lOMoARcPSD|5592403

MAFS Exam Theory Notes

Management Accounting Fundamentals (Western Sydney University)

StuDocu is not sponsored or endorsed by any college or university

Downloaded by Manas SunilMadhuri (manassunilmadhuri@gmail.com)
 lOMoARcPSD|5592403

MAFS Exam Theory Notes:

Chapter 1: Managerial Accounting and Cost Concepts:
Needs of management:
o Financial Accounting: concerned with reporting financial information to external parties such as
stockholders, creditors and regulators.
o Managerial accounting: concerned with providing information to managers within an organization so
that they can formulate plans, control operations and make decisions.
Purpose of Cost Classification:
1. Assigning costs to coast objects
2. Accounting for costs in manufacturing companies
3. Preparing cost behaviour in response to changes in activity
4. Making decisions

Learning Objective 1:: direct costs and indirect costs.

o Direct costs: can be easily and conveniently traced to a unit of product or other cost object. E.g. DM
and DL
o Indirect cost: cannot be easily and conveniently traced to a unit of product or other cost object. E.g.
MOH.
o Common costs: indirect costs incurred to support a number of cost objects. These costs cannot be
traced to any individual cost object.
Learning Objective 2: the three basic manufacturing cost categories.
Classifications of manufacturing costs:
1. DM: raw materials that become an integral part of the product and that can be conveniently traced
directly to it. E.g. radio installed in an automobile.
2. DL: labor costs that can be easily traced to individual units of product. E.g. wages paid to automobile
workers.
3. MOH: includes all manufacturing costs except DM and DL. These costs cannot be readily traced to
finish products. Includes indirect materials that cannot be easily or conveniently traced to specific
units of products. E.g. depreciation of manufacturing equipment, utility costs, property taxes and
insurance premiums incurred to operate a manufacturing facility.
Only indirect costs associated with operating the factory are included in MOH. Manufacturing costs
include DM<, DL and MOH.
Prime Costs and Conversion Costs:
Prime costs are the combination of DM and DL costs because most of the manufacturing operations DM and DL
occupy the highest percentage of costs.
Conversion costs are the combination of DL and MOH costs. It is the cost of converting the DM into finished
products.

Non-manufacturing costs:
o Selling costs: necessary to secure the order and deliver the product to the customers. Can be either
direct or indirect costs.
o Administrative costs: all costs associated with the general management of an organization. Can be
either direct or indirect costs.
Learning Objective : product costs and period costs.
Product Costs: all the costs involved in acquiring or making a product.
Attach to a unit of product as it is purchased or manufactured, and they
stay attached to each unit of product as long as it remains in inventory
awaiting sale. In accounting system, we add the costs to the inventory
account until they are sold. Once sold we transfer costs to expense
account called cost of goods sold on account.
Manufacturing Product costs:
o Raw materials: cost of any materials used to create the final product.
o Work in process: units of product that are only partially complete and will require further work before
they are ready for sale to the customer.
o Finished goods cost: consists of completed units of product that have not yet been sold to customers.
Transfer of product costs:

Downloaded by Manas SunilMadhuri (manassunilmadhuri@gmail.com)

 lOMoARcPSD|5592403

o When DM are used in production their costs are transferred from raw materials to work in process.
o DL and MOH costs are added to work in process to convert DM into finished goods.
o Once units of product are completed, costs are transferred from WIP to finished goods.
o When manufacturer sells its finished goods to customers, the costs are transferred from finished
goods to cost of goods sold.
Learning Objective 4: variable costs, fixed costs and mixed costs.
Costs classification to predict cost behaviour:
Cost behaviour refers to how a cost will react to changes in the level of activity. Most common classifications
are:
o Variable costs: cost that vary in total and in direct proportion to changes in the level of activity. The
per unit here is constant. Variable in total but fixed on per unit basis.
o Fixed costs: cost that remains constant, in total, regardless of changes in the level of activity. If
expressed on a per unit basis, the average FC per unit varies inversely with changes in activity. Types of
FC are committed which is long term, cannot be significantly
reduced in the short term and discretionary which may be altered
in the short term by current managerial decisions.
The relevant range and FC
Relevant range of activity pertains to fixed cost as well as variable costs.
Relevant range of activity for a FC is the range of activity over which the
graph of the cost is flat.
Discretionary FC: a fairly short planning horizon usually a year. Such costs arise from annual decisions by
management to spend on certain fixed cost items, such as advertising, research, and management
development. Committed FC: relate to a company’s investment in facilities, equipment, and basic organization.
Once such costs have been incurred, they are “locked in” for many years.

Mixed cost: contains both variable and fixed elements.

Learning Objective 5: differential costs, sunk costs and opportunity costs.
Cost classification for decision making: Goal of making decisions is to identify these costs that are either
relevant or irrelevant to the decision. To make decisions, it is essential to have a grasp on three concepts:
1. Differential costs (or incremental costs): difference in cost between any two alternatives. A difference
in revenue between two alternatives is called differential revenue. Both are always relevant to
decisions. Costs can be either fixed or variable.
2. Sunk costs: cost that have been already incurred and cannot be charged now or in the future. Should
be ignored when making decisions.
3. Opportunity costs: potential benefit that is given up when one alternative is selected over another.
Not usually found in accounting records but must be explicitly considered in every decision.
Learning Objective 6: Prepare Income statements for a merchandising company using the tradition and
contribution formats.
Use of contribution format:
Used and prepared as an internal planning and decisions making tool
mostly for management. It is based on separation of cost into variable
and fixed components. The contribution margin is the difference
between the sales and variable expense. The amount of sales revenue
is left over after all variable expenses are covered and can be used to
fixed expenses and operating income. Useful for: cost volume profit
analysis, segmented reporting of profit data, budgeting and special
decisions such as pricing and make or buy analysis.
Traditional Approach:
organizes costs by function, such as production, selling, and administration. Within a functional area, fixed and
variable costs are intermingled. The contribution approach income statement organizes costs by behaviour, first
deducting variable expenses to obtain contribution margin, and then deducting fixed expenses to obtain net
operating income.

Topic 2: Determining how costs behave: (still chapter 1)

Analysing Mixed Costs: Mixed costs contain both variable and fixed elements e.g. utility cost. For calculating
future costs, we need to breakdown the mixed cost into its variable and fixed components. For a utility cost you

Downloaded by Manas SunilMadhuri (manassunilmadhuri@gmail.com)

 lOMoARcPSD|5592403

need to pay the monthly fixed charge which is a fixed cost and the monthly usage cost per KW depending on
the usage of electricity which is a variable cost.
Methods of Separating mixed costs:
o Account analysis approach: each account is classified as either variable or fixed based on the analyst’s
knowledge of how the account behaves.
o Engineering approach: classifies costs based upon an industrial engineer’s evaluation of production
methods and material, labor and overhead requirements. Involves detailed analysis of what cost
behaviour should be based upon an industrial engineer’s evaluation of production methods to be
used.
o Scatter graph: data points for past costs are plotted against a potential cost driver.
o High low method: used to reveal a linear relationship between two variables. It relies on two data
points to estimate the fixed and variable portions of a mixed cost.
o Least square regression method: analyse mixed costs if a scatter graph plot reveals an approximately
linear relationship between the X and Y variables. uses all of the data points to estimate the fixed and
variable cost components of a mixed cost. The goal of this method is to fit a straight line to the data
that minimizes the sum of the squared errors.
Comparing results:
 The high-low and least-squares regression methods provide different estimates of the fixed and
variable cost components of a mixed cost.
 This is to be expected because each method uses differing amounts of the data points to provide
estimates.
 Least-squares regression and high low provide the most accurate estimates because it uses all of the
data points.

Chapter 2: Job order costing: calculating unit product costs:

Process costing: used by businesses that produce large number of products in a continuous flow of production
with the products being in similar nature. E.g. processed foods, beverages etc.
Job order costing: used by a business that produce a number of products or services that are unique from one
another and it needs separate cost estimation. E.g. furniture manufacturer produces different types of
products depending on the customer. Used in in situations where many different products, each with individual
and unique features, are produced each period.
Absorption Costing: all manufacturing costs, both fixed and variable, are assigned to units of product—units are
said to fully absorb manufacturing costs. Conversely, all nonmanufacturing costs are treated as period costs
and they are not assigned to units of product.
Normal costing systems: apply overhead costs to jobs by multiplying a predetermined overhead rate by the
actual amount of the allocation incurred by the job.

Predetermined Overhead Rate:

The predetermined overhead rate (POHR) used to apply overhead to jobs is determined before the period
begins. Predetermined overhead rates that rely upon estimated data are often used because:
1. Actual overhead for the period is not known until the end of the period, thus inhibiting the ability to
estimate job costs during the period.
2. Actual overhead costs can fluctuate seasonally, thus misleading decision makers.
We calculate POHR by following the four steps:
1. Estimate how much of the selected allocation base (the denominator) will be required for the next
production period.
2. Estimate the total fixed manufacturing overhead cost for the coming period and the variable
manufacturing overhead cost per unit of the allocation base.
3. Use the equation to estimate the total amount of manufacturing overhead: Y = a + bX
4. We divide the estimated manufacturing overhead by the denominator volume.

Some production costs must be assigned to products through an allocation process as some cannot be traced
to a particular product or job but rather incurred as a result of overall production activities. some production
costs such as indirect materials cannot be easily traced to jobs. If these costs are to be assigned to products,
they must be allocated to the products

Downloaded by Manas SunilMadhuri (manassunilmadhuri@gmail.com)

 lOMoARcPSD|5592403

2-8) Why do companies use predetermined overhead rates rather than actual manufacturing overhead costs to
apply overhead to jobs?
If actual manufacturing overhead cost is applied to jobs, the company must wait until the end of the
accounting period to apply overhead and to cost jobs. If the company computes actual overhead rates more
frequently to get around this problem, the rates may fluctuate widely due to seasonal factors or variations in
output. For this reason, most companies use predetermined overhead rates to apply manufacturing overhead
costs to jobs.

Underapplied Overhead: When a company applied less overhead to production than it actually incurs.
Overapplied overhead: When it applies more overhead to production than it actually incurs.

Plantwide Overhead Rate: single overhead rate used throughout a plant. In a multiple overhead rate system,
each production department may have its own predetermined overhead rate and its own allocation base.
Some companies use multiple overhead rates rather than plantwide rates to more appropriately allocate
overhead costs among products. Multiple overhead rates should be used, for example, in situations where one
department is machine intensive and another department is labor intensive.

Chapter 4: Process Costing:

Process costing is the difference between job order costing and process costing. It records cost in process. A
process costing system should be used in situations where a homogeneous product is produced on a
continuous basis in large quantities.
In a process costing system, a Work in Process account is maintained for each processing department.

Similarities between them:

o Both systems have the same basic purposes – to assign material, labor and manufacturing overhead
costs to products and to provide a mechanism for computing unit product costs.
o Both use the same basic manufacturing accounts.
o Flow of costs through the manufacturing accounts is basically the same in both systems.
Differences
Job-Order Costing Process Costing
o Used when many different jobs are worked o Used when company produces a
on during each period, with each job having continuous flow of units that are
unique production requirements. indistinguishable from one another. All
o Costs are accumulated by individual job. units are identical.
o Unit costs are completed by job on the job o Costs are accumulated by department.
cost sheet. o Unit costs are computed by department.
The journal entry to record the transfer of work in process from the Mixing Department to the Firing
Department is:

Work in Process, Firing XXXX

Work in Process, Mixing XXXX

Under the weighted-average method, equivalent units of production consist of units transferred to the next
department (or to finished goods) during the period plus the equivalent units in the department’s ending work
in process inventory.

Chapter 5: Cost-Volume-Profit Analysis:

The Contribution Margin Ratio:
The CM ratio is the ratio of the total contribution margin to total sales revenue. It can also be expressed as the
ratio of the contribution margin per unit to the selling price per unit. It is used in target profit and break-even
analysis and can be used to quickly estimate the effect on profits of a change in sales revenue.

Company A and company B are idnetlical except that Company A’s costs are more variable, whereas Company
B’s costs are mostly fixed. When sales increase, which company will tend to realize the greatest increase in
profits? Explain.

Downloaded by Manas SunilMadhuri (manassunilmadhuri@gmail.com)

 lOMoARcPSD|5592403

All other things equal, Company B, with its higher fixed costs and lower variable costs, will have a higher
contribution margin ratio than Company A. Therefore, it will tend to realize a larger increase in contribution
margin and in profits when sales increase.

Operating Leverage: measures the impact on net operating income of a given percentage change in sales. The
degree of operating leverage at a given level of sales is computed by dividing the contribution margin at that
level of sales by the net operating income at that level of sales

5-6) In response to a request from your immediate supervisor, you have prepared a CVP graph portraying the
cost and revenue characteristics of your company’s product and operations. Explain how the lines on the graph
and the break-even point would change if the selling price per unit decreased, FC increased throughout the
entire range of activity portrayed on the graph and variable cost per unit increased.
If the selling price decreased, then the total revenue line would rise less steeply, and the break-even point
would occur at a higher unit volume. (b) If the fixed cost increased, then both the fixed cost line and the total
cost line would shift upward, and the break-even point would occur at a higher unit volume. (c) If the variable
cost per unit increased, then the total cost line would rise more steeply, and the break-even point would occur
at a higher unit volume.
Sales Mix: The sales mix is the relative proportions in which a company’s products are sold. The usual
assumption in cost-volume-profit analysis is that the sales mix will not change.

5-9) explain how a shift in the sales mix could result in both a higher breakeven point and a lower net operating
income.
A higher break-even point and a lower net operating income could result if the sales mix shifted from high
contribution margin products to low contribution margin products. Such a shift would cause the average
contribution margin ratio in the company to decline, resulting in less total contribution margin for a given
amount of sales. Thus, net operating income would decline. With a lower contribution margin ratio, the break-
even point would be higher because more sales would be required to cover the same amount of fixed costs.

Chapter 12: Differential analysis: the key to decision making:

Relevant Cost: Cost that differs in total between the alternatives in a decision.
Incremental cost: (or benefit) is the change in cost (or benefit) that will result from some proposed action
Opportunity Cost: An opportunity cost is the benefit that is lost or sacrificed when rejecting some course of
action.
Sunk Cost: a cost that has already been incurred and that cannot be changed by any future decision.
Variable costs: variable costs are relevant costs only if they differ in total between the alternatives under
consideration. A variable cost is a cost that varies in total amount in direct proportion to changes in the level of
activity. Differential cost: is the difference in cost between two alternatives. If the level of activity is the same
for the two alternatives, a variable cost will not be affected, and it will be irrelevant.
Future Costs: only future costs that differ between the alternatives are relevant.

12-8) “if a product cost is generating a loss, then it should be discontinued” do you agree? No, an apparent loss
may be the result of allocated common costs or of sunk costs that cannot be avoided if the product is dropped.
A product should be discontinued only if the contribution margin that will be lost as a result of dropping the
product is less than the fixed costs that would be avoided. Even in that situation the product may be retained if
it promotes the sale of other products.

12-9) What is the danger in allocating common fixed costs among products or other segments of an
organization? Allocations of common fixed costs can make a product (or other segment) appear to be
unprofitable, whereas in fact it may be profitable.

12-15) What guideline should be used in determining whether a joint product should be sold at the split-off
point or processed further?
If the incremental revenue from further processing exceeds the incremental costs of further processing, the
product should be processed further.

Downloaded by Manas SunilMadhuri (manassunilmadhuri@gmail.com)