ARBAMINCH UNIVERSITY

COLEGE OF BUSINESS AND ECONOMICS

DEPARTIMENT OF ACCOUNTING AND FINANCE
POST GRADUATE PROGRAM

ASSIGNMENT ON ADVANCED COST AND MANAGEMENT ACCOUNTING

PREPARED BY:

1. CHOLE SHUMBULO ID NO PRBE/016/11

2. YONAS AREGA ID NO PRBE/105/11

Submitted to: TAMRAT G /PhD candidate/

January 15, 2019

Arba- Minch
 16. COST BEHAVIOR
Cost behavior is associated with a change in an organization's level of activity. The costs which
vary proportionately with the changes in the level of activity are referred to as variable costs. The
costs that are unaffected by changes in the level of activity are classified as fixed costs. Cost
behavior is not required for external reporting under U.S. GAAP. However, the understanding of
cost behavior is very important for management's efforts to plan and control its organization's
costs. Budgets and variance reports are more effective when they reflect cost behavior patterns.
The understanding of cost behavior is also necessary for calculating a company's break-even
point and for any other cost-volume-profit analysis.
2. COST FUNCTION
A cost function is a mathematical formula used to chart how production expenses will change at
different output levels. It estimates the total cost of production given a specific quantity
produced. Management uses this model to run different production scenarios and help predict
what the total cost would be to produce a product at different levels of output. The cost function
equation is expressed as C(x)= FC + V(x), where C equals total production cost, FC is total fixed
costs, V is variable cost and x is the number of units. The management understand the cost
behavior of a product. This is vital to anticipate costs that will be incurred in the next operating
period at the planned activity level. Management to evaluate how efficiently the production
process was at the end of the operating period. The term "cost" is often used in business in the
context of marketing and pricing strategies, while the term "expense" implies something more
formal and something related to the business balance sheet and taxes. The expense sounds
similar to that of cost: "an amount of money that must be spent especially regularly to pay for
something." A cost function is a mathematical formula used to chart how production expenses
will change at different output levels. In other words, it estimates the total cost of production
given a specific quantity produced. Management uses this model to run different production
scenarios and help predict what the total cost would be to produce a product at different levels of
output. The cost function equation is expressed as C(x)= FC + V(x), where C equals total
production cost, FC is total fixed costs, V is variable cost and x is the number of units.
Understanding a firm’s cost function is helpful in the budgeting process because it helps
management understand the cost behavior of a product. This is vital to anticipate costs that will
be incurred in the next operating period at the planned activity level. Also, this allows
management to evaluate how efficiently the production process was at the end of the operating
period
EXPENSES IN ACCOUNTING. In a business sense, an expense is "an item of business
outlay chargeable against revenue for a specific period." "Chargeable against revenue" means
that expenses are figured against gross income in the calculation of profits and losses. They are
subtracted from the business gross income to get a net income or profit on the net income (profit
and loss) statement. Expenses are used to produce revenue and they are deductible on your
business tax return, reducing the business's income tax bill. Costs don't directly affect taxes, but
the cost of an asset is used to determine the depreciation expense for each year, which is a
deductible business expense. Train employees in its use.

3. CONTROLEBILITY COST

Cost control is a series of steps that a business uses to maintain proper control over its cost.
Implementing this level of control can have a profound positive impact on profits over the
long term. The following four steps are associated with cost control: Establish a standard or
baseline against which actual costs are to be compared. These standards may be based on
historical results, a reasonable improvement on historical results, or the theoreti cally best
attainable cost performance. The middle alternative is generally considered to yield the best
results, since it sets an achievable standard. CALCULATE A VARIANCE. Calculate
the variance between actual results and the standard or baseline noted in the first step.
Particular emphasis is placed on the detection of inferable, which are those actual costs that
are higher than expected. If a variance is immaterial, it may not be worthwhile to report t he
item to management if there is an unusual spike in the trend line, then the spike is
investigated in relation to the average cost level, and corrective action is taken. Thus,
operating without a budget eliminates the first two steps in the preceding lis t of activities, but
cost control still requires investigatory work and recommendations to management for
corrective action. The shareholders of a publically held company are particularly interested in
a system of cost control, for they realize that tight cost control gives a company considerable
influence over its cash flows and reported profits.
 4. RELEVANT COST

Relevant cost is a managerial accounting term that describes avoidable costs that are incurred
when making business decisions. The concept of relevant cost is used to eliminate unnecessary
data that could complicate the decision-making process.

ii. PLANING

Planning is the most fundamental function of management. An organization can succeed in

effective utilization of its human, material and financial resources only when its management
decides in advance its objectives and methods of achieving them. If group effort is to be
effective, people must know what they are expected to accomplish. This is the function of
planning. Managerial accounting involves collecting, analyzing, and reporting information
about the operations and finances of a business. These reports are generally directed to the
managers of a business, rather than to any external entities, such as shareholders or lenders.
The functions of managerial accounting include: margin ANALYSIS. Determining the
amount of profit .or cash flows that a business generates from a specific product, product line,
customer, store, or region. Break even analysis. Calculating the mix of contribution margin
and unit volume at which a business exactly breaks even, which is useful for
determining price points for products and services. constraints analysis controllable costs
.Assisting in the design of new products by accumulating the costs of new designs,
comparing them to target cost levels, and reporting this information to management. After
spotting a variance through trend analysis, a person engaged in managerial accounting might
dive deeper into the underlying information and examine individual transactions, in order to
understand exactly what caused the variance. This information is then aggregated into a
report to management. if they are needed, and what the appropriate form of financing may be
with which to acquire them.
 CONTROLLING

Controlling consists of verifying whether everything occurs in conformities with the plans
adopted, instructions issued and principles established. Controlling ensures that there is effective
and efficient utilization of organizational resources so as to achieve the planned goals.
Controlling measures the deviation of actual performance from the standard performance,
discovers the causes of such deviations and helps in taking corrective actions. Controlling is a
systematic exercise which is called as a process of checking actual performance against the
standards or plans with a view to ensure adequate progress and also recording such experience as
is gained as a contribution to possible future needs.” According to Donnell, “Just as a navigator
continually takes reading to ensure whether he is relative to a planned action,
DECISION MAKING
Decision making is crucial for running a business enterprise which faces a large number of
problems requiring decisions. which product to be produced, what price to be charged, what
quantity of the product to be produced, what and how much advertisement expenditure to be
made to promote the sales, how much investment expenditure to be incurred are some of the
problems which require decisions to be made by managers.
RELEVANT DESIGN OF EFFECTIVE MANAGEMENT

Organization Design is the process of aligning an organization’s vision and strategy with its
structure, talent, accountabilities, authorities, rewards and processes. When any one of these
elements is out of line a company is not able to achieve optimal results.
THE RELASHIN SHIP OF STATEMENTS
The financial statements are comprised of the income statements, balance sheet, and statement
of cash flow. These three statements are interrelated in several ways, the net income figure in
the income statement is added to the retained earnings line item in the balance sheet, which
alters the amount of equity listed on the balance sheet. The net income figure also appears as
a line item in the cash flow from operating activities section of the statement of cash flows.
Changes in various line items in the balance sheet roll forward into the cash flow line items
listed on the statement of cash flows. The ending cash balance in the balance sheet also
appears in the statement of cash flows. The purchase, sale, or other disposition of assets
appears on both the balance sheet (as an asset reduction) and the income statement (as a gain
or loss, if any). In short, the financial statements are highly interrelated. Consequently, when
reviewing the financial statements of an organization, one should examine all of the financial
statements in order to obtain a complete picture of its financial situation.

17. Explain
Activity-Based Costing The activity-based costing (ABC) approach allocate overhead costs to
products by first assigning the overhead costs to major activities done by the organization, and
then using the appropriate cost driver for each activity, the overhead costs are allocated to the
product in proportion to the amount of the cost driver consumed by the product. ABC
proponents indicate that ABC captures the economics of the production process more closely
than traditional volume-based costing systems (Cooper and Kaplan 1990). ABS also identifies
the different levels of activities. The cost hierarchy under ABS categorizes costs into different
cost pools on the bases of the difference in the cost deriver, whether it is a unit, batch, or product
line.

Discuss the difference between ABC and a traditional costing system. Explain the advantages
and disadvantages of the ABC system. Is it applicable to all types of organizations? Search the
internet for companies that applied this system and discuss the degree of success they met. What
are the measures of success that are used in evaluating the success of ABC? The difference
between ABC or Activity Based Costing and TCA or Traditional Cost Accounting is that ABC is
complex whereas TCA is simple.

Traditional cost accounting is obsolete whereas Activity Based Accounting is used more by
various target-oriented companies.

ABC methods help the company to identify the needs of keeping or eliminating certain activities
to add value to the products.

1/. Advantages ABC system

Calculating the costs of the goods or services offered is essential for businesses to maintain
profitability. Direct costs like supplies and the labor of employees who manufacture a product or
deliver a service provide some of the information that companies need to assess their expenses
accurately. But they also must account for indirect costs like overhead expenses relating to
facilities, utilities or administration. Traditional costing is one of two ways to assign overhead
costs to goods or services.

Simple Traditional costing assigns expenses according to an average overhead rate. Companies
calculate this rate by pooling all indirect costs and applying them equally in a common unit, like
machine hours. Then they calculate the cost of each product or service using the same rate. This
is less complex than the alternative method of activity-based costing, which calculates the cost of
each product or service based on the specific expenses involved.

2/. Dis advantages ABC System

Cost-Effective Since it is less complicated than activity-based costing, a company’s accountants

don’t have to spend as much time performing calculations for traditional costing. Nor do they
have to create costly systems for tracking expenses. Therefore, traditional costing is also less
expensive than activity-based costing

What are the measures of success that are used in evaluating the success of ABC.

ABC and the Balanced Scorecard provide managers with the information needed to make “value
creating” decisions. EVA provides a decision framework, performance measures and incentives
to motivate management to create value. Is it applicable to all types of organization the reason
small spaces should be organized as much as possible is simple. If you have a big area, it can be
a little on the messy side, and you won’t notice as much. If your space is tiny, however, it
doesn’t matter if it’s a bedroom, a closet or a shelf. The smaller it is, the easier it is for it to
become messy and cluttered. It’s important to put things back where they belong. Don’t just
drop items on the closet floor or shelf with a vague promise to "take care of it later." Doing so
will quickly add up and leave you feeling overwhelmed and crowded-out. Instead, take the time
to put things away. Create a specific place where everything goes. This action is the first and
arguably most important step to any set of small closet solutions.

If so, that’s great. You’re already one step closer to having a more spacious and functional
closet space. If not, there’s no need to worry. We’re not telling you that you need to become a
neat-freak overnight. However, one of the keys to keeping your space workable lies in keeping it
organized. Because of this need, there's value in slowly training yourself to become better at
cleaning and organizing.

Evaluation is a series of monthly reports from Stern Stewart Europe Limited, drawing on the
depth of our experience and internal research, to cover issues of valuation, organizational design,
decision making, remuneration, and corporate governance. Our focus is to assist managers in
understanding how their actions affect the value of their organizations. We believe that all
stakeholders benefit from the creation of value through both innovation and efficiency.

18. Explain EVA.

Economic value added (EVA) is a financial measurement of the return earned by a firm that is in
excess of the amount that the company needs to earn to appease shareholders. In other words, it
is a measure of an organization’s economic profit that takes into account the opportunity cost of
invested capital and ultimately measures whether organizational value was created or lost.

EVA compares the rate of return on invested capital with the opportunity cost of investing
elsewhere. This is important for businesses to keep track of, particularly those businesses that are
capital intensive. When calculating economic value added, a positive outcome means that the
company is creating value with its capitals investments.
Conversely, a negative outcome would mean that the company is destroying value with its
capital investments and the capital would be better spent elsewhere. Businesses can use
economic value added to assess managerial performance as it serves as a measure of value
creation for shareholders.

The formula for calculating EVA is: Net Operating Profit After Taxes (NOPAT)- Invested
Capital * Weighted Average Cost of Capital (WCC)

An equation for invested capital often used to calculate EVA is = Total Assets - Current
Liabilities, two figures easily found on a firm's balance sheet. In this case, the formula for EVA
is: NOPAT - (Total Assets - Current Liabilities) * WACC.
Advantages of EVA

 EVA provides for better assessment of decisions that affect balance sheet and income
statement or tradeoffs between each through the use of the capital charge against
NOPAT.
 EVA decouples bonus plans from budgetary targets.
 EVA covers all aspects of the business cycle.
 EVA aligns and speeds decision making, and
 Enhances communication and teamwork.

Limitations of EVA

EVA does not control for size differences across plants or divisions.
EVA is based on financial accounting methods that can be manipulated by managers
EVA may focus on immediate results which diminishes innovation.
EVA provides information that is obvious but offers no solutions in much the same way
as historical financial statement do.

A very common problem when implementing corporate governance is due to conflict of interest
both owners and managers. Managers intend to work and implement such accounting principles
that help them to increase their bonus and compensation plan, whereas owners want to maximize
their own wealth. In view with this argument, Young (1997) asserts that the significant
advantage of using EVA can help firms in resolving this agency problem. By implementing EVA
managers will eventually also act like owners, as their wealth is linked to that of the investors. In
addition, Managers have less scope to manipulate the accounting profits under EVA. On the
other hand, if ROI, ROE and other traditional performance measures are used for manager’s
compensation plan, they are highly intended to manipulate the figures in order to maximize their
own wealth.

Yes I believe that because, EVA is exceptional from other traditional tools in the sense that all
other tools mostly depend on information generated by accounting. And we know accounting;
more often produces historical data or distorted data that may have no relation with the real
status of the company. But, EVA goes for adjustments to accounting data to make it
economically viable.
EVA is gaining popularity because each of the traditional tools only can explain a specific market
or firm situation only. For example, earnings per share can only explain the capital market not
the capital budgeting. Likewise, net present value cannot explain target return but it can explain
only capital budgeting. On the other hand, EVA offers more than just one performance. EVA can
explain capital market, capital budgeting and net assets at the same time. As a result, managers
are not required to calculate three financial measures for three different performances, EVA itself
can explain all three different performances.

19. Explain the idea behind the balanced scorecard

Balanced scorecard is a management system, it’s a way of looking at your organization that
focuses on your big picture strategic goals. It also helps you choose the right things to measure
so that you can reach those goals.

 BSC is strategic planning and management system that organizations use to:-
 Communicate what they are trying to accomplish
 Align the day-to-day work that everyone is doing with strategy
 Prioritize projects ,products and services
 Measure and monitor progress towards strategic targets

The system connects the dots between big picture strategic elements such as mission (our
purpose), vision (what we aspire for), core values (what we believe in), strategic focus areas
(themes, results and or goals) and the more operational elements such as objectives (continuous
improvement activities), measures or key performance indicators, targets (our desired or KPIs,
which track strategic performance, targets (projects that help you reach your targets). Show how
companies in different industries are using it and how successful it. BSC are used extensively in
business, industries, government and non-profit organizations worldwide. Gartner Group
suggests that over 50% of large US firms have adopted the BSC. More than half of major
companies in the US, Europe, and Asia are using the BSC, with use growing in those areas as
well as in the Middle East and Africa. Recent global study by Bain and co listed balanced
scorecard fifth on its top ten most widely used management tools around the world, a list that
includes closely related strategic planning at number one. BSC has also been selected by the
editors of Harvard Business Review as one of the most influential business ideas of the past 75
years.

BSC terminology: Measures (key performance indicators) For each objective on the strategic
map, at least one measure or key performance indicator (KPI) will be identified and tracked over
time. KPI's indicator progress toward a desirable outcome. Strategic KPI's monitor the
implementation and effectiveness of an organizations strategies, determine the gap between
actual and targeted performance and determine organization and effectiveness and operational
efficiency.

Good KPIs:-

 Provide an objective way to see if strategy is working

 Other comparison that gauges the degree of performance change over time
 Focus employees attention on what matters most to success
 Allow measurement of accomplishments, not just of the work that is
performed
 Provide a common language for communication
 Help reduce intangible uncertainty. The BSC is strategic performance
management system used by many companies in the international business
environment. According to Kaplan and Norton (1992:1996a) the creators
of BSC, this tool can balance both the financial and non-financial
measures that accompany uses. It is separated in to four perspectives:-
 Customer perspective
 Internal business perspective
 Innovation and learning perspective
 Financial perspective

According to Gumbus and Lussier (2006), the BSC can be used in both large and small
businesses if employees are working towards achieving the same targets and strategic goals. The
final building blocks of a balanced scorecard are measures. Every strategic objectives should
have one or two things that you measure to determine how it’s performing. These measures
needs goals and should be measured on a regular schedule. Perquisites for successful application
and success recorded

 Al- Matarneh(2011) noted that the balanced scorecard must provide the
following basic set of requirement for success of applying
 Clear definition of the objective of the strategy because the determination
of strategic goals in the core of using(BSC)
 The success of the use of (BSC) as a measure of strategic management
system depends on the (BSC) approaches by integrating the four
perspectives as BSC.
 It must respond to environmental changes and pressure on companies such
as the intensity of competition and focus on the client, and the
phenomenon of industrial integration.

20. Non Financial Performance Measures.

Non financial Performance measures are the qualitative measures that cannot be expressed in the
monetary units or they are performance Measures of either an individual or an entity’s
performance that is not expressed in monetary units. Some of non financial Performance
Measures are:

 Company reputation
 Customers influences and values and Competitiveness
 Innovation.

They measure performance of company. In addition to the company’s non financial Performance
Measures there are also key non financial Performance measures for marketer which includes
brand performance, take rate, customer retention and churn, customer experience innovation,
and market share. The impotence of non-financial Performance Measures: Non-financial
measures have increasing impotence indecision making and performance evaluation of
companies. They deal with progresses relative to customer requirements or competitors, they are
used as a data for strategic performance and implementation of strategic plans, they serve as
better indicators of future financial Performance and they can provide the mission link between
the beneficial activities and financial results but supply forward looking information on
accounting or stock performance.

The reason for using non financial Performance Measures alongside the financial measures are:

 they have a close link to long – term organizational strategies ;

 They can provide indirect, qualitative indicators of a firm’s intangible assets.
 they can better indicate the future financial Performance
 They provide information about managerial action and level of noise in the measures.

In addition to the points associated with the exclusive use of financial Performance indicators to
monitor the performance that are caused due to:

 Short termism
 Internal focus
 manipulation of results
 failure of conveying the whole picture
 backward looking
 introduction
 the management of human resource
 product and service quality
 brand awareness and company profile etc

Finally non financial Performance Measures provide non financial information that are not
provided by the financial Performance Measures that provide the financial information.