost per unit is given by gradient

Materials accounting and control procedures

Key study system questions Topics

Ordering and receiving stock Alternatively, a special order item might be

2 Storekeeper raises purchase requisition

Copy sent to supplier, to accounts

Supplier may also leave a delivery note

Invoice checked against purchase order

Issuing stock from stores

Ensures that cost of unused material is

3 Excess materials transferred to another job

Recording and checking stock

Bin cards and/or stores ledger cards record all

Stock may be counted and checked against stock

Alternatively, a number of items may be counted Continuous stocktaking cannot be carried

Stock kept at optimum level to minimise risk of Study tip

Reorder level ¼ maximum usage maximum lead time

The EOQ formula will be provided in the

EOQ ¼ when total cost is

First In First Out (FIFO) – prices issues at the

Last In First Out (LIFO) – prices issues at the

Weighted average (AVCO) – prices issues at the

When prices are rising FIFO LIFO AVCO

Calculating the weighted average price

Labour accounting and control procedures

Key study system questions . Remuneration systems

Time-based systems Piecework systems Bonus schemes

Overtime hours usually paid at minimum wage employer

Important to check quality performance, whole group

Learn this formula. It will not be provided in the

Time recording systems Activity recording systems

Clock cards: record starting and finishing times. Piecework/bonus ticket

Usually treated as direct labour Usually treated as indirect labour

The analysis of overhead

Apportionment and re-apportionment Reciprocal servicing

Overhead not incurred evenly over period: actual