What are the differences between Cost Control and Cost Reduction?

The following are the major differences between Cost Control and Cost Reduction:

1. The activity of maintaining cost as per the established norms is known as cost control.
The activity of decreasing per unit cost by applying new methods of production in such a
way that it does not affect the quality of the product is known as cost reduction.
2. Cost Control focuses on decreasing the total cost while cost reduction focuses on
decreasing per unit cost of a product.
3. Cost Control is temporary in nature. Unlike Cost Reduction which is permanent.
4. The process of cost control is completed when the specified target is achieved.
Conversely, the process of cost reduction has no visible end as it is a continuous process
that targets for eliminating wasteful expenses.
5. Cost Control does not guarantee quality maintenance. However, 100% quality
maintenance is assured in case of cost reduction.
6. Cost Control is a preventive function as it ascertains the cost before its occurrence. Cost
Reduction is a corrective action.
What is responsibility centre? Briefly differentiate cost, profit and investment
centers identifying the basic characteristic of each.

A Responsibility Centre is a segment of an organization for which a particular executive is

responsible. There are three types of responsibility centers: (1) expense (or cost) center. (2)
profit center. (3) investment center.

Expense (Cost) Centers.

a responsibility center incurring only expense (cost) items and producing no direct
revenue from the sale of goods or services.
managers are held responsible only for specified expense items.
the appropriate goal of an expense center is the long-run minimization of expenses. -
short-run minimization of expenses may not be appropriate.

Revenue Centers
managers are held responsible for revenues (sales) only.
managers of such centers also responsible for controlling expenses of unit as well.

Profit Centers.
a responsibility center having both revenues and expenses.
the manager must be able to control both of these categories.
controllable profits of a segment are shown when expenses under a manager's control
are deducted from revenues under that manager's control.
 Investment Centers.
a responsibility center having revenues, expenses, and an appropriate investment base.
the manager in charge of an investment center is responsible for and has sizable control
over revenues, expenses, and the investment base.

Equivalent units is a cost accounting concept that is used in process costing for cost calculations. If
100 units are in process but you have only expended 40% of the processing costs on them, then you are
considered to have 40 equivalent units of production.
The loss expected or anticipated prior to production is a normal process loss. It is
thus called a standard loss. A provision for such a loss is made before starting production. Weight losses,
shrinkage, evaporation, rusting etc. are the examples of normal loss. Normal loss increases the cost of
production of the usable goods realized.

The loss realized over the normal loss is called an abnormal loss. Abnormal loss
arises because of abnormal working conditions, bad working condition, carelessness, rough handling, lack
of proper knowledge, low quality raw material, machine breakdown, accident etc .Therefore an abnormal
loss is an unanticipated loss. Abnormal loss is a controllable loss and thus can be avoided if corrective
measures are taken. Therefore, abnormal loss is also called an avoidable loss.

An opportunity cost is the benefit that is lost or sacrificed when rejecting some course of action.

Limiting Factors refer to the constraints in availability of production resources (e.g. shortages in labor,

machine hours or materials) that prevent a business from maximizing its sales.

What is meant by the following terms? Give an example of each in a situation

where a factory makes use of the same production facility to make products M, N, O
and P using the same raw material of ZZ.
(a) Opportunity cost
(b) Relevant cost
(c) Replacement cost

Opportunity cost: Opportunity cost is the value of next best alternative that is sacrificed
while making a decision. Opportunity costs are implicit costs because they do not appear in
the accounting records.
For example: suppose, a certain piece of land is capable to produce 10 tons of rice or 5 tons
of jute. If a farmer produces rice, he needs to sacrifice to produce jute.
Relevant cost: A relevant cost is a future cash cost that is relevant to a particular decision.
This is used to exclude sunk costs, committed costs and non-cash costs from decision
making as considering these costs is typically illogical.
 Replacement cost: Replacement cost is the price that an entity would pay to replace an
existing asset at current market prices with a similar asset. If the asset in question has been
damaged, then the replacement cost relates to the pre-damaged condition of the asset.

For example: insurance policies to cover damage to a company's assets.

Cost-Volume-Profit (CVP) analysis:

Cost-Volume-Profit (CVP) analysis is a managerial accounting technique that is concerned

with the effect of sales volume and product costs on operating profit of a business. It deals with
how operating profit is affected by changes in variable costs, fixed costs, selling price per unit
and the sales mix of two or more different products.

The underlying assumptions of CVP analysis:

a) Selling price is constant. The price of a product or service will not change as volume
changes.
b) Costs are linear and can be accurately divided into variable and fixed elements. The variable
element is constant per unit, and the fixed element is constant in total over the relevant range.
c) In multi-product companies, the sales mix is constant.
d) In manufacturing companies, inventories do not change. The number of units produced
equals the number of units sold.

Limitations of CVP analysis:

1. Segregation of total costs into its fixed and variable components is difficult to do.

2. Fixed costs are unlikely to stay constant as output increases beyond a certain range of activity.

3. The analysis is restricted to the relevant range specified and beyond that the results can be
unreliable

4. Besides volume, other elements like inflation, efficiency, capacity and technology can affect
costs

5. Impractical to assume sales mix remain constant since this depend on the changing demand
levels.

6. The assumption of linear property of total cost and total revenue relies on the assumption that
unit variable cost and selling price are constant. However, this is likely to be valid within
relevant range only.
 Outline TWO advantages and TWO disadvantages of activity based costing
compared to a traditional absorption costing system.

Advantages of activity based costing (ABC)

Provides more realistic product costs especially in factories where support overheads are a
significant proportion of total costs.
More overheads can be traced to the product which is very useful as in most modern
factories there are a growing number of non factory floor activities.
ABC recognises that it is activities which cause cost not products and it is products which
consume activities.
ABC focuses attention on the real nature of cost behaviour and helps in reducing costs and
identifying activities which do not add value to the product.
ABC recognises the complexity and diversity of modern production by the use of multiple
cost drivers, many of which are transaction based rather than based on production volume.
ABC provides useful financial measures (e.g. Cost driver rates) and non-financial rates
(e.g. Transaction volumes).
Disadvantages of activity based costing (ABC)
A full ABC system with numerous cost pools to multiple cost drivers is understandably
more complex than traditional systems and will thus be more expensive to develop and
administer.
There may be difficulty in selecting appropriate cost drivers.
In most organisations there are overhead costs that are common across activities and as such
there will be problems in deciding how to accurately split these costs between activities.

Explain how the information obtained from the activity based costing might be used by
the management of the company.

Using an activity based costing (ABC) system the cost drivers that cause a change to the cost
of activities are identified. These cost drivers provide information to management to enable
them to take actions to improve the overall profitability of the company. Cost driver analysis
will provide information to management about how costs can be controlled and managed.
Variance analysis will also be more useful as it is based on more accurate costs. The
establishment of more accurate product costs should also help managers to assess product
profitability and make better decisions concerning pricing and product mix.

ABC gives more detailed information about how costs are incurred and the potential for cost
reduction by reducing activity levels. The company may also consider the possibility of
discontinuing the clothing product group as it is loss-making or allocating less store space to
that product group.
An activity based costing system can be extended beyond product costing to a range of cost
management applications known as activity based management. These include the
identification of value added and non value added activities and performance management in
terms of measuring efficiency through cost driver rates.
Explain why a back flush cost accounting system may be considered more
appropriate than a traditional cost accounting system, in a company that a just-in time
production and purchasing system.

Traditional cost accounting systems track the sequence of raw materials and components
moving through production. Such systems are time consuming and expensive to operate as
they require considerable documentation, such as material requisitions and time sheets, and
detailed accounting in order to maintain the job cards and inventory records.

Back flush costing delays the recording of costs until after production has been completed or
even sold. Standard costs can then be used to work backwards to 'flush' out the
manufacturing costs.

The absence of inventory in a just-in-time purchasing and production system makes choices
about inventory valuation methods unnecessary and the rapid conversion of direct materials
costs into cost of goods sold simplifies the cost accounting system.

Cost accounting is simplified in a backflush system. For example, inventory valuation is

avoided. Also, all production labour is treated as an indirect cost and is included with the
other overheads in conversion costs. This is because, in a JIT system, supplies of raw
material and production activity are only required when there is sales demand and so
production labour will be paid regardless of activity.
What is working capital cycle? Explain what is meant by an aggressive policy in respect
of the level of investment in, and financing of working capital.

The working capital cycle (WCC) is the amount of time it takes to turn the net current assets
and current liabilities into cash. The longer the cycle is, the longer a business is tying
up capital in its working capital without earning a return on it.

Investment in working capital is normally in inventory, accounts receivable and cash or

highly liquid, short-term assets.These are partly financed by accounts payable and overdraft.
In conditions of uncertainty,companies must hold some minimum level of cash and
inventory.

With an aggressive working capital investment policy, a company would hold minimal safety
inventories. Such a policy would minimise costs but it could reduce sales as the company
could not respond rapidly to changes in demand. Generally, the expected return is higher
under an aggressive policy but the risks are also greater. In cash management, an aggressive
policy involves holding low levels of cash which would expose the company to the risk that
they could not meet payments when they become due. In the case of accounts receivable
and account payable, an aggressive policy would mean low levels of receivables in relation
to sales and high levels of accounts payable.
With an aggressive working capital financing policy, the company finances part of its
permanent asset base with short term debt. This policy generally provides the highest
expected return but it is very risky due to the frequent need to refinance or if the company
relied on an overdraft, the risk of withdrawal of that facility at short notice.

What is working capital? Identify some working capital ratios and explain them. What
is the specialty in managing working capital needs for a supermarket?

Working capital is the amount of a company's current assets minus the amount of its current
liabilities. For example, if a company's balance sheet dated June 30 reports total current
assets of $323,000 and total current liabilities of $310,000 the company's working capital on
June 30 was $13,000. If another company has total current assets of $210,000 and total
current liabilities of $60,000 its working capital is $150,000.
See your study text.
Discuss the advantages to a company of taking steps to improve its working capital
management, giving examples of steps that might be taken.

Working capital is a vital part of a business and can provide the following advantages to a
business:

Firms with lower working capital will post a higher return on

capital so shareholders will benefit from a higher return for every dollar invested in the
business.
The ability to meet short-term obligations is a
pre-requisite to long-term solvency and credit risk.
Adequate working capital management will allow a business to pay on time its short-term
obligations which could include raw materials, salaries, and other operating expenses.

The management of account payables and receivables is an important

A large amount of cash can be tied up in working capital, so a company

managing it efficiently could benefit from additional liquidity and be less dependent on
external financing.

Firms with more efficient working capital management will

generate more free cash flows which will result in a higher business valuation and enterprise
value.

A firm with a good relationship with its trade partners

and paying its suppliers on time will benefit from favorable financing terms such as discount
payments from its suppliers and banking partners.

A firm paying its suppliers on time will also benefit from a

regular flow of raw materials, ensuring that the production remains uninterrupted and clients
receive their goods on time.

An efficient working capital management will

help a firm to survive through a crisis or ramp up production in case of an unexpectedly large
order.

Firms with an efficient supply chain will often be able to sell their
products at a discount versus similar firms with inefficient sourcing.

Ways to Improve Working Capital

1. Improve Accounts Receivables Collections
2. Improve Accounts Payable
3. Negotiate Better Pricing with Suppliers
4. Reduce Expenses
5. Segment and Analyze for Credit Risk
6. Review Tax Opportunities
 Discuss the effectiveness of the economic order quantity (EOQ) model for
inventory management purposes.

The economic order quantity (EOQ) is based on the assumption that demand for the period is
known and constant. Therefore the optimum order quantity will be determined by the costs
that are affected by either the quantity of inventory held or the numbers of orders placed. A
higher quantity ordered each time will mean fewer orders each year and therefore a reduction
in ordering costs. However, this will also result in higher average inventory levels which
results in an increase in holding costs.
The EOQ therefore is a trade-off between the costs of carrying high inventory against the
costs of placing more orders. The optimum order size is the quantity that will result in the
total of the ordering and holding costs being minimised.

The EOQ model assumes a world of certainty where the usage and delivery of inventory can
be predicted accurately and management can therefore avoid stock-out costs and concentrate
on achieving the optimal balance between ordering costs and holding costs.
However this is unlikely to be the case in reality for most companies. The EOQ model
ignores two types of risk:
a) Uncertainty over the time it takes for the order to be delivered i.e. the lead time. The lead
time is neither zero as assumed by the model or necessarily predictable.
b) The rate at which inventory is used may not be constant, demand may be subject to
fluctuations and the overall annual demand may be difficult to predict with accuracy.

The company can cope with these two risk elements, to a certain extent, by holding a buffer
inventory. The buffer inventory level can be calculated by weighing up the cost of stock-outs
and the costs of holding additional inventory. The determination of lead time and dealing
with uncertainty of demand requires subjective managerial judgement as does determining
the cost of stock-outs since many of the costs involved are difficult to quantify.

Briefly discuss the relevance of the concept 'Cash is King' in today's economic
environment.

The importance of strong cash flow is aptly stated in the common expression "cash is king." The
premise of this is that having cash puts you in a more stable position with better buying power.
While you can borrow money at times, cash affords you greater protection against loan defaults
or foreclosures. Cash flow is distinct from cash position. Having cash on hand is critical, but
cash flow indicates an ongoing ability to generate and use cash.

In the world of investments, investors who favor the 'cash is king' phrase may opt to buy short-
term debt instruments versus buying high-priced securities. If employing a strategy of holding a
lot of cash, an investor should work with a financial planner to estimate future cash needs and
rates of inflation. Cash, cash equivalents and some short-term debt instruments lose spending
power over time if they do not offer a return that keeps up with the rate of inflation. This can
cause holders of cash as a long-term investment to experience a negative return over time.

The phrase also refers to the ability of a corporation or a business to have enough cash on hand
to cover short-term operations, buy assets such as equipment and machinery or acquire other
facilities. More businesses fail for lack of cash flow than for lack of profit.

In recent years since the global financial crisis, tech companies such as Apple and Amazon have
been hoarding cash on their balance sheets as opposed to spending it. In 2017, market disruptor
Amazon made an extremely large cash outlay to purchase Whole Foods, sending panic through
the grocery industry and putting the stock of companies such as Kroger into a temporary tailspin.
Cash gave Amazon the power to make that large purchase and disrupt the markets.

When deciding how much cash to hold for operating purposes, a company needs to
strike a balance between the cost of holding too little cash and the cost of holding too
much cash.
-

According to the trade-off theory, we can identify two costs of holding cash. If we assume
that managers maximize shareholder wealth, the main cost experienced by holding cash is
the opportunity cost of the capital invested in liquid assets.
On the other hand, if managers don't maximize shareholders' value, they increase their cash
holdings to increase assets under their control and so to be able to increase their managerial
discretion.
As a result, the cost of cash holdings will increase and include the agency cost of managerial
discretion.
The main advantage of holding cash is that the firm saves transaction costs to raise funds and
does not have to liquidate assets to make payments. Consequently, firms will hold more cash
when it is likely to incur higher transactions costs to convert non-cash assets to cash.
Alternatively, firms will tend to hold lower amount of cash when the opportunity costs of
cash retention are greater.

Differentiate Factoring and Bills discounting.

Factoring and Invoice Discounting are both financial services that can release the funds tied up
in your unpaid invoices, involving a provider who agrees to advance money against outstanding
debtor balances.

The essential difference between Factoring and Invoice Discounting lies in who takes control of
the sales ledger and responsibility for collecting payment:

With Factoring, the provider takes the role of managing the sales ledger, credit control
and chasing customers for settlement of their invoices.
With Invoice Discounting, your business retains control of its own sales ledger and
chases payment in the usual way.
 Another difference between Factoring and Invoice Discounting is in the area of
confidentiality:
With Factoring, the customer settles their invoice directly with the Factoring company; so
customers are more likely to be aware of your Factoring arrangement.
With Invoice Discounting, your customers still pay you directly; there is no need for
them to know that a third party is involved

Overdraft is a temporary facility obtained by the companies to meet their ultra-short term cash
shortage/requirement. One needs to bear in mind that such facility comes with a high cost and should
be used as a stop-gap management of funds or as an emergency activity rather than a routine funding
activity. Higher dependence on overdraft for working capital financing indicates poor working capital
management and a liquidity constraint faced by the company. Only temporary working capital should
be financed by bank overdraft. The permanent working capital should be financed by long-term
financing.

Your CFO sent you an email asking for your explanations on the factors that should be
considered in determining the most appropriate mix of short term financing(e.g.
overdraft) and long term financing (e.g. fixed term bank loan).

Reply the email to CFO stating briefly the factors asked by him.
 Cost:
Financial strength and stability of operations
Form of organization and legal status
Purpose and time period
Risk profile
Control
Effect on credit worthiness
Flexibility and ease
Tax Benefits
State TWO ways in which an accepted bill of exchange can be used by the holder.

post, email and telephone to recover an overdue debt. Despite this, the customer has
still not paid and the credit controller is considering other actions that could be taken
to recover the debt.

control department could take in order to collect the overdue debt.

can encourage rapid settlement of debts particularly if the customer has no other sources of
supply for the goods or services. It will avoid any further outstanding debt but may not result
in payment of the existing debt if the customer can obtain supply of goods or services from
other suppliers.
The credit control department could use a debt collection agency to collect the debt from
the customer. This should result in rapid settlement of the debt and allow the credit control
department to concentrate on other customers. It would however involve further expense
as the agency would charge a fee for the collection. The quality of service varies
considerably and the company must be careful to select an agent whose approach to the

The credit control department could take legal action to recover the debt. This is normally

payment and would avoid the need to go to court. It may not be cost effective to take court
action but it may discourage other customers from delaying payment.

When deciding where to invest short term cash surpluses, it is necessary to consider the
following two types of risk:
(i) Default risk;
(ii) Interest rate risk.
Explain what is meant by each of the TWO types of risk listed above. Your answer
should include an example of each type of risk.

Default risk
This refers to potential doubt about the payment of interest or the eventual repayment of the
capital invested. Investments in government securities are generally considered to have very
low default risk however the recent financial crisis has shown that even investment in
government securities is not risk free. Investment in equities is generally considered high risk
and is not a suitable form of short-term investment.
Interest rate risk
This refers to the risk that market interest rates will change and the investor will be worse off.
Interest rates cannot be predicted with any degree of accuracy. Variable rate bank deposits
will leave the company vulnerable to a fall in interest rates. If the investment is in a fixed rate
term deposit, whilst the investor will receive a guaranteed return, there will be an opportunity
cost if market interest rates increase above the fixed rate.

A company has recently sold part of its trading operations and is reviewing
potential long term investment opportunities for the funds. Until a suitable
opportunity is identified the funds are being held in a bank deposit account but the
company is considering the following alternative short-term investments:
(i) Certificate of deposit
(ii) Bill of exchange
Instructions:
Describe the alternative short-term investments in terms of their risk, return and
liquidity.

Certificates of deposit
These are securities that are issued by a bank as an acknowledgement that funds have been
deposited. Certificates of deposit are traded on the money market and so the holder can sell
them to obtain immediate cash at any time. They are therefore a suitable option in terms of
liquidity and have a low risk. Interest is paid on the deposit at a fixed rate based on current
market interest rates at the date of issue but this will reflect the low risk involved. They are
therefore subject to interest rate risk since if market rates increase they lose the opportunity
for higher rates.
They normally have maturities from three months to five years. The lower end of this time

marketability the upper end of this time range gives flexibility. The company however would
also be exposed to capital risk as the value of the investment changes in response to market
interest rate movements.
Bills of exchange
A bill of exchange is an unconditional order by one person/company to pay another a given
sum of money at a specified future date. These are tradeable and have a short date normally
within 180 days. There is a particularly active market in bills that are payable by top-quality
banks although it is also possible to buy bills that have been accepted by trading companies.
These would therefore be a suitable option in terms of liquidity. They are issued at a discount
to the face value with the yield on the bill dependent on the credit worthiness of the drawee
and market interest rates. They are therefore subject to interest rate risk since if market rates
increase they lose the opportunity for higher rates. They are also subject to default risk
depending on the credit worthiness of the drawee.
Why is it necessary to consider risk & uncertainty when making appraisal of an
investment, explain?

If risk and uncertainty were not considered, managers might make mistake of placing too
much confidence in the results of investment appraisal, or they may fail to monitor
investment projects in order to ensure that expected results are in fact being achieved.

Investment appraisal analysis and forecast the return on the investment and the return is
subject to probable risks and uncertainties, hence it is critical to consider it in the investment
appraisal as an important step to try to ensure a return on the investment.

Sensitivity analysis is a management tool that helps in determining how different values of
an independent variable can affect a particular dependent variable.

Advantages
It compels the decision maker to identify the variables which affect the cashflow
forecasts. This helps him in understanding the investment project in totality.
It indicates the critical variables for which additional information may be obtained.
The decision maker can consider actions which may help in strengthening the "weak
spots" in the project.
It helps to expose inappropriate forecasts and thus guides the decision maker to
concentrate on relevant variables.
Disadvantages

It does not provide clear cut results. The terms optimistic and pessimistic could mean
different things to different people.
It fails to focus on the interrelationship between underlying variables. For example
sales volume may be related to price and cost but we analyse each variable differently.

Discuss the use of sensitivity analysis in decision modeling. Identify some real examples
of sensitivity analysis.

Sensitivity analysis is one of the tools that help decision makers with more than a solution to
a problem. It provides an appropriate insight into the problems associated with the model
under reference. Finally the decision maker gets a decent idea about how sensitive is the
optimum solution chosen by him to any changes in the input values of one or more
parameters.
Uses of Sensitivity Analysis

The key application of sensitivity analysis is to indicate the sensitivity of simulation to

uncertainties in the input values of the model.
They help in decision making
Sensitivity analysis is a method for predicting the outcome of a decision if a situation
turns out to be different compared to the key predictions.
It helps in assessing the riskiness of a strategy.
Helps in identifying how dependent the output is on a particular input value. Analyses if
the dependency in turn helps in assessing the risk associated.
Helps in taking informed and appropriate decisions
Aids searching for errors in the model

Risk and uncertainty is part and parcel of every business. Business managers
have to make their decisions considering and analyzing the risk and uncertainty
to
have a very good understanding of the risk management methods, process, tools and
techniques.
Briefly explain you understanding regarding the enterprise risk management (ERM)
framework.

management and other personnel, applied in strategy setting and across the enterprise,
designed to identify potential events that may affect the entity, and manage risk to be
within its risk appetite, to provide reasonable assurance regarding the achievement of
entity objectives It is important to establish an ERM Framework because it enables a firm
to gain a clear view of its overall risk level.

Following steps are need to be taken to establish an ERM Framework, the potential benefits
that can be expected, and the challenges that may be faced.
(a) Setting common language around risk
(b) Establishing risk management steering committee
(c) Defining roles and responsibilities of the committee
(d) Risk identification
(e) Risk prioritization
(f) Risk monitoring and reporting
In a recent senior management meeting, it has been discussed which one is the best
method to be considered when evaluating a capital expenditure projects and based on
which, the investment decision can be made reliably and precisely. As an expert on the
subject matter you are asked to state the reasons why the net present value investment
appraisal method is preferred to other investment appraisal methods?
The net present value investment appraisal method is preferred to other investment
appraisal methods for the following reasons:

NPV uses cash flows. Cash flows from a project can be used for a number of corporate
purposes (e.g. dividends, other capital-budgeting projects, interest payments). By
contrast, other forms of inflow such as earnings with ARR are an artificial construct.
NPV uses all cash flows. Many other capital budgeting techniques including PB ignore
cash flows beyond a particular date.
NPV discounts the cash flows properly. We know the time value of money is a
pervasive factor in human behavior. Other approaches incl. PB and ARR may ignore
this aspect.
NPV relates projects to improvements in shareholder wealth. All projects are
evaluated on the basis that they increase shareholders wealth, rather than some mere

NPV is better than IRR, the next-best alternative. IRR also does most of these as is
closely related to NPV, but can rank inconsistently depending on the scale, timing and
signs of cash flows with mutually exclusive projects. IRR also has an unrealistic
reinvestment rate assumption for interim cash flows.

When management rejects projects with positive NPV because of capital constraints,
they lose opportunities to enhance the value of shareholders.
Suggest three practical ways of dealing with capital rationing so as not to discard
projects with positive NPV.

Practical ways of dealing with capital constraints so as not to lose opportunities to further
increase the value of the company further include the following:
Seek joint venture partners with which to share projects investment requirement
Use licensing or franchising arrangement with other entities to get the product produced
and sold. The firm will earn royalties while avoiding financing of the investment
requirements.
Contract out parts of the project to subcontractors who would finance the project in
advance.
Seek alternative financing such as venture capital and asset securitization.
Seek grants or aid from government or organizations if the project advances an object
the government or such organizations promote or seek to achieve.
In Standard Costing the comparison is made between actual cost and standard cost of
actual output.
On the other hand, in Budgetary Control the comparison is made between the actual and
budgeted performance.
Standard costs do not change due to short-term changes in the conditions, but budgeted
costs may change.

Reliability and accuracy of the figures. Mistakes in calculating budget figures, or in

recording actual costs and revenues, could lead to a variance being reported where no

Materiality. The size of the variance may indicate the scale of the problem and the
potential benefits arising from its correction.
Possible interdependencies of variances. Sometimes a variance in one area is related to
a variance in another. For example, a favourable raw material price variance resulting
from the purchase of a lower grade of material, may cause an adverse labour efficiency
variance because the lower grade material is harder to work with.
These two variances would need to be considered jointly before making an investigation
decision.
The inherent variability of the cost or revenue. Some costs, by nature, are quite
volatile (oil prices, for example) and variances would therefore not be surprising. Other
costs, such as labour rates, are far more stable and even a small variance may indicate a
problem.
Adverse or favorable? Adverse variances tend to attract most attention as they indicate
problems. However, there is an argument for the investigation of favourable variances so
that a business can learn from its successes
Trends in variances. One adverse variance may be caused by a random event. A series
of adverse variances usually indicates that a process is out of control.
Controllability/probability of correction.
control (such as the world market price of a raw material) then there is little point in
investigating its cause.
Costs and benefits of correction. If the cost of correcting the problem is likely to be
higher than the benefit, then there is little point in investigating further.
 Suggest possible reasons for the following variances:
(i) raw materials total cost variance;
(ii) fixed overhead efficiency variance;
(iii) fixed overhead expenditure variance.

(i) Reasons for raw materials total cost variance:

- Change in order size
- Rise in price
- Urgent needs
- Quality
- Transportation
- Unreliable suppliers
(ii) Reasons for fixed overhead efficiency variance:
With labour efficiency variance, this variance is closely related to under- or over- recovery
of fixed overhead arises as a result of a change in efficiency and thereby fixed overhead
efficiency variance arises. A change in efficiency means that the actual hours which have
been worked will be different from the standard hours of output. Only on the basis of
production, recovery of fixed overhead will be done, thus resulting in under- or over recovery.
(iii) Reasons for fixed overhead expenditure variance:
Fixed overhead expenditure variance occurs due to the differences between the fixed
overhead which has been actually incurred and the fixed overhead which has been
originally budgeted

Budgetary control is one of the important tools used by management, yet most
organizations are unable to derive its full benefits.
Identify and explain FOUR reasons that may account for unsuccessful implementation
of a budgetary control system.

Reasons that may account for unsuccessful implementation of Budgetary control system
Lack of clear organizational objectives
Unclear definition of responsibilities
Lack of top management support
Lack of involvement by staff
Poor monitoring and feedback system
Too much exercise of discretional powers by top management.
Lack of understanding of the entire concept and process
Zero-based budgeting (ZBB) is a method of budgeting in which all expenses must be
justified for each new period. The process of zero-based budgeting starts from a "zero base,"
and every function within an organization is analyzed for its needs and costs.

The major advantages of zero-based budgeting (ZBB) are flexible budgets, focused
operations, lower costs, and more disciplined execution. The disadvantages include the
possibilities of resource intensiveness, being manipulated by savvy managers and bias toward
short-term planning.

Explain why it is important for a business to prepare a cash budget.

The objective of a cash budget is to ensure that sufficient cash is available to meet the level
of operations in the various functional and capital budgets. Cash deficits can be identified in
advance and steps taken to ensure that sources of finance will be available to cover any
deficits. Cash budgets can also help a company to avoid cash surpluses by enabling
management to take actions in advance to invest the surplus cash in short-term or long-term
investments as appropriate. The overall aim should be to manage the cash of the company to
ensure that cash is available when required and that the maximum benefit is gained from the
use of any idle funds.

State THREE ways, other than borrowing, of improving the cash flow position of a
business.

The question asks for three methods. Examples that would be rewarded are given below:
e.g. leasing rather than
purchasing outright.
-term investments.
-essential capital expenditure.
-current assets that are no longer required.
.

reducing credit terms or factoring the debt.

MANGO uses a top-down approach to budgeting. Budgets are imposed by
senior management and budget holders are not given the opportunity to participate in
the budget setting process.
Required:
Explain ONE advantage and TWO disadvantages to the MANGO of using this top-
down budgeting approach.

The participation of managers in the budget setting process has several advantages.
Managers are more likely to be motivated to achieve the budget if they have participated in
the budget setting process. Participation can also reduce the information asymmetry gap that
can arise when targets are imposed by senior management and should result in more realistic
budgets. Imposed budgets are likely to make managers feel demotivated and alienated and
result in poor performance.
Participation however can cause problems; in particular, managers may attempt to negotiate

budget reflects their importance within the organisation. This can result in budgets that are
unsuitable for control purposes. Manager participation is only effective if it is true
participation.
Pseudo participation can be worse for motivation than no involvement at all. The
involvement of managers in the budget setting process is time consuming and the benefits of
participation would need to weighed against the cost of the resources used.

Explain the advantages of management participation in budget setting and the

potential problems that may arise in the use of the resulting budget as a control
mechanism.

One of the main purposes of budgeting is to act as a control mechanism, with actual results
being compared against budget. Another purpose of a budget is to set targets to motivate
managers and optimise their performance. The participation of managers in the budget
setting process has several advantages. Managers are more likely to be motivated to achieve
the target if they have participated in setting the target. Participation can reduce the
information asymmetry gap that can arise when targets are imposed by senior management.
Imposed targets are likely to make managers feel demotivated and alienated and result in
poor performance. Participation however can cause problems; in particular, managers may

believe that the size of their budget reflects their importance within the organisation. This can
result in budgets that are unsuitable for control purposes.
 - Hospital are in the process of preparing the annual
budget for the next financial year using incremental budgeting. The s
directors are concerned that the approach used will result in a budget that does not
reflect the aims and objectives of the hospital. They have requested that the budget
should be produced using zero based budgeting.
Instruction:
Explain the pot - s managers may face when
setting budgets using zero based budgeting.

The hospital has previously used an incremental budgeting system and therefore the potential
difficulties with setting a budget using a zero based budgeting system are as follows:
Zero based budgeting is extremely time consuming; the work involved in the creation of
decision packages and their ranking is considerable. The hospital may not have the resources
available to enable a full zero based budget to be prepared within the timescale required. It
may also require skills that the current management of the hospital do not possess as they
are inexperienced in this type of budgeting. As this is the first time a zero based budgeting
approach has been used it will mean that all activities carried out by the hospital will need to
be reviewed and justified.
There may be difficulty in identifying the activities undertaken by the hospital particularly if
the organisation structure is based on traditional functional departments. This may result in a
tendency to try to cut costs rather than identifying the main drivers behind costs.
The ranking process can be very difficult as value judgements are required. Widely different
activities cannot be compared on quantitative measurement alone.
 Value inventory the cost per unit can be used to value inventory in the statement of
financial position (balance sheet).
Record costs the costs associated with the product need to be recorded in the income
statement.
Price products the business will use the cost per unit to assist in pricing the product.
For example, if the cost per unit is $0.30, the business may decide to price the product at
$0.50 per unit in order to make the required profit of $0.20 per unit.
Make decisions the business will use the cost information to make important decisions
regarding which products should be made and in what quantities.

The three major elements of product costs in a manufacturing company are direct materials,
direct labor, and manufacturing overhead.

A product cost is any cost involved in purchasing or manufacturing goods. In the

case of manufactured goods, these costs consist of direct materials, direct labor,
and manufacturing overhead.
A period cost is a cost that is taken directly to the income statement as an expense
in the period in which it is incurred.

Cost equations are derived from historical cost data. Once a cost equation has been
established (using methods such as the high/low method which will be revised later in the
course) it can be used to estimate future costs. In the exam, cost functions will be linear:
y = a + bx

variable)

You are given the following cost data:

Fixed costs $250,000.
Variable costs $6 per unit up to 5,000 units. 10% discount on all units
purchased over 5,000 units.
Required:
Derive equations for the total cost function.
Solution

y = 250,000 + 5.4x for x > 5,000.

 A cost might be an expense or it might be an asset.
An expense is a cost that has expired or was necessary in order to earn revenues.

cost identifies an expenditure ,

while expense refers to the consumption of the item acquired.
Example- A company has a cost of $6,000 for property insurance covering the next six
months. Initially the cost of $6,000 is reported as the current asset Prepaid Insurance.
However, in each of the following six months, the company will report Insurance
Expense of $1,000 the amount that is expiring each month. The unexpired portion of
the cost will continue to be reported as the asset Prepaid Insurance.

The cost of equipment used in manufacturing is initially reported as the long lived asset
Equipment. However, in each accounting period the company will report part of the
asset's cost as Depreciation Expense.
A retailer's purchase of merchandise is initially reported as the current asset Inventory.
When the merchandise is sold, the cost of the merchandise sold is removed
from Inventory and is reported on the income statement as the expense entitled Cost of
Goods Sold.

No. A variable cost is a cost that varies, in total, in direct proportion to changes in the
level of activity. A variable cost is constant per unit of product. A fixed cost is fixed
in total, but will vary inversely on an average per-unit basis with changes in the level
of activity.

No; differential costs can be either variable or fixed. For example, the alternatives
might consist of purchasing one machine rather than another to make a product. The
difference in the fixed costs of purchasing the two machines would be a differential
cost. Cost of Goods Sold is an expense on the income statement.

Variable cost: The variable cost per unit is constant, but total variable cost changes in
direct proportion to changes in volume.
Fixed cost: The total fixed cost is constant within the relevant range. The average fixed
cost per unit varies inversely with changes in volume.
Mixed cost: A mixed cost contains both variable and fixed cost element

Cost behavior: Cost behavior refers to the way in which costs change in response to
changes in a measure of activity such as sales volume, production volume, or orders
processed
Relevant range: The relevant range is the range of activity within which assumptions
about variable and fixed cost behavior are valid.
 Step cost: A step cost is a cost that does not change steadily with changes in activity
volume, but rather at discrete points. The concept is used when making investment
decisions and deciding whether to accept additional customer orders. A step cost is a
fixed cost within certain boundaries, outside of which it will change.
Prime cost: Prime cost is the combination of a manufactured product's costs of direct
materials and direct labor. In other words, prime cost refers to the direct production costs.
Indirect manufacturing costs are not part of prime cost.

The high-low method

The scatter graph (or, line of best fit) method
Regression Method

Since product costs accompany units of product into inventory, they are sometimes
called inventoriable costs. The flow is from direct materials, direct labor, and
manufacturing overhead to Work in Process. As goods are completed, their cost is
removed from Work in Process and transferred to Finished Goods. As goods are sold,
their cost is removed from Finished Goods and transferred to Cost of Goods Sold.

Cost leadership is a strategy that companies use to achieve competitive advantage by

creating lowest cost among its competitors. Company owners must keep a close eye on
both fixed and variable expenses.

If fixed cost changes then break-even point also changes. If fixed cost increases then the break-
even point also increases and vise-versa. In this case Company B will do better in a price
competition scenario since its total fixed cost is lower than Company A.

Yes, a cost object is anything for which a company wants to assign costs. For example,
this can be a product, service, project, customer, or activity.
 Fixed costs do not change within the relevant range of production. As long as the
production volume remains within the relevant range, the total amount of fixed costs does
not change with a change in production volume.
The fixed cost per unit decreases as increases and increases as production decreases. The
fixed cost is related with the usage of capacity.

Whereas The per unit variable cost remains unchanged as production increases or decreases
while total variable cost increases as production increases and decreases as production decreases.
For example:
Suppose,
Variable per unit is Tk.3
Fixed cost Tk.200 for 50 units.
If we produce 25 units then,
Variable cost is cost per unit is Tk.3
Fixed cost per unit is = (200/25 )= Tk.8
Again,
If we produce 40 units then,
Variable cost is cost per unit is Tk.3
Fixed cost per unit is = (200/40 )= Tk.5.
So, variable cost per unit is fixed but fixed cost per unit is variable (Tk.8 for 25 units, Tk.5 for 40
units).

Per unit fixed cost is not fixed, it is variable. Production output and fixed costs typically
remain the same for a relevant range of output and then it is changes. Therefore, a
company may undertake worse decision by using unit fixed cost. For example, a company
can produce between 1,000 and 2,000 widgets without experiencing an increase in fixed
costs. This allows for multiple production output estimates as fixed costs are easy to
calculate for any output between 1,000 and 2,000 units. A disadvantage, however, is the
increase in per-unit fixed costs when a company operates at the lower range of its
production output.
If all other things remain same, Company B with its higher fixed costs and lower variable
costs will have a higher contribution margin ratio. Therefore, it will tend to realize the
most rapid increase in contribution margin and in profits when sales increase.

In general, labor cost is defined as wages paid to workers during an accounting period on
daily, weekly, monthly.
In theory, labor cost is considered as variable cost because it varies directly with the
production volume. But when the labor cost is paid as daily, weekly or monthly basis
ignoring production volume, it becomes fixed.
In Bangladesh, the industrial growth has been observed in the area of jute, readymade
garments, pharmaceuticals and some agro based sectors. In these industries, labor costs are
paid directly as periodical payment basis rather than relating it with the production
volume. This practice gradually spreads on other industries and thus labor cost becomes a
fixed cost for Bangladeshi industries.

are broadly classified into

Specific Order Costing: The term Specific Order Costing refers to the basic costing method which
is applicable where the work consists of separate contracts, jobs or batches. The specific order
costing is further classified into Job Costing, Batch Costing and Contract Costing.
Operation Costing.
Job Costing is that form of specific order costing which applies where industries which
manufacture products or render services against specific orders such as civil contracts, construction
works, automobile repair shop, printing press, machine tool manufacturing, ship building and
furniture making etc.

In order to ensure the successful application of Job Costing method, it is essential to consider the
following pre-requisites :
(1) A sound production planning and controlling system.
(2) An appropriate time booking and time keeping system to avoid idle time.
(3) Maintenance of necessary records with regard to job tickets, work order, operation tickets, bills
of materials and tools requirements etc.
(4) Appropriate methods of overhead apportionment and absorption rate.
(5) Effective designing and scheduling of production.
Process Costing is a method of costing. It is employed where each similar units of
production involved in different series of process from conversion of raw materials into finished
output.
The application of process costing where industries adopting costing procedure for continuous or
mass production. Textiles, chemical works, cement industries, food processing industries etc.

In Batch Costing, a lot of similar units which comprise the batch may be used as a
cost unit for ascertainment of cost. Separate Cost Sheet is maintained for each batch by assigning a
batch number. Cost per unit of product is determined by dividing the total cost of a batch by the
 number of units of that batch.
Batch costing is used in number drug industries, ready made garment industries, electronic
components manufacture, TV sets, radio etc.
The cost of normal process loss in practice is absorbed by good units
produced under the process. This is known as Normal Process Loss or Normal Wastage. For
exaJll1'le, evaporation, scrap, stamping process etc. The amount realized by the sale of normal
process loss units should be credited to process account.
: The cost of an abnormal process loss unit is equal to the cost of good unit. .
The total cost of abnormal process loss is credited to process account from which it arises. This is
known as Abnormal Process Loss. Such loss may be caused by breakdown of machinery, false
production planning, lack of effective supervision, substandard materials etc., Cost of abnormal
process loss is not treated as cost of the product. In fact, the total cost of abnormal process loss is
debited to Costing Profit and Loss Account.
Abnormal Process Gain may be defined as unexpected gain in production
under normal conditions. The process account under which abnormal gain arises is debited with
abnormal gain. The cost of abnormal gain is computed on the basis of normal production.

Job Costing Process Costing

(1) Production is against specific order from the
(1) Production is a continuous process based on
customers.
future demand.
(2) Variety of products are produced according
(2) Homogenous products are produced in large
to specifications.
scale.
(3) Output and costs are not involved in any
(3) Output and costs are transferred from one
transactions from one job to another.
process
(4) Cost control is more difficult because each
to another process.
job is different from other.
(4) Effective cost control is possible because
(5) Cost ascertainment and determination of unit
production is standardized.
cost can be possible only when job is
(5) Costs are collected and accumulated at the end
completed.
of the accounting period.
(6) There is no question of work in progress at
(6) Work in progress is always there because
the beginning or end of the period.
production is continuous.

When a company uses standard costing, it derives a

standard amount of overhead cost that should be incurred in an accounting period, and
applies this standard amount of overhead to cost objects (usually produced goods). If the
actual amount of overhead turns out to be different from the standard amount of overhead,
then the overhead is said to either over absorbed or under absorbed.
 :
There can be several reasons for overhead under absorption or over absorption, including:
The amount of overhead incurred is not the same as the amount expected.
The basis upon which overhead is applied is in an amount different than expected.
There may be seasonal differences in the amount of overhead actually incurred or in
the basis of application, versus a standard rate that is based on a longer-term average.
The basis of allocation may be incorrect, perhaps due to a data entry or calculation
error.

Predetermined overhead rates are the rates used to apply manufacturing overhead to
work-in-process inventory.
Predetermined overhead rates are the rates used to charge overhead cost to jobs in
production.
Selection of right base is important to have right predetermined overhead rates because
predetermined overhead rates are used to charge overhead cost and applied as the basis of
determining the cost of a product. Since, the predetermined overhead rates are used for
costing inventories and play an important role in establishing product cost, an accurate
predetermined overhead rate should be measured. The accuracy of predetermined
overhead rate largely depends on

:
The difference between actual and normal costing systems involves the procedure for
applying manufacturing overhead to work in process inventory.
Under actual costing, applied overhead is based on the actual overhead rate
(calculated at the end of period) multiplied by the actual amount of the cost driver
used.
Under normal costing, applied overhead is based on the predetermined overhead rate
(calculated at the beginning of period) multiplied by the actual amount of the cost
driver used.
: The primary benefit of using a
predetermined overhead rate instead of an actual overhead rate is to provide timely
information for decision making, planning and control. Also the predetermined rate
removes fluctuations inherent in monthly actual overhead rates.
 : It is something which is assigned a separate measure of cost because
management need such cost information. For example, responsibility centers, products,
projects and so on.
: It is a collection of costs that are to be assigned to cost objects. Costs are often
pooled because they have the same cost driver. An example of cost pool is all costs related
to material handling in a manufacturing firm.
: It is some factor or variable that is used to allocate costs in a cost pool
to cost objects. An example of a cost allocation base may be the weight of materials handled
for each production department that uses material handling services.
:
The difference between cost allocation bases and cost drivers is that cost drivers are
allocation bases but not all allocation bases are cost drivers. Ideally allocation bases
should be cost drivers; that is, there should be a cause and effect relationship between the
costs in the cost pool and the allocation base. In practice, some allocation bases do not have
this relationship or the relationship is imperfect. Under these circumstances, the accuracy of
cost allocations can be questioned.

The basic difference between absorption and variable costing is due to the
handling of fixed manufacturing overhead.
Under absorption costing, fixed manufacturing overhead is treated as a product
cost and hence is an asset until products are sold.
Under variable costing, fixed manufacturing overhead is treated as a period cost
and is charged in full against the current period s income.

:
It includes an element of fixed overheads in inventory values, in accordance with IAS 2
Analysing under/over absorption of overheads is a useful exercise in controlling costs
of an organisation.
In small organisations, absorbing overheads into the cost of products is the best way of
estimating job costs and profits on jobs.

of absorption costing is that it is more complex to operate than

marginal costing, and it does not provide any useful information for decision making, like
marginal costing does.
 ADVANTAGES & DISADVANTAGES OF MARGINAL COSTING

s
volumes.

income statement).

ision-making process.

of marginal costing is that closing inventory is not valued in

accordance with IAS-2 principles, and that fixed production overheads are not shared out
between units of production, but written off in full instead.

If production and sales are equal, net operating income should be the same under
absorption and variable costing. When production equals sales, inventories do not
increase or decrease and therefore under absorption costing fixed manufacturing
overhead cost cannot be deferred in inventory or released from inventory.

If production exceeds sales, absorption costing will usually show higher net operating
income than variable costing. When production exceeds sales, inventories increase and
therefore under to the next period. In contrast, all of the fixed manufacturing overhead
cost of the current period will be charged immediately against income as a period cost
under variable costing.

Absorption costing part of the fixed manufacturing overhead cost of the current period
will be deferred in inventory

Under absorption costing, fixed manufacturing overhead costs are included in product
costs, along with direct materials, direct labor, and variable manufacturing overhead. If
some of the units are not sold by the end of the period, then they are carried into the
next period as inventory.
The fixed manufacturing overhead cost attached to the units in ending inventory follow
the units into the next period as part of their inventory cost. When the units carried over
as inventory are finally sold, the fixed manufacturing overhead cost that has been carried
over with the units is included as part of that period s cost of goods sold.
The break-even point is the level of sales at which profits are zero. It can also be defined
as the point where total revenue equals total cost, and as the point where contribution
margin total equals total fixed cost.

: Cost-Volume-Profit (CVP) analysis is a managerial

accounting technique that is concerned with the effect of sales volume and product costs on
operating profit of a business. It deals with how operating profit is affected by changes in
variable costs, fixed costs, selling price per unit and the sales mix of two or more different
products.
: The contribution margin ratio is the difference between a
company's sales and variable expenses, expressed as a percentage. The total margin
generated by an entity represents the total earnings available to pay for fixed expenses and
generate a profit.

A Break-even chart lets the businesses to determine what they need to sell, monthly or
annually, to cover the costs of doing business-- its break-even point.

The Break-even chart determines a break-even point based on fixed costs, variable costs per
unit of sales and revenue per unit of sales.
(i) The break-even point will increase when the variable expenses increase without a
corresponding increase in the selling prices.
(ii) The break-even point will also increase when the amount of fixed costs and expenses
increases.

: See above.

Selling price is constant. The price of a product or service will not change as
volume changes.
Costs are linear and can be accurately divided into variable and fixed elements. The
variable element is constant per unit, and the fixed element is constant in total over
the relevant range.
In multi-product companies, the sales mix is constant.
 In manufacturing companies, inventories do not change. The number of units
produced equals the number of units sold.

Cost-volume-profit (CVP) analysis provides useful information for making decisions

about pricing, short-term biding and deleting or adding product lines all of which a major
portion of managerial planning.
Management must know the CVP analysis to promote the products with high contribution
margin and to reduce the emphasis on less profitable products.
CVP analysis allows managers to decide whether to accept an order or not. Accountants
often use computer spreadsheet programs to find cost-volume-profit answers quickly.

A profit-volume chart is a graphical representation of the

relationship between the sales and profits of a business. A profit-volume chart can also
be used to estimate the profit that will likely be earned based on a certain sales level.

Segregation of total costs into its fixed and variable components is difficult to do.
Fixed costs are unlikely to stay constant as output increases beyond a certain range
of activity.
The analysis is restricted to the relevant range specified and beyond that the results
can be unreliable
Besides volume, other elements like inflation, efficiency, capacity and technology
can affect costs
Impractical to assume sales mix remain constant since this depend on the changing
demand levels.
The assumption of linear property of total cost and total revenue relies on the
assumption that unit variable cost and selling price are constant. However, this is
likely to be valid within relevant range only

The margin of safety is the excess of budgeted (or, actual) sales over the break-even
volume of sales. The formula for its calculation is:

Margin of safety = Total budgeted (or, actual) sales Break even sales

The margin of safety can also be expressed in percentage form.

It is a useful concept for management because it states the amount by which sales can be
dropped before losses to be incurred. The higher margin of safety indicates the lower risk
of not breaking even.
RELEVANT COST: A relevant cost is any cost that will be different among various alternatives.
Decisions apply to future, relevant costs are the future costs rather than the historical costs. Relevant cost
describes avoidable costs that are incurred to implement decisions.

For example, a company truck carrying some goods from city A to city B, is loaded with one more ton of
goods. The relevant cost is the cost of loading and unloading the additional cargo, and not the cost of the
fuel, driver salary, etc. It is due to the fact that the truck was going to the city B anyhow, and the
expenditure was already committed on fuel, drive salary, etc. It was a sunk cost even before the decision
of sending additional cargo.

Relevant costs are also referred to as differential costs. They differ among different alternatives. They are
expected future costs and relevant to decision making.

Future Cash Flows Cash expense, which will be incurred in future because of a decision, is a relevant
cost.
Avoidable Costs Only the costs, which can be avoided if a particular decision is not implemented, are
relevant for decision making.
Opportunity Costs Cash inflows, which would have to be sacrificed as a result of a decision, are relevant
costs.
Incremental Costs Only the incremental or differential costs related to the different alternatives, are
relevant costs.
Irrelevant Cost: Irrelevant costs are costs which are independent of the various decisions or alternatives.
They are not considered in making a decision. Irrelevant costs may be classified into two categories viz.
sunk costs and costs which are same for different alternatives.

Sunk cost is a cost which is already incurred. It cannot be changed by any current or future action. For
example if a new machine is purchased to replace an old machine; the cost of old machine would be sunk
cost. Irrelevant costs are fixed costs, sunk costs, book values, etc.

Sunk Cost Sunk costs refer to the expenditures which have already been incurred. Sunk costs are
irrelevant, as they do not affect the future cash flows.
Committed Costs Future costs, which cannot be altered, are not relevant as they will have to be incurred
irrespective of the decision made.
Non-cash expenses Non-cash expenses like depreciation are not relevant as they do not affect the cash
flows of a firm.
Overheads General and administrative overheads, that are not affected by the alternative decisions, are
not relevant.

The key to decisions to delete a product or department is identifying avoidable costs.

Avoidable costs are expenses that can be avoided if a decision is made to alter the course of a
project or business..
For example, a manufacturer with many product lines can drop one of the lines, thereby
eliminating associated expenses such as labor and materials.
Corporations looking for methods to reduce or eliminate expenses often analyze avoidable costs
associated with underperforming or non-profitable product lines

A relevant cost is a cost that differs in total between the alternatives in a decision.

An incremental cost (or benefit) is the change in cost (or benefit) that will result from some
proposed action.
An opportunity cost is the benefit that is lost or sacrificed when rejecting some course of action.
A sunk cost is a cost that has already been incurred and that cannot be changed by any future
decision.

No. Not all fixed costs are sunk only those for which the cost has already been irrevocably incurred.
A variable cost can be a sunk cost, if it has already been incurred.
No. Variable costs are relevant costs only if they differ in total between the alternatives under
consideration.

No. A variable cost is a cost that varies in total amount in direct proportion to changes in the level of
activity. A 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.

No. Only those future costs that differ between the alternatives under consideration are relevant

Normally, cost written-off as depreciation is irrelevant when it is related to a past cost. But
cost of new equipment that will be acquired in future and will then be written-off as
depreciation is often relevant.

If a product line s pretty good evidence that the product line

should be discontinued, I agree with this statement when the product line is losing money.
er products or if it serves
as a magnet to attract customers.
For example, Bread may not be a profitable line in some food stores but customers expect
it to be available and many of them would shift their buying elsewhere if a particular store
neglects to carry it.
 : Throughput accounting is very similar to marginal costing, but it can be
used to make longer-term decisions about capacity / production equipment. In throughput accounting,
the only cost that is deemed to relate to volume of output is the direct material costs. All other costs
(including labor cost) are deemed to be fixed.

Throughput contribution = Revenue Totally variable costs (direct material cost).

The aim of throughput accounting is to maximize this measure of throughput contribution.

Throughput accounting
because the concept of throughput has
similarities to the concept of contribution. However there is a major difference in the definition of
contribution in two systems or, more specifically, in what is described as a variable cost. The
traditional marginal costing approach assumes that direct labor is a variable cost. In the short term,
throughput accounting treats labor as a fixed cost. Furthermore, throughput accounting uses the total
of direct materials purchase in the period in the calculation of throughput rather than the cost of
material actually used, as in the case with marginal costing.

Throughput accounting challenges these assumptions.

Direct labor costs are not wholly variable. Skilled worker are paid fixed salaries, and so their cost
does not vary directly with output volume.

The only totally variable cost is the purchase cost of raw material and components that are bought
from external suppliers.

: Using throughput accounting, the aim should be to maximize

throughput, on the assumption that operating expenses are a fixed amount in each period.
If the business has more capacity that there is customer demand, it should produce to meet the
demand in full.
If less capacity, it should give the priority to those products earning the highest throughput for
each unit of the constraining resource that it requires.

A bottleneck may be a machine whose capacity limits the output of the whole production process. The
aim is to identify the bottlenecks and remove them, or, if this is not possible, ensure that they are fully
utilized at all times.

Every process has a constraint (bottleneck) and focusing improvement efforts on

that constraint is the fastest and most effective path to improved profitability.
The Theory of Constraints is a methodology for identifying the most important limiting factor (i.e.

constraint) that stands in the way of achieving a goal and then systematically improving that

constraint until it is no longer the limiting factor. In manufacturing, the constraint is often referred to

as a bottleneck.

The Theory of Constraints takes a scientific approach to improvement. It hypothesizes that every

complex system, including manufacturing processes, consists of multiple linked activities, one of

kest link in the

1.
2. Decide how to exploit the bottlenecks
3. Subordinate everything else to the decision in Step 2
4.
5. If, in the previous steps, a bottleneck has been broken, go beck to Step 1.

A successful Theory of Constraints implementation will have the following benefits:

Increased profit (the primary goal of TOC for most companies)

Fast improvement (a result of focusing all attention on one critical area the system constraint)

Improved capacity (optimizing the constraint enables more product to be manufactured)

Reduced lead times (optimizing the constraint results in smoother and faster product flow)

Reduced inventory (eliminating bottlenecks means there will be less work-in-process)

Three actions
that could be considered to improve the TA ratio are as follows:
i) Increase the selling price of the product.
ii) Reduce the operating expenses in the process. This would reduce the denominator in the
ratio calculation.
iii) Improve the productivity of the employees engaged in the process, thus reducing the time
taken to production on each unit of product. Therefore the TA ratio would increase.
: The underlying methodology is the same except

profits by maximizing throughput by identifying and where possible, removing bottlenecks.

Maximizing throughput on a bottleneck is similar to the marginal costing idea of maximizing
contribution per unit of scarce resources. TA controls production costs through a series of ratios that
focus on throughput per bottleneck resource. Marginal costing is used in many aspects of decision
making as pricing and breakeven analysis.
 : Activity-based costing (ABC) is an alternative approach to product costing. It is
a form of absorption costing, but, rather than absorbing overheads on a production volume basis it firstly
allocates them to cost pools before absorbing them into units using cost driver.

is an activity that consumes resources and for which overhead costs are identified and
allocated. For each cost pool, there should be a cost driver.

is a unit of activity that consumes resources. An alternative definition of a cost driver is a

factor influencing the level of cost.

Pricing: Pricing decision will be improved because the price will be based on more accurate data.
Decision making: This should also be improved. For example, research, production and sales
effort can be directed towards the most profitable products.
Performance management should be improved. The more realistic overhead should result in
more accurate budgets and should improve the process of performance management.
Sales strategy: This should be more soundly based. For example, target customers with products
that appeared unprofitable under absorption costing but are actually profitable, and vice versa.

: Under an activity based costing (ABC) system the various

support activities that are involved in making products or providing services are identified. ABC
recognizes that there are many different driver of cost not just production or sales volume. The cost
drivers are identified in order to recognize a causal link between activities and costs. They are then
used as the basis to attach activity costs to a particular product or service. Through the tracing of costs
to cost objects in this way, ABC establishes more accurate costs for the product or service.

ABC is a more expensive system to operate than traditional costing, so it

should only be introduced when it is appropriate to do so. Activity-based costing could provide much
more meaningful information about product costs and profits when:
Indirect costs are high relative to direct costs
Products or services are complex
Products or services are tailored to customer specifications
Some products or services are sold in large numbers but others are sold in small numbers.

In these situations, ABC will often result in significantly different product or service overhead costs,
compared with traditional absorption costing.

Advantages:

It provides a more accurate cost per unit. As a result, pricing, sales strategy, performance
management and decision making should be improved.
 It provides much better cost understanding.
Fairer allocation of costs.
Better cost control.
Can be used in complex situations.
ABC can be used in service industries easily.

Disadvantages:

Not always relevant. ABC will be of limited benefit of the overhead is a small proportion of the
overall cost.
Still need arbitrary cost allocation.
Need to choose appropriate drivers and activities
ABC can be more complex to explain to the stakeholder of the costing exercise.
Expensive to operate.

Using an ABC system the cost

drivers that cause a change to the cost of activities are identified. An individual product will probably
make use of a number of different activities, and a proportion of the cost of each activity will be
attributed to the product using these predetermined cost driver rates.

This should enable management to control such costs more easily, the variances reported will be more
meaningful and this will help management to control costs. The cost drivers identified under an ABC
system provide information to management to enable them to take actions to improve the overall
profitability of the company. Cost driver analysis will provide information to management on how
cost can be controlled and managed.

Activity-based costing (ABC) could provide more meaningful information

about product costs and profitability in the following circumstances.
An ABC approach should lead to more accurate costing of products and departments by
considering the processes that actually cause overhead costs to be incurred.
By identifying the activities that consume resources and the cost drivers for each activity, the
costs incurred can be traced more accurately to products and services according to the
number of cost drivers that they generate.
An ABC system recognizes the direct labor hours and machine hours are not the drivers of
cost in many modern business environments. Some of these activities are not necessarily
related to the volumes that are produced.
An ABC system is more likely to trace accurately the costs incurred on each specific
customer order. The result will be more accurate coast determination which will help in
decisions such as pricing.
 : Environmental costs can be categorized as quality related
costs. This results in four cost categories:
Environmental prevention cost those costs associated with preventing adverse environmental
impacts. The aim here is to prevent adverse environmental impacts occurring in the first place.
Examples include:
Training staff
Designing processes and products
Investment in protective equipment
Environmentally driven research and development.
Environmental appraisal costs the cost of activities executed to determine whether products,
service and activities are in compliance with environmental standards and policies. Examples
include:
Monitoring, testing and inspection costs
Reporting costs
Certification costs
Developing performance measures.
Environmental internal failure costs costs incurred to eliminate environmental impacts that
have been created by the firm. Examples include:
Cost of recycling or disposing of waste or harmful materials
Product take back cost
Legal costs, insurance and fines
Environmental external failure costs costs incurred after environmental damage has been
caused outside the organization. Examples include:
Medical costs for employees and local communities
Adverse impact on natural resources such as rivers and forests.
The objectives of working capital management
The main objective of working capital management is to get the balance of current assets and
current liabilities right.

This can also be seen as the tradeoff between cash flow versus profits.

Mismanagement of working capital is therefore a common cause of business failure, e.g.:

on cash during periods of growth being too great (overtrading)

Working capital is the capital available for conducting the day to day operations of an
over current liabilities.
Working capital management is the management of all aspects of both current assets and
current liabilities, to minimise the risk of insolvency while maximising the return on assets.

Overtrading happens when a business expands too quickly without having the
financial resources to support such a quick expansion. If suitable sources of finance are not
obtained, overtrading can lead to business failure.

Importantly, overtrading can occur even a business is profitable. It is an issue of working

capital and cash flow.
Overtrading is, therefore, essentially a problem of growth.
It is particularly associated with retail businesses who attempt to grow too fast.
 Overtrading is most likely to occur if:

Growth is achieved by making significant capital investment in production or operations

capacity before revenues are generated
Sales are made on credit and customers take too long to settle amounts owed
Significant growth in inventories is required in order to trade from the expanding capacity
A long-term contract requires a business to incur substantial costs before payments are made
by customers under the contract

Classic Symptoms/Indicators of Overtrading

High revenue growth but low gross and operating profit margins
Persistent use of a bank overdraft facility
Significant increases in the payables days and receivables days ratios
Significant increase in the current ratio
Very low inventory turnover ratio
Low levels of capacity utilisation

Managing the Risk of Overtrading The most effective steps to avoid overtrading are essentially
those that would be taken as part of a sensible cash flow and working capital management. For example:

Reducing inventory levels

Scaling back the pace of revenue growth until profit margins and cash reserves have improved
Leasing rather than buying capital equipment
Obtaining better payment terms from suppliers
Enforcing better payment terms with customers (e.g. through prompt-payment discounts)
 Responsibility accounting is a system in which a manager is held
responsible for those items of revenues and costs and only those items that the manager
can control to a significant extent. Each line item in the budget is made the responsibility of a
manager who is then held responsible for differences between budgeted and actual results.

is a detailed plan outlining the acquisition and use of financial and other resources
over a given time period. As such, it represents a plan for the future expressed in formal
quantitative terms.
involves the use of budgets to control the actual activities of a firm.

Planning : A budgeting process forces a business to look to the future. This is essential
for survival since it stops management from relying on ad hoc or poorly co-ordinated
planning.
Control : Actual results are compared against the budget and action is taken as
appropriate.
Communication: The budget is a formal communication channel that allows junior and
senior managers to converse.
Co-ordination : The budget allows co-ordination of all parts of the business towards a
common corporate goal.
Evaluation : The budget may be used to evaluate the actions of a manager within the
business in terms of the costs and revenues over which they have control.
Motivation : The budget may be used as a target for managers to aim for. Reward should
be given for operating within or under budgeted levels of expenditure. This acts as a
motivator for managers.
Authorisation: The budget acts as a formal method of authorisation to a manager for
expenditure, hiring staff and the pursuit of plans contained within the budget.
Delegation : Managers may be involved in setting the budget. Extra responsibility
may motivate the managers. Management involvement may also result in more realistic
targets.
 Budgets provide a
organization.
Budgets force managers to think about and plan for the future.
The budgeting process provides a means of allocating resources to those parts of the
organization where they can be used most effectively.
The budgeting process can uncover potential bottlenecks before they occur.
Budgets coordinate the activities of the entire organization. Budgeting helps to ensure that
everyone in the organization is pulling in the same direction.
Budgets define goals and objectives that can serve as benchmarks for evaluating subsequent
performance.

#Approaches to budgeting
There are a number of different budgetary systems:

-based budgeting (ZBB)

-based budgeting
-forward control

#Budgeting and participation

There are basically two ways in which a budget can be set: from the top down (imposed
budget) or from the bottom up (participatory budget).

##Imposed style : An imposed/top-down budget is 'a budget allowance which is set without
permitting the ultimate budget holder to have the opportunity to participate in the budgeting
process'
Advantages of imposed style
There are a number of reasons why it might be preferable for managers not to be involved in
setting their own budgets:
(1) Involving managers in the setting of budgets is more time consuming than if senior managers
simply imposed the budgets.
(2) Managers may not have the skills or motivation to participate usefully in the budgeting
process.
(3) Senior managers have the better overall view of the company and its resources and may be
better-placed to create a budget which utilizes those scarce resources to best effect.
(4) Senior managers also are aware of the longer term strategic objectives of the organisation and
can prepare a budget which is in line with that strategy.
##Participative budgets : Participative/bottom up budgeting is 'A budgeting system in which all
budget holders are given the opportunity to participate in setting their own budgets'
Advantages of participative budgets
(1) The morale of the management is improved. Managers feel like their opinion is listened to,
that their opinion is valuable.
(2) Managers are more likely to accept the plans contained within the budget and strive to
achieve the targets if they had some say in setting the budget, rather than if the budget was
imposed upon them. Failure to achieve the target that they themselves set is seen as a personal
failure as well as an organisational failure.
(3) The lower level managers will have a more detailed knowledge of their particular part of the
business than senior managers and thus will be able to produce more realistic budgets

##Incremental budgets :
actual results and adds (or subtracts) an incremental amount to cover inflation and other known
changes.
It is suitable for stable businesses, where costs are not expected to change significantly. There
should be good cost control and limited discretionary costs.

Advantages of incremental Disadvantages of incremental

budgets
(1) Quickest and easiest method.
(2) Suitable if the organisation is stable and
historic figures are acceptable since only the
increment needs to be justified.
budgets
(1) Builds in previous problems and inefficiencies.
(2) Uneconomic activities may be continued. E.g.
the firm may continue to make a component in-
house when it might be cheaper to outsource.
(3) Managers may spend unnecessarily to use up
their budgeted expenditure allowance this year, thus
ensuring they get the same (or a larger) budget next
year.

##Zero-based budgeting

activities to which the budget relates were being undertaken for the first time. Without approval,

It is suitable for:

research and development, advertising and training.

There are four distinct stages in the implementation of ZBB:

(1) Managers should specify, for their responsibility centres, those activities that can be
individually evaluated.
(2) Each of the individual activities is then described in a decision package. The decision
package should state the costs and revenues expected from the given activity. It should be drawn
up in such a way that the package can be evaluated and ranked against other packages.
(3) Each decision package is evaluated and ranked usually using cost/benefit analysis.
(4) The resources are then allocated to the various packages.

Advantages of ZBB Disadvantages of ZBB

(1) Inefficient or obsolete operations can be
identified and discontinued
(2) ZBB leads to increased staff involvement at all
levels since a lot more information and work is
required to complete the budget
(3) It responds to changes in the business
environment
(4) Knowledge and understanding of the cost
behaviour patterns of the organisation will be
enhanced
(1) It emphasises short-term benefits to the
detriment of long term goals
(2) The budgeting process may become too rigid
and the organisation may not be able to react to
unforeseen opportunities or threats
(3) The management skills required may not be
present
(4) Managers may feel demotivated due to the
large amount of time spent on the budgeting
process

##Rolling budgets
A budget (usually annual) kept continuously up to date by adding another accounting period (e.g.
month or quarter) when the earliest accounting period has expired.
Suitable if:

Advantages of rolling budgets
(1) Planning and control will be based on a more
accurate budget
(2) Rolling budgets reduce the element of
uncertainty in budgeting since they
concentrate on the short-term when the degree
of uncertainty is much smaller
Disadvantages of rolling
budgets
(1) Rolling budgets are more costly and time
consuming than incremental budgets
(2) May demotivate employees if they feel that they
spend a large proportion of their time
budgeting or if they feel that the budgetary targets
are constantly changing

##Activity Based Budgeting

ABB
driver data in the budget-
Or, put more simply, preparing budgets using overhead costs from activity based costing
methodology.
The advantages of ABB are similar to those provided by activity-based costing (ABC).

operating costs.
sts. If we can control the causes (drivers) of
costs, then costs should be better managed and understood.

relating the cost of an activity to the level of service provided.

Disadvantages of ABB

their cost drivers.

the short-term many overhead costs are not controllable and do not
vary directly with changes in the volume of activity for the cost driver. The only cost variances
to report would be fixed overhead expenditure variances for each activity.

##Feedforward control A feedforward control system operates by comparing budgeted results

against a forecast. Control action is triggered by differences between budgeted and forecast
results.
Feedforward control is control based on forecast results. In other words, if forecast is bad,
control action is taken before the actual results come through.

## Feedback control Feedback control is defined as 'the measurement of differences between

planned outputs and actual outputs achieved, and the modification of subsequent action and/or
plans to achieve future required results'. This is the most common type of control system.

What is a master budget? Briefly describe its contents.

outlines the way in which these plans are to be accomplished. The master budget is composed of
a number of smaller, specific budgets encompassing sales, production, raw materials, direct
labor, manufacturing overhead, selling and administrative expenses, and inventories. The master
budget generally also contains a budgeted income statement, budgeted balance sheet, and cash
budget.

##
Do you agree? Explain.
No, although this is clearly one of the purposes of the cash budget. The principal purpose is to
provide information on probable cash needs during the budget period, so that bank loans and
other sources of financing can be anticipated and arranged well in advance.
 Chapter 06,07,08 Standard Costing

#What is meant by the term management by exception?

Under management by exception, managers focus their attention on results that deviate from
expectations. It is assumed that results that meet expectations do not require investigation. Why
are separate price and quantity variances computed?

#Standard costing: A standard cost for a product or service is a predetermined unit cost set
under specified working conditions.

#Purpose of Standard Costing:

Control: the standard cost can be compared to the actual costs and any differences
investigated.
Planning: standard costing can help with budgeting.
Performance measurement: any differences between the standard and the actual cost can be
used as a basis for assessing the performance of cost centre managers.
Inventory valuation: an alternative to methods such as LIFO and FIFO.
Accounting simplification: there is only one cost, the standard.

#Standard costing is most suited to organisations with:

The large scale repetition of production allows the average usage of resources to be determined.

Standard costing is less suited to organisations that produce non homogenous products or
where the level of human intervention is high.

#Should standards be used to identify who to blame for problems?

If standards are used to find who to blame for problems, they can breed resentment and
undermine morale. Standards should not be used to conduct witch-hunts, or as a means of
finding someone to blame for problems.

When standard absorption costing is used, capacity levels are needed to

establish a standard absorption rate for fixed production overhead. Any one of three capacity
levels might be used for budgeting.
is 'Output achievable if sales orders, supplies and workforce for
example, were all available.'
is 'Full capacity less an allowance for known unavoidable volume
losses.
 is 'Standard hours planned for the budget period, taking account of, for
example, budgeted sales, workforce and expected efficiency.'
is defined as the practical capacity in a period less the budgeted capacity
measured in standard hours of output. It represents unused capacity that ought to be available

#Types of standard
Attainable standards
conditions.

fatigue, machine breakdowns, etc.

since they provide a realistic but

challenging target

Basic standards
-term standards which remain unchanged over a period of years.

efficiency and the effect of changing methods.

as a result, employees may feel bored and unchallenged.

Current standards

meaningless information.
rove upon current
working conditions and, as a result, employees may feel unchallenged.

Ideal standards

short, no inefficiencies.

where close examination may result in large cost savings.

feel that the
standard is impossible to achieve.
 CHAPTER 11: Uncertainty and risk in decision making

Risk-There are a number of possible outcomes and the probability of each outcome is known
Risk.

Uncertainty- There are a number of possible outcomes and the probability of each outcome is
not known uncertainty.

The difference between risk and uncertainty:

RISK UNCERATINTY
1.Risk can be measured 1. IT cannot be measured
2.Controllable 2. Uncontrollable
3.Probablities assigned 3.probanlites not assigned
4.risk is objective 4.uncertainty is subjective
5.risk can be transferred into another risk 5.it cannot be transferred

EXPECTED VALUES (EV)

An expected value summarizes all the different possible outcomes by calculating a single weight
average. it is the long run average (mean).

Advantages and disadvantages of EVs

Advantages
1. Takes risk into account by considering the
probability of each possible outcome.
2. The information is reduced to a single number
resulting in easier decisions.
3.Calculations are relatively simple
Disadvantages
1. The probabilities used are usually very
subjective.
2. The EV is merely a weighted average
and therefore has little meaning for a one-
off project.
3. The EV gives no indication of the
dispersion of possible outcomes about the
EV.
4. The EV may not correspond to any of the
actual possible outcomes.

TYPES OF DECISION MAKER There are three types of decision maker.

Risk neutral decision makers consider all possible outcomes and will select the strategy
that maximizes the expected value or benefit.
Risk seekers are likely to select the strategy with the best possible outcomes. They will
apply the maximax criteria.
 Risk averse decision makers try to avoid risk .They would rather select a lower, but
certain, outcome than a risk going for a higher pay-off which is less certain to occur. They
will apply the maximin criterion.

Maximax, maxmin and minimax regret

Maximas- The maximax rule involves selecting the alternative that maximizes the
maximum pay-off achievable.
This approach would be suitable for an optimist who seeks to achieve the best results if
the best happens.
Maximin- The maximin rule involves selecting the alternative that maximises the
minimum pay-off achievable.
This approach would be appropriate for a pessimist who seeks to achieve the best results if
the worst happens.
The minimax regret rule The minimax regret strategy is the one that minimises the
maximum regret. It is useful when probabilities for outcomes are not available or where
the investor is risk averse and wants to avoid making a bad decision.

Pay off tables A pay off table is simply a table that illustrates all possible profits/losses

Perfect and imperfect information

Perfect information- The forecast of the future outcome is always a correct prediction. if a firm
can obtain a 100% accurate prediction they will always be able to undertake the most beneficial
course of action for that prediction.

Imperfect information- The forecast is usually correct, but can be incorrect. Imperfect
information is not as valuable as perfect information.

Decision trees and multi-stage decision problems

A decision trees is diagrammatic representation of a decision problem, where all possible courses
of action are represented, and every possible outcome of each course of action is shown.
Decision trees should be used where a problem involves a series of decision being made and
several outcomes arise during the decision making process.

Sensitivity analysis: A sensitivity analysis determines how different values of an

independent variable impact a particular dependent variable under a given set of assumption.

Strengths of sensitivity analysis:-

There are no complicated theory to understand

Information will be presented to management in a form which facilities subjective
judgment to decide the likelihood of the various possible outcomes considered.
 It identifies areas which are crucial to the success of the project. If the project is chosen,
those areas can be carefully monitored.

Weaknesses of sensitivity analysis:-

It is assumes that changes to variables can be made independently

It only identifies how far a variable needs change; it does not look at the probability of
such a change
It provides information on the basis of which decisions can be made but does not point to
the correct decision directly.

CHAPTER 10: FORECASTING TECHNIQUES

Time series analysis A time series is a series of figures recorded over time, e.g.
unemployment over the last 5 years, output over the last 12 months etc.
Advantages:-
Forecast are based on clearly understood assumption
Trend lines can be reviewed after each successive time period
Forecasting accuracy can possibly be improved with experience
The reliability of the forecast can be assessed
Disadvantages:-
There is an assumption that what has happened in the past is a reliable guide to the future
There is an, assumption that a straight line trend exists
There is an assumption that seasonal variation are constant

Linear regression and its limitations

Linear regression To take account of two observations a more advanced calculation is used
known as linear regression which uses a formula to estimate the linear relationship between the
variables as follows: y = a + bx

Limitations of linear regression

Assumes a linear relationship between the variables.

Only measures the relationship between two variables,
Only interpolated forecast tend to be reliable,
Historical behavior of the data assumes,
Interpolated predictions are only reliable if there is a significant correlation between the
data.