MAC3701/102/3/2022

Tutorial Letter 102/3/2022

APPLICATION OF MANAGEMENT
ACCOUNTING TECHNIQUES
MAC3701

Semesters 1 and 2

Department of Management Accounting

This tutorial letter contains important information

about your module.

BARCODE
 CONTENTS
Page
PURPOSE OF THE MODULE ................................................................................................................. 4
PREREQUISITE AND PRIOR KNOWLEDGE.......................................................................................... 4
OVERVIEW OF THE MODULE ................................................................................................................ 5
STRUCTURE OF THE TUTORIAL LETTERS FOR THE MODULE ......................................................... 6
LECTURERS’ CONTACT DETAILS ........................................................................................................ 6
STRUCTURE OF THIS TUTORIAL LETTER ........................................................................................... 6
PRESCRIBED STUDY MATERIAL .......................................................................................................... 7
ASSESSMENTS AND SCOPE ................................................................................................................ 7
INTRODUCTION TO MANAGEMENT ACCOUNTING ............................................................................ 7
LEARNING UNIT 1: COST CLASSIFICATION ........................................................................................ 9
1.1 Introduction ................................................................................................................................... 9
1.2 Learning outcomes ....................................................................................................................... 9
1.3 Topic outline ................................................................................................................................. 9
1.4 Summary .................................................................................................................................... 10
1.5 Self-review exercises .................................................................................................................. 10
LEARNING UNIT 2: COST ESTIMATION .............................................................................................. 11
2.1 Introduction ................................................................................................................................. 11
2.2 Learning outcomes ..................................................................................................................... 11
2.3 Topic outline ............................................................................................................................... 11
2.4 Summary .................................................................................................................................... 12
2.5 Self-review exercises .................................................................................................................. 12
LEARNING UNIT 3: BUDGETS, PLANNING AND CONTROL.............................................................. 13
3.1 Introduction ................................................................................................................................. 13
3.2 Learning outcomes ..................................................................................................................... 13
3.3 Topic outline ............................................................................................................................... 14
3.4 Summary .................................................................................................................................... 15
3.5 Self-review exercises .................................................................................................................. 15
LEARNING UNIT 4: COST-VOLUME-PROFIT (CVP) RELATIONSHIPS .............................................. 16
4.1 Introduction ................................................................................................................................. 16
4.2 Learning outcomes ..................................................................................................................... 16
4.3 Topic outline ............................................................................................................................... 17
4.4 Information technology (IT) and CVP analysis ............................................................................ 17
4.5 Standard deviation and the coefficient of variation ...................................................................... 20
4.6 Summary .................................................................................................................................... 21
4.7 Self-review exercises .................................................................................................................. 21
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LEARNING UNIT 5: DIRECT- AND ABSORPTION COSTING SYSTEMS ............................................ 22

5.1 Introduction ................................................................................................................................. 22
5.2 Learning outcomes ..................................................................................................................... 22
5.3 Topic outline ............................................................................................................................... 23
5.4 Statement of profit or loss (income statement) presentation and formats .................................... 24
5.5 Summary .................................................................................................................................... 24
5.6 Self-review exercises .................................................................................................................. 24
LEARNING UNIT 6: OVERHEAD ALLOCATION .................................................................................. 25
6.1 Introduction ................................................................................................................................. 25
6.2 Learning outcomes ..................................................................................................................... 25
6.3 Topic outline ............................................................................................................................... 26
6.4 Summary .................................................................................................................................... 26
6.5 Self-review exercises .................................................................................................................. 27
LEARNING UNIT 7: JOINT AND BY-PRODUCT COSTING .................................................................. 28
7.1 Introduction ................................................................................................................................. 28
7.2 Learning outcomes ..................................................................................................................... 28
7.3 Topic outline ............................................................................................................................... 29
7.4 Summary .................................................................................................................................... 29
7.5 Self-review exercises .................................................................................................................. 29
BIBLIOGRAPHY .................................................................................................................................... 29

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PURPOSE OF THE MODULE

This module (MAC3701) is intended to equip you (as a student) with specific competencies in
management decision making and control. The module will enable you to demonstrate
integrated knowledge in these competencies, including pervasive skills, ethics and professional
practice, and other accounting competencies.

This module is designed to facilitate your acquisition of these competencies through knowledge
of and engagement in relevant management accounting topics at the forefront of the field,
including an understanding of the theories, methods and techniques relevant to the field, and
of how to apply this knowledge in a particular context.

The syllabus includes the following main topics: cost accounting, planning and control, and
decision making.

PREREQUISITE AND PRIOR KNOWLEDGE

To a large extent, this module builds upon prior knowledge you would have obtained from your
second year (NQF level 6) of management accounting studies. The prerequisite for this module
is MAC2601 (Principles of management accounting) and therefore, this module is designed on
the premise and assumption that you have already completed this prerequisite (or its equivalent)
and that you have achieved the necessary prior learning. MAC2601 study guides are also posted
on myUnisa, in the event that you need to revisit some principles already covered in second year
management accounting.

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OVERVIEW OF THE MODULE

Tutorial letter (TL) 101

General information, planning and administrative matters

QB001 QUESTION BANK

TL102 TL103
Learning units: Learning units:
1. Cost classification and behaviour 8. Process costing
2. Cost estimation 9. Standard costing
3. Budgets, planning and control 10. Relevant costing
4. Cost volume-profit relationships 11. Performance management
5. Direct and absorption costing systems 12. Price setting
6. Overheads allocation 13. Other ancillary topics
7. Joint and by-product costing 14. Inventory management and
planning techniques

TL104
Examination Guidance

Assignment 1 (MCQ)
(Assignment 1 covers Learning units 1–7)

Written Assignment 2
(Assessment based on all the learning units in TL102 and TL103)

Final written examination

(The examination is based on all the learning units in TL102 and TL103)

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STRUCTURE OF THE TUTORIAL LETTERS FOR THE MODULE
The following tutorial letters will be made available to you during the semester. Two tutorial letters
(TL102 and TL103) which contain a total of 14 learning units to study, two tutorial letters which
contain solutions to Assignments 01 and 02 (TL201 and TL202), and one tutorial letter containing
information about the examination (TL104). You will also receive one question bank (QB001).
Other study resources, including the assignment questions, will be made available online. Kindly
note that Tutorial letters 102 to 103 act as guides to help you navigate the prescribed book and
therefore no separate study guide is issued for this module.

SERIES CONTENT OVERVIEW

TL101 General information, planning and administrative matters

TL102 Technical contents – Learning units 1 to 7
TL103 Technical contents – Learning units 8 to 14
TL104 Examination guidance
TL201 Suggested solution to compulsory Assignment 01
TL202 Suggested solution to compulsory Assignment 02
QB001 Question bank and suggested solutions

LECTURERS’ CONTACT DETAILS

For an effective and efficient turnaround time, refer to MAC3701 myUnisa site for the relevant
lecturers’ contact details.

STRUCTURE OF THIS TUTORIAL LETTER

This tutorial letter (TL102) provides a “learning compass” to the prescribed study material(s) in
relation to learning units 1 to 7 (all inclusive) of the module. This learning compass is outlined in
the “Topic outline” section of each learning unit, and it specifies the concepts you must learn
from each learning unit. Lastly, it provides the expected “SAICA knowledge level” that is linked to
each concept.

This tutorial letter consists of the following seven learning units:

LEARNING UNIT TITLE

Learning unit 1 Cost classification
Learning unit 2 Cost estimation
Learning unit 3 Budgets, planning and control
Learning unit 4 Cost-volume-profit relationships
Learning unit 5 Direct- and absorption costing systems
Learning unit 6 Overhead allocation
Learning unit 7 Joint and by-product costing

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PRESCRIBED STUDY MATERIAL

The prescribed study material for this part of the module (tutorial letter) is as follows:

STUDY MATERIAL REFERENCE

Principles of management accounting: A TL101, section 5.1
South African perspective (2020, 3rd edition)
Question bank QB001
Additional notes and videos myUnisa/Additional Resources

ASSESSMENTS AND SCOPE

In preparation for the summative assessment (examination), you will be assessed continuously
throughout the semester. For this reason, your knowledge of the learning units covered in this
tutorial letter (TL102) will be assessed in both assignments. It is therefore important that you are
fully aware and cognisant of the scope of each assessment throughout the year.

INTRODUCTION TO MANAGEMENT ACCOUNTING

From a perspective of you being a commerce and/or business sciences student, it will not be
unusual to ask yourself, “What is management accounting?” and “Why is it important to my
studies?” We trust that your second level management accounting modules would have
somewhat addressed these questions, and also any other related question.

Chapter 1, paragraph 1.2 of the prescribed textbook (refer to prescribed study material section)
defines management accounting by reference to the definition as provided by the Chartered
Institute of Management Accountants (CIMA), a United Kingdom based organisation that focuses
on the management accounting profession. In this regard, CIMA defines management accounting
as “the application of the principles of accounting and financial management to create, protect,
preserve and increase value for the stakeholders of for-profit and not-for-profit enterprises in the
public and private sectors”. Furthermore, according to CIMA, management accounting forms an
integral part of managing a company in that, it requires an “identification, generation, presentation,
interpretation and use of information” for the use in: (i) planning (ii) strategy; (iii) operations; (iv)
decision-making; (v) performance management, measurement and reward; (vi) capital structure
determination and funding thereof; (vii) reporting; (viii) efficient use and safeguarding of
resources; and (ix) corporate governance and risk management.

“As the term suggests, management accounting is a form of accounting” (Williams et al. 2020:2);
as such, it is often confused with or mistaken for financial accounting. Therefore, one of the ways
that is often used to explain what management accounting is, is to contrast it with financial
accounting. “Financial accounting involves the preparation of financial statements in line with
prescribed standards to satisfy the needs of various external stakeholders of the organisation”
(Williams et al. 2020:4). At its core, financial accounting is concerned with the reporting to
external stakeholders about management’s stewardship and governance of the shareholders’
funds that the management is entrusted with.

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In contrast, management accounting is concerned with the information used for internal reporting
purposes. “It involves a combination of past information, together with future-orientated
information, such as forecasts and budgets, to enable managers to perform their duties” (Williams
et al., 2020:4). In the main, the aim of management accounting is the timeous supply of relevant,
appropriate, sufficient and quality information to enable the management of an organisation to
make the best possible decisions for the organisation. Refer to paragraph 1.3 of the prescribed
textbook for an outline of the main differences between financial accounting and management
accounting.

In summary, it should now be clear to you that in studying management accounting, you seek to
be equipped with the theoretical knowledge of the application of various accounting and
management accounting principles aimed at the creation, protection, preservation and the
increasing of stakeholders’ value within an organisation. In this regard – in contrast to financial
accountants whose focus is on external reporting – as a management accountant, you will be
tasked with supplying relevant accounting and related information to the management of an
organisation, mainly for the purposes of internal planning, strategy, operational decision-making,
funding, performance management and measurement, risk-management and resource
management.

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LEARNING UNIT 1: COST CLASSIFICATION

1.1 Introduction
In the second-year costing module, you learnt about the nature and behaviour of costs.
Specifically, you learnt about cost objects, classification, behaviour and allocation/assignment.
An understanding of all these concepts is equally relevant and important for this module. In fact,
all these concepts “form the foundation of all of the management accounting tools and techniques”
(Williams et al. 2020:10).

1.2 Learning outcomes

After studying Learning unit 1, you should be able to
▪ Describe various costing terms and systems
▪ Identify, classify and explain the behaviour of costs
▪ Understand the reasons for classifying costs according to various cost attributes

1.3 Topic outline

Learning unit 1 assumes that you have already mastered the concepts below, as covered in the
second-year costing module. You are now required to revise the following sections in chapter 2
of the prescribed textbook:
Concepts SAICA Principles of management
knowledge accounting (3rd edition)
level Theoretical Revision/prescribed
basis exercises
Introduction Section 2.1 none
Cost classification 3 Section 2.1.1 none
Cost behaviour 3 Section 2.2 none
▪ Variable costs Section 2.2.1 Example 2.1
▪ Fixed costs Section 2.2.2 Example 2.2
▪ Step costs Section 2.2.3 Example 2.3
▪ Mixed costs Section 2.2.4 Example 2.4 and 2.5
▪ Application of cost behaviour Section 2.2.5
principles
Assignment 3 Section 2.3 Example 2.6
Relevance 3 Section 2.4 none
▪ Relevant cost Section 2.4.1 Example 2.7
▪ Opportunity cost Section 2.4.2
▪ Differential cost Section 2.4.3
▪ Sunk cost Section 2.4.4
Function 3 Section 2.5 Example 2.8
▪ Direct materials Section 2.5.1
▪ Direct labour Section 2.5.2
▪ Manufacturing overheads Section 2.5.3
Timing 3 Section 2.6 none

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What you learnt and/or revised in this learning unit is graphically summarised as follows:

COST CLASSIFICATION SUMMARY

Cost Cost Cost

Cost function Cost timing
behaviour assignment relevance

Direct
Variable costs Direct costs Relevant cost Product costs
materials

Opportunity
Fixed costs Indirect costs Direct labour Period costs
cost

Differential Manufacturing
Step costs
cost overheads

Mixed costs Sunk cost

1.4 Summary
Management accounting is primarily concerned with the creation and enhancement of value for
shareholders in the company. To achieve this, the management of the company is charged with
the responsibility of understanding, analysing and interpreting financial information for the
purpose of making decisions for, and controlling, the entity. Cost information forms an integral
part of the financial information used to make various decisions. It is therefore imperative that, as
a management accountant, you are able to properly identify, classify and interpret the costs from
which financial information is derived. “An undiscerning use of financial information may result in
sub-optimal and counterproductive decisions being implemented” (Williams et al. 2020:30).

1.5 Self-review exercises

1.5.1 Listen to the “Cost classification and behaviour” podcast and view the videos about
direct and absorption costing that can be found on myUnisa.
1.5.2 Attempt basic questions (BQ) BQ9 and BQ10 in chapter 2 of the prescribed textbook.
1.5.3 Attempt long questions (LQ) LQ3 and LQ4 in chapter 2 of the prescribed textbook.
1.5.4 ▪ Review the 2020 annual financial statements of Balwin Properties Limited
(available under Additional Resources and reflect on how the company’s cost
objects have been classified on the statement of comprehensive income).

▪ Were you able to identify and link the classification therein to the “cost classification
summary” as per section 1.3 above?

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LEARNING UNIT 2: COST ESTIMATION

2.1 Introduction
In Learning unit 1, you learnt about various costing concepts, cost behaviour and the classification
thereof. Learning unit 2 focuses on using mathematical and statistical techniques to reasonably
predict or determine the quantitative value(s) of the cost objects learnt in the previous learning
unit. In practice, a number of different mathematical and statistical techniques are available in this
regard. However, this module only focuses on two techniques: the high-low method and the
least squares regression method. Lastly, you will learn how to determine the reliability of these
two techniques in predicting the values and magnitude of cost objects.

2.2 Learning outcomes

After studying Learning unit 2, you should be able to
▪ Split mixed costs into variable and fixed components, using both the high-low and the least
squares regression methods
▪ Identify and differentiate a dependent variable (cost driver) from an independent variable
▪ Formulate a cost estimation equation based on the results of the high-low method and least
squares regression method
▪ Use a cost estimation equation to predict costs at various manufacturing levels
▪ Calculate and interpret both the correlation coefficient (r) and the coefficient of determination
(r2)

2.3 Topic outline

In your second-year costing module, you learnt how to use basic linear equation (simple
regression) to split mixed costs (semi-variable costs) into their fixed and variable components.
This learning unit builds on your prior learning. Study the following sections in chapter 3 of the
prescribed textbook:

Concepts SAICA Principles of management accounting

knowledge (3rd edition)
level Theoretical Revision/prescribed
basis exercises
Introduction Section 3.1 none
Cost drivers 3 Section 3.2 none
▪ Plausibility of the cost driver Section 3.2.1
▪ Extent to which the cost Section 3.2.2
driver determines total cost
Scatter graphs 1 Section 3.3 none
High-low method 3 Section 3.4 Example 3.2
Least squares regression 1 Section 3.5 Example 3.3
▪ Manual approach to Section 3.5.1
determining the equation of
the line

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2.4 Summary
In this learning unit, you learnt how to identify and distinguish a dependent variable from an
independent variable; and use the principles of the high-low and the least squares regression
methods to estimate costs. Importantly, you learnt how to split semi-variable costs into variable
and fixed components. Although it is virtually impossible to predict costs with absolute precision,
the splitting of these costs represents an important step towards estimating costs with an
acceptable level of accuracy. To reduce cost estimate inaccuracies to an acceptable level, you
also learnt how to determine the reliability of the cost estimation techniques in predicting costs.

2.5 Self-review exercises

2.5.1 Listen to the “Cost estimation” podcast on myUnisa.
2.5.2 Attempt BQ3, BQ7 and BQ8 in chapter 3 of the prescribed textbook.

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LEARNING UNIT 3: BUDGETS, PLANNING AND CONTROL

3.1 Introduction
We have already established that management accountants are concerned with the internal use
of financial information that is presented in the management accounts to make decisions about
the organisation. According to Drury’s Management and Cost Accounting, an organisation’s
decision-making process is largely informed and guided by its strategic-plan, which focuses on
the long-term objectives of an organisation (Drury, 2015:396–397). As part of achieving the
organisation’s long-term plan, short-term operational plans are also created and documented in
various types of budgets. Drury defines a budget as “a financial plan for implementing
management decisions” (Drury, 2015:397). Therefore, in making various decisions about the
organisation, the management will be guided by the organisation’s budgets, which cascades from
the organisation’s strategic-plan. The budgets are subsequently used for variance investigation
and analysis, this to establish and understand how the organisation has actually performed in
relation to its plans.

3.2 Learning outcomes

After studying Learning unit 3, you should be able to
▪ Discuss the multiple (and sometimes conflicting) functions of a budget and the
administration thereof
▪ Compile different sub-budgets and master budgets derived from strategic organisational
targets
▪ Appreciate the role of computerised budgeting
▪ Use spreadsheet software to compile various sub-budgets
▪ Discuss the behavioural implications of the budgeted targets

Assumed prior knowledge:

You can
▪ define the concepts “budgeting” and “budgetary control”
▪ explain the functions and aims of budgetary control
▪ differentiate between controllable and uncontrollable costs
▪ define “responsibility centres”
▪ list and identify various types of budgets
▪ prepare fixed cost budgets
▪ prepare a cash budget
▪ define and compile a flexible budget
▪ list, discuss and/or critique the advantages and disadvantages of budgeting

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3.3 Topic outline
This learning unit builds on the budgeting principles/concepts you learnt in your second-year
studies. The majority of the sections to study, as outlined below, constitutes a revision of the work
covered during your second year. Study the following sections in chapter 12 of the prescribed
textbook:

Concepts SAICA Principles of management

knowledge accounting (3rd edition)
level Theoretical Revision/prescribed
basis exercises
Introduction Section 12.1 none
Objectives of budgets 2 Section 12.2 none
Strategic, tactical and operational 1 Section 12.3 none
budgets
Responsibility for budgets 3 Section 12.4 none
Determining the principal 1 Section 12.5 none
budgeting factor
The sequence in budget 2 Section 12.6 Example 12.1
preparation
Production and related budgets 3 Section 12.7 Example 12.2
Cash budgets 3 Section 12.8
▪ Drawing up a cash budget Section 12.8.1 Example 12.3
▪ Management action based on Section 12.8.2
cash budgets
The master budget 3 Section 12.9 Example 12.4
The role of ratio analysis and key 3 Section 12.10 none
performance indicators in the
budgeting process
Alternative approaches to 1 Section 12.11
budgeting
▪ Incremental budgeting Section 12.11.1 Example 12.5
▪ Zero-base budgeting Section 12.11.2
▪ Zero-base budgeting over Section 12.11.3
incremental budgeting Section 12.11.4
▪ Rolling budgets Section 12.11.5 Example 12.6
Budgeting and probability theory 2 Section 12.12 Example 12.7
Preparing projections using Section 12.13
historical data
▪ Projections using the high-low 3 Section 12.13.1 Example 12.8
method
▪ Other methods for preparing 1 Section 12.13.2
projections using historical data
Projecting sales 3 Section 12.14 none

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Concepts SAICA Principles of management

knowledge accounting (3rd edition)
level Theoretical Revision/prescribed
basis exercises
Preparing a flexed budget 3 Section 12.17 Example 12.9
Impact of budgeting on the 3 Section 12.18 none
motivation of managers*
Participation and performance Section 12.19
evaluation*
▪ Potential relative advantages of 2 Section 12.19.1 none
imposed budgets over
participative budgets
▪ Potential relative disadvantages 2 Section 12.19.2 none
of imposed budgets over
participative budgets
Negotiated style of budgeting 2 Section 12.20 none
Continuous feedback on 2 Section 12.21 none
performance*
The role of the management 3 Section 12.22 none
accountant in the budgeting
process
Beyond Budgeting® 2 Section 12.23 none

*You are required to revisit these sections as part of your Learning unit 11: Performance
management’s prescribed learning. Take note, learning unit 11 is prescribed in Tutorial letter 103.

3.4 Summary
In this learning unit, you revised the importance and objectives of budgeting. You learnt about the
different types of budgets, including, amongst others, the sales, cash, production and master
budgets. Although in practice the processes might differ from one organisation to the next, the
learning unit provided you with a general sequence to follow in the budget preparation process.
Furthermore, you were introduced to a number of budgeting approaches.

3.5 Self-review exercises

3.5.1 Attempt BQ8 and BQ9 in chapter 12 of the prescribed textbook.
3.5.2 Attempt LQ1 and LQ3 in chapter 12 of the prescribed textbook.

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LEARNING UNIT 4: COST-VOLUME-PROFIT (CVP) RELATIONSHIPS

4.1 Introduction
Up to this point, you have learnt about the classification, behaviour, estimation, budgeting and
forecasting of various financial information that feeds into the internal management accounts that
are used for decision-making purposes. This learning unit explores the interrelationship between
the key elements of the management accounts (costs, production levels, sales volumes and
revenue) and the organisation’s profit. This interrelationship is commonly referred to as a cost-
volume-profit (CVP) analysis (Williams et al. 2020:78). Moreover, the learning unit also focuses
on analysing the sensitivity of the aforementioned relationships. More often, decision-making
takes place within uncertain conditions and environments. Therefore, it is important for
management to realise that their inputs into projection models are sensitive to a variety of factors.
This learning unit will explain some of the tools we can use to understand and analyse the
relationships between cost, volume and profit.

4.2 Learning outcomes

After studying Learning unit 4, you should be able to

▪ Construct contribution and profit-volume graphs as alternatives to the break-even chart

▪ Apply CVP analysis in a multi-product setting
▪ Explain the meaning of “operating leverage”
▪ Describe the role of operating leverage in measuring risk and the way it influences profits
▪ Evaluate the operating leverage of different organisations
▪ Identify and explain the assumptions and limitations of the CVP
▪ Use computerised models to determine sensitivities to changes in different CVP variables
▪ Explain the meaning of standard deviation and the coefficient of variation as measures of
risk
▪ Recommend courses of action based on elementary scenarios involving standard deviation
and the coefficient of variation

Assumed prior knowledge:

You can
▪ use CVP analysis to determine the expected effect of decisions and events on profit or the
variables that influence profitability
▪ make suitable recommendations based on the above calculations
▪ determine the sensitivity of profit to changes in selling prices, costs and volumes
▪ determine what actions or decisions are required to achieve a predetermined outcome in
different scenarios, by using appropriate techniques
▪ differentiate between biased and unbiased probabilities
▪ describe the different concepts relating to probability measurements
▪ describe the concept and components of a decision tree as well as conditional profits
▪ identify qualitative factors that may have to be considered when a decision is made in
conditions of risk and uncertainty

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4.3 Topic outline

In the second-year costing module you learnt the basics of CVP analysis, which included the
probability theory and decision trees. This learning unit builds on your prior learning. Study the
following sections in chapter 4 of the prescribed textbook:

Concepts SAICA Principles of management

knowledge accounting (3rd edition)
level Theoretical Revision/prescribed
basis exercises
Introduction Section 4.1 none
CVP analysis – the accountant’s 1 Section 4.2 none
and economist’s models
▪ Variable versus absorption costing Section 4.2.1 none
systems
Break-even analysis 2 Section 4.3
▪ Profit formula Section 4.3.1 Example 4.1
▪ Contribution margin formula Section 4.3.2 Example 4.2
▪ Break-even chart Section 4.3.3
Sensitivity analysis 2 Section 4.4
▪ Amount of profit given a level of Section 4.4.1 Example 4.3
activity
▪ Target profits Section 4.4.2 Example 4.4 & 4.5
▪ Margin of safety Section 4.4.3 Example 4.6
▪ Additional sales volume required Section 4.4.4 Example 4.7
to cover additional costs
▪ Reduction in selling price to Section 4.4.5 Example 4.8
increase sales volumes
Break-even analysis with multiple 2 Section 4.5 Example 4.9 & 4.10
products
CVP analysis assumptions and 2 Section 4.6 none
limitations

4.4 Information technology (IT) and CVP analysis

With the advent of the Fourth Industrial Revolution, modern software packages (computerised
models) are increasingly used to perform CVP analysis. These models allow managers to
efficiently and effectively run various CVP scenarios and to perform sensitivity analysis. Although
the use of IT can improve the efficiency and effectiveness of CVP analysis, “the output of a CVP
model is only as good as the input” (Drury, 2015:188). It is therefore important that, in designing
these computerised models, suitably qualified and knowledgeable management accountants are
involved.

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Various computer programmes are available to perform a variety of CPV and sensitivity analysis
for decision-making purposes. For the purposes of this module, we only focus on the use of
Microsoft Excel®.

A basic application of Microsoft Excel® for CVP and sensitivity analysis is illustrated in
section 4.4.1.

4.4.1. Practice exercise

Dumelang-Bagaetsho (Pty) Ltd (“DB”) is a maize farming and selling company. The company’s
20X2 budget for business as usual (Scenario A) is as follows:

Budgeted maize harvest and sales demand 120 tonne

Selling price per kilogram (kg) of maize R15,00
Total variable cost per kg of maize R8,50
Total fixed costs R525 000

DB’s budgeting process includes using the Microsoft Excel® programme to analyse and illustrate
various scenarios indicating the sensitivity of a number of variables to changes in other variables.
On the back of possibly unusual rain patterns, DB has identified the following scenarios for the
20X2 financial year, and is thus required to illustrate the impact of each.

Scenario B Selling price per kg of maize to reduce by 10%, and no other changes
Scenario C Variable costs per kg to increase by 6%, and no other changes
Scenario D Total harvest to reduce by 30 tonne, and no other changes
Scenario E Total harvest to reduce by 30 tonne, and selling price of maize to reduce by 10%

Suggested solution to practice exercise 4.4.1:

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Suggested solution to practice exercise 4.4.1 (display formulas):

To display formulas and/or calculations, click on the “Formulas” tab, then on “Show Formulas”.

Suggested solution to practice exercise 4.4.1 (Alternative method):

▪ Besides illustrating each scenario in a separate column (as above), a “Scenario Manager”
function can also be used (see screenshot below).
▪ For illustration purposes, we reflect the results of “Scenario E” only).

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4.5 Standard deviation and the coefficient of variation
Sensitivity analysis is performed on a number of “what-if” scenarios that result in several
“possible outcomes”. Depending on the variable being analysed, these possible outcomes can
be various profit levels, sales values, contribution values and/or costs levels, etc. Besides being
interested in the possible outcomes, those charged with the decision-making responsibility
(management) are also interested in the degree of uncertainty associated with the possible
outcomes. For example, although the various possible profit/(loss) levels indicated in section 4.4.1
are +R225 000, +R75 000, +R193 800, +R60 000 and (R75 000), these are not guaranteed,
because there is always some degree of uncertainty. Therefore, a certain degree of the
determined possible outcomes (profits) is always at risk.

It is management’s responsibility to measure and quantify this risk. This measurement can be
done by means of the “standard deviation” and the “coefficient of variation”. Standard
deviation is a statistical tool used to quantify the extent to which a spread of possible outcomes
within a group differs from the “mean” (expected) value of the group. It is also referred to as “the
conventional measure of the dispersion of a probability distribution” (Drury, 2015:290). The use
of standard deviation is often criticised because it provides a quantified estimate as an absolute
value which is usually difficult to use when comparing different sets of data. “This scale effect can
be removed by replacing standard deviation with a relative measure of dispersion”, the coefficient
of variation (Drury, 2015:291). Coefficient of variation is the expression of the relative amount
of dispersion, which is simply the standard deviation divided by the expected values (Drury,
2015:291). Coefficient of variation is independent of the unit which the measurement has taken –
it is a dimensionless number. It is relative and expressed as a percentage. When you need to
compare sets of data to different units of measurement (e.g. hours and metres), or widely used
means, you should use the coefficient of variation instead of standard deviation.

Note: The calculation of possible outcomes and expected values (mean) were comprehensively
covered in your second-year costing module. Therefore, you are expected to know how to perform
those calculations.

4.5.1. Practice exercise

Management is considering two marketing plans. The outcome of each is as follows:

Details TV campaign Flyers at traffic lights

Expected outcome/mean profit R540 288 R640 203
Standard deviation in profits R36 964 R154 491

REQUIRED
Perform a risk analysis and advise management on the most suitable marketing plan.

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Suggested solution to practice exercise 4.5.1

On the surface, it seems as if the flyers campaign is the most profitable. However, the uncertainty
is higher, as evidenced by the higher standard deviation. We should therefore calculate the
coefficient of variation of each.

TV campaign Flyers at traffic lights

Coefficient of variation R36 964 / R540 288 R154 491 / R640 203

= 6,84% = 24,13%

The range of outcomes for the TV campaign is grouped more closely together (smaller standard
deviation). The coefficient of variation is also smaller. Because the outcome of the TV campaign
is more certain (less risky), you should recommend it. However, management’s risk appetite
should also be taken into account, as a risk-seeking management team might be prepared to take
a chance on a campaign with a 24% coefficient of variation.

4.6 Summary
In summary, this learning unit taught you about the existence of interrelationships between the
various items of the income statement, and their impact on the company’s profit. The learning unit
illustrated that CVP analysis can be a useful planning tool to assist managers in analysing the
sensitivity of the aforementioned interrelationships. Specifically, you learnt how to calculate the
following, amongst others, the break-even point for both single and multi-products, the margin of
safety, contribution ratios and profit-volume ratios. You also learnt how CVP analysis can be
applied to a number of “what-if” scenarios, including target profits, pricing and volume decisions
(Williams et al. 2020).

4.7 Self-review exercises

4.7.1 View the videos about CVP that can be found on myUnisa.
4.7.2 Attempt BQ1, BQ2, BQ3 and BQ10 in chapter 4 of the prescribed textbook.
4.7.3 Attempt LQ3 and LQ4 in chapter 4 of the prescribed textbook.

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LEARNING UNIT 5: DIRECT- AND ABSORPTION COSTING SYSTEMS

5.1 Introduction
You should now be comfortable with the identification and classification of costs; cost estimation;
various budgeting, planning and control techniques; and using the CVP analytical tool. What you
have learnt up to this point is how to identify, collate, classify, predict, measure and analyse
certain aspects of the financial information used in decision making. This learning unit addresses
the proper presentation of the financial information in financial statements and, more specifically,
in the income statement. Not only must the financial information be accurate and complete, the
presentation thereof should also allow for efficient internal reporting, decision making,
consistency, comparability, adherence to external reporting requirements (where applicable) and
adherence to various other statutory obligations, including tax compliance.

5.2 Learning outcomes

After studying Learning unit 5, you should be able to

▪ Explain how direct- and absorption costing systems are used in the context of reporting
▪ Distinguish between different statement of profit or loss, and other comprehensive income
(income statement) formats used under the direct- and absorption costing systems
▪ Calculate the impact of a change in inventory levels on profits calculated, using the direct-
and absorption costing systems
▪ Discuss the relative strengths and weakness of the direct- and/or absorption costing
systems

Assumed prior knowledge:

You can
▪ identify the differences between the direct- and absorption costing systems
▪ draft the statement of profit or loss, and other comprehensive income (income statement)
according to both the direct- and absorption costing systems, using different inventory
valuation methods
▪ reconcile the difference between the direct- and absorption costing systems’ net profits
▪ identify which costing system is most appropriate in different circumstances

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 MAC3701/102/3/2021

5.3 Topic outline

This learning unit was comprehensively covered in the second-year costing module. Although the
majority of sections in this learning unit are a revision of the second-year module, you are urged,
where needed, to refer back to the second-year study material. Study the following sections in
chapter 5 of the prescribed textbook:

Concepts SAICA Principles of management accounting

knowledge (3rd edition)
level Theoretical Revision/prescribed
basis exercises
Introduction Section 5.1 none

Cost accounting concepts 3 Section 5.2

▪ Absorption costing Section 5.2.1 Example 5.1
▪ Variable costing Section 5.2.2 Example 5.2
▪ Conclusion on similarities Section 5.2.3 none
and differences between
variable and absorption
costing
The impact of changes in 3 Section 5.3
inventory levels on profit
▪ No inventory Section 5.3.1 Example 5.3
▪ Opening inventory Section 5.3.2 Example 5.4
▪ Closing inventory Section 5.3.3 Example 5.5
▪ Further discussion and Section 5.3.4 none
conclusion on the effect of
inventory on profit figures
▪ Reconciling absorption profit Section 5.3.5 none
to variable profit
Strengths and weaknesses of 3 Section 5.4 None
absorption and variable
costing

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5.4 Statement of profit or loss (income statement) presentation and formats

You must be comfortable with the preparation and presentation of the income statement, using
either of the costing systems. Below is an illustrative presentation of the income statement of both
costing systems. These presentation formats are not provided in the examination or any other
assessments, therefore it is important that you are able to prepare and present the income
statement using either of the costing systems.

5.5 Summary
In this learning unit, you learnt to distinguish between the direct- and the absorption costing
systems. The main difference between them is in the treatment of fixed manufacturing costs. You
further learnt about the difference between period and product costs, mainly in relation to how
some items on the income statement are classified and/or presented. Furthermore, you learnt
how to draft and present the income statement using either of the two costing systems, and how
to eventually reconcile the profits between the two systems. In preparing the income statement,
it was also illustrated how inventory is valued differently between the two costing systems, using
different inventory valuation methods.

5.6 Self-review exercises

5.6.1 View the Direct and absorption costing videos that can be found on myUnisa.
5.6.2 Attempt BQ2, BQ6, BQ7, BQ8, BQ9 and BQ11 in chapter 5 of the prescribed textbook.
5.6.3 Attempt LQ1, LQ2 and LQ5 in chapter 5 of the prescribed textbook.

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LEARNING UNIT 6: OVERHEAD ALLOCATION

6.1 Introduction
In Learning unit 1 of this tutorial letter you learnt about direct costs and indirect costs (also known
as overheads). In that learning unit, you learnt that because of their direct relationship with cost
objects, direct costs are generally easier to assign to cost objects. However, the allocation of
overheads to cost objects is generally problematic. This learning unit focuses on outlining some
of the approaches employed in allocating overheads to cost objects, specifically, the traditional
and the activity-based costing (ABC) systems. Note: although these two allocation approaches
are addressed as a stand-alone independent learning unit (Learning unit 6), they are an extension
of the absorption costing system (see Learning unit 5).

6.2 Learning outcomes

After studying Learning unit 6, you should be able to

▪ Advise on the allocation of non-manufacturing overheads in manufacturing and service

organisations, for decision-making purposes
▪ Allocate inter-service departments’ overheads
▪ Determine cost hierarchies on an activity-based costing (ABC) system
▪ Discuss the application of the ABC system in service organisations, as well as other
management applications
▪ Show proficiency in using the ABC system, calculating the rates of cost drivers and applying
these in the costing of cost objects
▪ Discuss the strengths and weaknesses of both the traditional costing and ABC systems

Assumed prior knowledge:

You can
▪ give the background of both the traditional and activity-based costing (ABC) systems
▪ identify and describe the differences between the ABC and the traditional costing systems
▪ identify those environments which are suited to the implementation of an ABC system
▪ design and implement the ABC system, with a view to costing products

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6.3 Topic outline
This learning unit was comprehensively covered in the second-year costing module. Although the
majority of the sections in this learning unit are a revision of the second-year module, you are
urged, if needed, to refer back to the second-year study material. Study the following sections in
chapter 6 of the prescribed textbook:

Concepts SAICA Principles of management accounting

knowledge (3rd edition)
level Theoretical Revision/prescribed
basis exercises
Introduction Section 6.1 none
Volume- and value-based 3 Section 6.2
techniques
▪ Selecting an appropriate basis Section 6.2.1 Example 6.1 and 6.2
▪ Level of detail and accuracy
▪ Plant-wide rate versus Section 6.2.2 Example 6.3, 6.4, 6.5
departmental rate 6.6 and 6.7
Allocation of support service 1 Section 6.3 none
department costs
▪ Direct approach Section 6.3.1 Example 6.8
▪ Step-down approach Section 6.3.2 Example 6.8
▪ Repeated distribution approach Section 6.3.3 Example 6.8
▪ Simultaneous equation
approach Section 6.3.4 Example 6.8
Activity-based costing 3 Section 6.4 Examples 6.9 and 6.10
▪ Steps in ABC Section 6.4.1
▪ Limitations of ABC Section 6.4.2
Activity-based management and 1 Section 6.5 none
activity-based budgeting
Digital technologies 1 Section 6.6 none

6.4 Summary
The allocation of direct costs to cost objects is generally simplistic and easy. By contrast, the
allocation of overheads (indirect costs) to cost objects is often problematic, mainly because the
majority of the time the relationship between the cost object(s) and overheads is not linear. To
address the allocation of overheads to the cost object(s), this learning unit taught you two of the
main approaches in this regard: the traditional allocation system and the ABC system. The former
system mainly uses a predetermined/blanket/plant-wide overheads allocation rate to allocate
overheads to the cost object(s). The latter approach allocates overheads based on the activities
that drive those overheads in relation to the cost object(s) in question. Note: while using a plant-
wide allocation rate might be convenient for the organisation from an overall point of view, it is not
always the most appropriate and/or accurate approach to allocate overheads to the cost object(s).

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 MAC3701/102/3/2021

In that case, such an organisation may prefer to calculate and use a departmental allocation rate
instead of a common, plant-wide allocation rate for all departments.

Also outlined here, is a link between learning units 5 and 6 (this learning unit). This link is
graphically summarised as follows:

Costing systems
types

Variable/direct Absorption
costing system costing system

Traditional costing Activity-based costing

system system

6.5 Self-review exercises

6.5.1 View the direct and absorption costing videos that can be found on myUnisa.
6.5.2 Attempt BQ3, BQ4, BQ6 and BQ7 in chapter 6 of the prescribed textbook.
6.5.3 Attempt LQ1, LQ2, LQ4 and LQ5 in chapter 6 of the prescribed textbook.

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LEARNING UNIT 7: JOINT AND BY-PRODUCT COSTING

7.1 Introduction
No single approach to allocating costs to cost objects is appropriate in all instances, hence the
existence of various costing techniques. This learning unit outlines the principles of one of these
techniques, that is, joint and by-product costing. In this instance, despite following the same
processes, the manufacturing process simultaneously yields more than one distinct product, thus
it is considered appropriate to use the joint and by-product costing technique. In this learning unit,
you will cement your second-year knowledge of how manufacturing costs within the “joint
manufacturing process” are allocated to the products yielded by that same process. As an
example, a tree planting and logs producing process that ultimately yields different kinds of wood
and paper can be regarded as a joint manufacturing process. A joint manufacturing process
typically yields: (a) joint products and more often also (b) by-product(s). This learning unit will,
therefore, build on your second-year learning and illustrate the treatment of the manufacturing
costs incurred within a joint manufacturing process, and how these costs are eventually allocated
to the applicable products.

7.2 Learning outcomes

After studying Learning unit 7, you should be able to
▪ Distinguish between joint and by-products, scrap and waste
▪ Account for the proceeds and costs relating to the sale/disposal of a by-product, scrap and
waste
▪ Identify and calculate joint costs to allocate to joint products
▪ Calculate the net proceeds of by-product(s)
▪ Calculate the inventory value of joint products and illustrate how these are presented in
financial statements
▪ Prepare the financial statements of an organisation that manufactures joint and by-products
▪ Allocate joint costs to joint products, using different methods
▪ Identify and calculate the relevant cost(s)
▪ Advise on whether or not products from the joint manufacturing process should be
processed further
▪ Discuss the relevance of joint costs for the purpose of decision making

Assumed prior knowledge:

You can
▪ differentiate between joint and by-products
▪ allocate joint costs using different methods
▪ account for by-products
▪ calculate the value of joint and by-product inventory
▪ calculate profits from the sale of joint products

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 MAC3701/102/3/2021

7.3 Topic outline

Study the following sections in chapter 9 of the prescribed textbook:
Concepts SAICA Principles of management accounting
knowledge (3rd edition)
level Theoretical Revision/
basis prescribed exercises
Introduction Section 9.1 none

Cost accounting treatment 3 Section 9.2 Review Table 9.1, Figure 9.2
of joint costs attempt Example 9.1
▪ Scrap Section 9.2.1
▪ Waste Section 9.2.2 Example 9.2
▪ Joint products Section 9.2.4 Example 9.3, 9.4, 9.5, and 9.6
Joint costs and financial 3 Section 9.3 none
reporting
Joint costs in relation to 3 Section 9.4 Example 9.7 and 9.8
decision-making

7.4 Summary
In closing, let us recap on what you have learnt in this learning unit. The concept of a joint
manufacturing process was revisited. You should by now be aware that a joint manufacturing
process simultaneously yields more than one product, i.e. joint products and more often by-
product(s) as well. Furthermore, you should also be aware that only joint costs (after deducting
net proceeds from the sale of by-product(s)) are allocated to joint products using any of the four
allocation methods. It is important to be cognisant of the fact that some joint products or by-
products can be sold at the split-off point, while others might require further processing before
being sold. Lastly, for decision-making purposes, joint costs are regarded as irrelevant, while only
incremental costs and incremental incomes are deemed relevant.

7.5 Self-review exercises

7.5.1 View the joint and by-products video that can be found on myUnisa.
7.5.2 Attempt BQ3, BQ4, BQ5 and BQ7 in chapter 9 of the prescribed textbook.
7.5.3 Attempt LQ1 and LQ3 in chapter 9 of the prescribed textbook.

BIBLIOGRAPHY

Drury, C (2015). Management and accounting, 9th edition. United Kingdom: Cengage Learning.
Williams, J, Cairney, C, Chivaka, R, Joubert, D,Pienaar, A, Pullen, E, Roos, S, & Streng, J. 2020.
Principles of management accounting: A South African perspective. 3rd Edition. Cape Town:
Oxford University Press Southern Africa.
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