Acca Ma Course Notes

lOMoARcPSD|15213202
ACCA MA Course-notes-
Management Accounting (Association of Chartered Certified Accountants)
StuDocu is not sponsored or endorsed by any college or university

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)
lOMoARcPSD|15213202
Course Notes
ACCA
Management Accounting (MA)
From September 2020
Tutor details

lOMoARcPSD|15213202
ii I n t ro d u c t i on A C C A MA
No part of this publication may be reproduced, stored in a retrieval system

or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without the prior written permission
of First Intuition Ltd.
Any unauthorised reproduction or distribution in any form is strictly

prohibited as breach of copyright and may be punishable by law.
© First Intuition Ltd, 2020
APRIL 2020 RELEASE

lOMoARcPSD|15213202
A C C A MA I n t ro d u c t i on iii
Contents
Page
Introduction i
1 Your exam vi
2 The Management Accounting syllabus vi
3 Technical Articles vi
1: Management accounting and information 1
1 Accounting for management 1

2 Planning, decision-making and control 2
3 Data and information 2
4 Sampling 5
5 Presenting information 6
2: Statistical techniques 13
1 Statistical techniques 13
3: Summarising and analysing data 25
1 Expected values 25
2 Averages and distributions 27
4: Costing 33
1 Cost classification 33
2 Cost behaviour 34
3 Cost coding 40
4 Cost measurement 40
5 Management of business units 41
5: Accounting for materials 43
1 Accounting for materials 43
6: Accounting for labour 53
1 Accounting for labour 53
7: Accounting for overheads 59
1 Accounting for overheads 59
8: Absorption and marginal costing 65
1 Absorption and marginal costing compared 65
9: Process costing 71
1 Process costing 71

lOMoARcPSD|15213202
iv I n t ro d u c t i on A C C A MA
10: Other costing techniques 81
1 Job and batch costing 81

2 Service and operation costing 84
3 Alternative cost accounting approaches 85
11: Nature and purpose of budgeting 89
1 Nature and purpose of budgeting 89

2 Budgetary control and reporting 91
3 Behavioural aspects of budgeting 94
4 Flexible budgets 95
12: Budget preparation 97
1 Budget preparation 97
2 Capital budgeting 104
13: Discounted cash flow 107
1 Discounted cash flow 107
14: Investment appraisal 115
1 Investment appraisal 115
15: Material and labour variances 121
1 Standard costing systems 121

2 Variance calculations 122
3 Causes of variances 125
16: Other variances 127
1 Variance calculations 127

2 Causes of variances 132
17: Variance review and control 135
1 Reconciliation of budgeted and actual profit 135

2 Cost control and reduction 137
18: Financial performance measures 139
1 Performance measurement overview 139

2 Financial measures 141
19: Non-financial performance measures and performance reporting 147
1 Non-financial measures 147

2 Balanced scorecard 148
3 Activity, efficiency and capacity ratios 150
4 Process and job performance measurement 151
5 Non-profit seeking and public sector organisations 151
6 Manufacturing and service businesses 152
7 Benchmarking 154
8 Performance reports 154

lOMoARcPSD|15213202
A C C A MA I n t ro d u c t i on v
Solutions to lecture examples 155
Chapter 1 155
Chapter 2 155
Chapter 3 158
Chapter 4 159
Chapter 5 159
Chapter 6 161
Chapter 5 162
Chapter 8 163
Chapter 9 165
Chapter 10 169
Chapter 11 170
Chapter 12 171
Chapter 13 173
Chapter 14 175
Chapter 15 177
Chapter 16 178
Chapter 17 179
Chapter 18 180
Chapter 19 180
Formulae sheets 181

Comparison of course notes content with study text 187

lOMoARcPSD|15213202
vi I n t ro d u c t i on A C C A MA
1 Your exam
Your examination is a 2-hour computer-based examination.
You will have two hours for the exam PLUS you may have up to 10 minutes to familiarise
yourself with the CBE system before starting the exam.
The exam is divided into two sections:
Section A 35 objective test questions worth 1 mark each.
Section B Three 10-mark case-based questions (each case has a number of objective
questions worth between 1 and 2 marks each)
All questions are compulsory. The exam will contain both computational and discursive elements.
Some questions will adopt a scenario / case study approach.
2 The Management Accounting syllabus

Full details of the Management Accounting syllabus can be found on the ACCA website at:
https://www.accaglobal.com/content/dam/acca/global/PDF-
students/fia/studyguides/MA.FMA%20syllabus%20and%20study%20guide%202020-21%20FINAL.pdf
These course notes cover the syllabus and include all you need to know to pass the Management
Accounting exam. These notes are supported by a question bank and two exams.
3 Technical Articles
The ACCA publish a number of technical articles relating to Management Accounting on their website
at https://www.accaglobal.com/uk/en/student/exam-support-resources/fundamentals-exams-study-
resources/f2/technical-articles.html.
These provide useful additional reading, and are worth reading once you are comfortable with
material in these notes.

lOMoARcPSD|15213202
Management accounting and

information
1 Accounting for management

1.1 Financial accounting v Cost and Management accounting
The purpose of cost and management accounting is to assist the management in running their
business to achieve its overall plans, make the correct decisions and to control the business.
Financial Accounting Cost and Management Accounting

 Required by law  Optional, organisations do not have to use
 Accurate (audited to prove accounts are it (although most do in some form)
accurate)  Information may be approximate
 More important to be accurate than  More important to be timely than accurate
timely  Can be produced for any segment of an
 Deals with a whole company/ organisation
organisation  There are no prescribed rules
 Has to comply with IFRSs, etc. i.e. items  Can be for periods in the past, present or
must be treated in certain ways future
 Historic i.e. all figures show what has  Produced when required
happened in the past  Prepared for management – INTERNAL
 Must be produced annually
 Prepared for many different
stakeholders, mostly EXTERNAL

lOMoARcPSD|15213202
2 1: M an ag e me n t ac c o u n ti n g an d i n fo rmat i o n A C C A MA
2 Planning, decision-making and control

2.1 Planning
Identifying where the business would like to be, at some future point, often by setting objectives or
targets. Financial targets are known as budgets.
2.1.1 Strategic planning

The process of deciding on long-term objectives of the organisation and on the resources used to
attain these objectives. Long-term objectives will include matters such as objectives around products
and markets (e.g. to gain a 5% share of the market for kettles in the USA within the next five years).
2.1.2 Tactical planning

The medium-term process by which managers fulfil the objectives of obtaining and using resources
effectively and efficiently in the accomplishment of the organisation’s objectives. An objective of
tactical planning could be “to increase output per employee by 4% in the next year”.
2.1.3 Operational planning

The short-term process of assuring that specific tasks are carried out effectively and efficiently, and
short-term targets necessary to manage the business on a day to day basis are achieved. An example
would be ‘’to achieve sales volume of 10,000 units in the North East of England next week.’’
2.2 Decision-making
Making decisions to get the business from where it is now, to where it wants to be i.e. deciding how to
achieve the plan. Decisions on products and markets are important here.
2.3 Control
Ensuring the decisions are implemented correctly and that the plans are actually fulfilled.
3 Data and information

3.1 Data
Data is the raw unprocessed figures that have been collected about an activity or procedure e.g. the
number of units made each day.
 Quantitative – data that can be measured (how old are you?)
 Qualitative – data that can’t be measured (how blue are your eyes?)
 Discrete – values / observations are distinct and separate, i.e. they can be counted (1,2,3,.).
Examples might include the number of kittens in a litter; the number of patients in a doctors’
surgery.
 Continuous – values / observations belonging to it may take on any value within a finite or
infinite interval. You can count, order and measure continuous data. For example, height,
weight, temperature, the time required to run a mile.
 Primary – data that has been gathered for the specific purpose by yourself (interviews,
questionnaires etc.).

lOMoARcPSD|15213202
A C C A MA 1: M an ag e me n t ac c o u n ti n g an d i n fo rmat i o n 3
 Secondary – data gathered by someone else for another purpose that you use for your purpose.
Examples include financial statements used to base a share investment decision on or
government inflation statistics used to decide on product price rises.
3.2 Information
Information is processed data that is in a form that makes it valuable to the user e.g. the percentage
increase in daily production.
3.2.1 Qualities of good information

 Accurate = information should be precise enough to allow the appropriate decision to be made
 Complete = nothing important should be missing
 Clear = the intended user must understand the information they have been given
 User friendly = there should not be too much information, with all information being relevant
 Reliable = users must have confidence in the information
 Accessible = the decision makers must be able to access the information they require
 Timely = the availability of information should coincide with the decision being made
 Effective = the information must be cost effective i.e. it must be more valuable than the cost of
producing it
3.2.2 Limitations of management information

Management information will often be based on what has already happened (i.e. historic information)
and will often be internally generated. For decision making it is much more useful to have information
on what might happen in the future. Part of this will depend on what is likely to happen in the external
environment as well as internally.
3.2.3 Uses and limitations of published information

Published information can be very quick and relatively cheap to acquire. However, one drawback is
that it has not been produced for the specific purpose that your organisation might need (i.e. it is not
tailored information). With the internet there is so much information available that there is a danger
of information overload.
Also, when gathering information from the internet care is needed to check the source of the
information as there is almost as much misinformation out there as there is information.
3.3 Sources of data and information

3.3.1 Internal sources
 Accounting system (sales, purchases, staff costs)
 HR records (staff pay levels)
 Marketing department (potential customers, advertising proposed)
 Production department (output per machine, maintenance required per machine)
3.3.2 External sources

 Government statistics (employment levels, national imports and exports, demographic trends
{age, wealth etc.}, financial data {inflation, interest rates, exchange rates})
 Financial press (daily information available on company and economic activity including up to
date exchange rates, interest rates, share prices etc.)

lOMoARcPSD|15213202
 Trade publications (detailed data and information on an individual industry including price levels
and cost behaviour potentially)
 The internet including Big Data
3.4 Big data and data analytics

Big data involves capturing and processing data on a vast scale and converting it into information
utilised by the organisation. Analysis of big data can uncover unexpected relationships and provide
new insights into business performance not only historically, but also in the future.
Big data includes data collected from many, previously separate, systems. What constitutes big data
can be as varied as a point of sale transaction record, a tweet or a thank you email from a customer.
Doug Laney identified three characteristics of big data, using 3 V’s.
 Volume. More data than ever before is being collected. This is driven by social media and
transactional-based data recorded by large organisations, for example data captured from
loyalty cards. Internal systems also provide large pools of data.
 Velocity refers to the speed at which data is being streamed into the organisation, in real time.
Transactions may be constant, particularly for multi-national organisations and those with
significant ecommerce presence.
 Variety. Big data includes data from many different systems which will be in many different
formats. Structured data will include transaction files. Unstructured data will include social
media posts, messages, and SMS (text messages).
3.4.1 Uses of big data

Big data can be useful for an organisation in a number of ways:
 Big data can be used to identify and / or analyse opportunities to increase revenues by
improving product offerings or targeting offers to specific customers. This can impact upon
expectations of revenue.
 Organisations can build a more detailed picture of their customers from multiple sources. This
can impact not only upon expected revenue but also the relationship between marketing
expenditure and revenue.
 Organisations can also build a better picture of their competitors from sources including
competitor locations, marketing, strategies, websites, information gained from their own
customers and forecasts of competitor transactions. This can enable them to forecast
competitor behaviour and assess the impact of competitor behaviour upon their own expected
results.
 Big data enables trends in customer behaviour influencing revenue to be compared with what
the organisation is doing to address these trends, and the behaviour of competitors.
 Big data identifies ways of reducing costs through process efficiencies. It can relate both to the
method used and the targets / yardsticks chosen, influencing the whole budgeting process.
 Big data provides more reliable information about the impact of factors in the wider
environment, whose impact may be difficult to determine, for example legal and political
developments and exchange rate changes.

lOMoARcPSD|15213202
3.4.2 Data analytics

Data analytics involves obtaining insights from the information sources available. Data analytics often
aim to discover trends/relationships that make information useful for addressing business issues. Data
analytics are often automated processes, for example using algorithms.
Types of data analytics:
 Description – for example, trends in customer and product sales
 Prediction – using information as a basis for scenarios using different strategies
 Prescription – information relating to business difficulties, with the aim of finding solutions to
those difficulties
4 Sampling
Data may be gathered using sampling techniques, based on a sampling frame (numbered list of all
items in the population). Approaches to sampling can be:
 Random – as the name suggests items are picked at random from the sampling frame until the
sample is complete.
 Stratified random – in a stratified sample the sampling frame is divided into non-overlapping
groups or strata, e.g. geographical areas, age-groups, genders. A random sample is taken from
each stratum.
 Systematic – every nth item in the sampling frame is taken for the sample.
 Cluster – divides the population into groups, or clusters. A number of clusters are selected
randomly to represent the population, and then all units within selected clusters are included in
the sample. No units from non-selected clusters are included. For example, 10 schools are taken
to represent all schools in a country. All students from within those schools are then sampled.
 Multistage – like cluster sampling, but involves selecting a sample within each chosen cluster,
rather than including all units in the cluster. Thus, multi-stage sampling involves selecting a
sample in at least two stages.
 Quota sampling involves separating a population into sub-groups like stratified sampling but the
difference is then that with quota sampling, individuals are chosen by the interviewer rather
than selected at random or systematically. In other words there is a risk that the sample is
biased but it is quick and useful if a budget is tight. Here, the fact that a cheap and
administratively simple method is wanted suggests quota sampling though it does not mean
this is the best way to take a sample.

lOMoARcPSD|15213202
5 Presenting information
5.1 Written reports
Section/Heading Description
Title What the report is about
Contents List of where in the report the different sections can be found (usually includes
page references)
Introduction Brief lead into the main document
Terms of reference Purpose of the report (who it is for and what was asked for along with relevant
disclaimers on the scope of the report)
Main issues Main body of the report, split into a number of clear subsections which are
numbered to make referencing easier
Recommendations or What the person who requested the report is going to be primarily interested in.
Conclusions Recommendations should be very clear and consistent with the work that has been
discussed in the main issues section
Appendices Any detailed information (tables, graphs, information sources used) included as
appendices to avoid overloading the main issues section with information
5.2 Tables
Tables are a very easy way of presenting information about variables where rows and columns are
used to analyse the information. To be effective, a table should have clear headings for the rows and
columns.
Consider for example a survey where men and women are surveyed to ask what their favourite colours
are. The results may be shown as follows:
The favourite colour of 56 students

Colour Men surveyed Women surveyed Total
Red 2 4 6
Blue 18 6 24
Pink 12 8 20
Green 2 4 6
TOTAL 34 22 56
The table above allows us to conclude that based on the sample of men and women that:
 53% of men prefer the colour blue (18/34).
 The most popular colour for women was pink and 36% of women preferred this colour (8/22).
 Overall red and green were the least popular colours for both men and women with only 21% of
the total sample preferring either of these two colours (12/56).

lOMoARcPSD|15213202
5.3 Bar charts

A bar chart is a visual way of showing information where quantities are represented as bars (either
vertical or horizontal) on a chart.
We can use the data in the previous table to illustrate different types of bar chart.
5.3.1 Simple bar chart

Data is shown by bars of equal width, the height of which corresponds to the value of the data.
24
20
Number of students
16
12
Red Blue Pink Green
5.3.2 Multiple bar chart
18
Number of men Number of women
16
14
Number of students
12
10
Red Blue Pink Green

lOMoARcPSD|15213202
5.3.3 Component bar chart
36
Green
32 Pink
Blue
28
Red
Number of students
24
20
16
12
Men Women
5.3.4 Percentage component bar chart

% Green
100 Pink
Blue
90
Numb222er of students
Red
80
70
60
50
40
30
20
10
Number of men Number of women

lOMoARcPSD|15213202
Workings for the above

Number of Number of
Colour men Cumulative women Cumulative
% % % %
Red 2 6 6 4 18 18
Blue 18 53 59 6 27 45
Pink 12 35 94 8 36 81
Green 2 6 100 4 19 100
TOTAL 34 100 22 100
5.3.5 Line graph

A line graph is a very simple graph showing the relationship between two variables such as sales
revenue and year. You just draw a straight line between the discrete points on the graph.
Year Sales
($000)
2014 10,500
2015 11,200
2016 11,450
2017 13,000
The line graph for this information would look something like this.
Annual sales 2014-2017

14,000
12,000
10,000
8,000
Series 1
6,000
4,000
2,000
0
2014 2015 2016 2017

lOMoARcPSD|15213202
5.4 Scatter graphs

A scatter diagram (or “scatter graph”) determines the relationship between two variables. The graph
should be drawn with:
 y axis representing the dependent variable
 x axis representing the independent variable; i.e. a change in the value of x, the factor we
control, will lead to a change in y.
For example, if a company increases its output (the independent variable), it would expect an increase
in its costs (the dependent variable). We could plot the output and costs for a series of months and
draw a straight “line of best fit” between the points, with the equation:
y = a + bx
where:
y = the dependent variable (here costs)
a = the intercept of the y axis i.e. the point below which the y variable cannot go. If y is a cost figure,
this is the “fixed” cost
b = gradient of the line of best fit. The higher “b” is, the steeper the gradient
x = the independent variable (here output)
Costs
($000)
7,400 X X
7,200
7,000 X
6,800 X
6,600 X
X
6,400
25 30 35 40 45 50 Output (units)

lOMoARcPSD|15213202
5.5 Pie chart

A pie chart is used to show what proportion or percentage individual elements of a total make up.
The word pie relates to the circular shape. If we consider the colour preference of men in the earlier
example, a pie chart using this information would be:
Favourite colours - men

Red Blue Pink Green
6% 6%
35%
53%

lOMoARcPSD|15213202

lOMoARcPSD|15213202
13
Statistical techniques
1 Statistical techniques
1.1 Scatter diagrams
In a CBA exam you will not be asked to draw a scatter graph but you may need to be aware of the
process that has to be gone through in order to make the cost estimates.
90,000
Total 80,000
Cost
70,000
60,000
50,000
40,000
30,000
20,000
10,000
Total
0
0 2000 4000 6000 8000 10000 12000 Output

lOMoARcPSD|15213202
14 2: St at i s t i c al t e c h n i qu e s A C C A MA
A graph is plotted of say, costs and output levels (scatter graph) and then a line of best fit is drawn
(sketched approximately) through the points.
The fixed cost can then be estimated as the point at which the line cuts the ‘y’ axis (vertical one).
Estimates can then be made of the variable cost per unit by using one of the other points that is fairly
close to the line as a guide.
The line of best fit in this illustration may look something like as follows:
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
0 2000 4000 6000 8000 10000 12000
1.2 Regression analysis

Using regression analysis it is possible to find, mathematically, the line of best fit between two variable
(called x and y). However while this is the best line, this does not necessarily mean that it is particularly
close to the actual variables.
1.2.1 Correlation coefficient (r)

 Indicates the strength of the relationship between the variables i.e. how close the line of best fit
is to the actual variables.
 Will always be somewhere between –1 and +1. The sign simply indicates that the gradient of
the best fit line. The closer the correlation coefficient is to 1, the closer the line of best fit is to
the actual variables. If the correlation coefficient was 1, then the variables would actually be on
a perfect straight line.
 In the illustration that follows, r = 0.957, so this would suggest a very strong positive
relationship between Output and Total cost.

lOMoARcPSD|15213202
A C C A MA 2: St at i s t i c al t e c h n i qu e s 15
1.2.2 Coefficient of determination (r2)

 Indicates the proportion of change in the y (dependent) variable which is explained by change in
the x (independent) variable.
 Will always be somewhere between 0 and +1.
 In the illustration that follows, r2 = 0.915849, so this indicates that 91.5849% of the change in
the total cost is explained by the change in the output.
The correlation coefficient is calculated using the following formula:
FORMULA GIVEN IN EXAM

𝑛𝑛 ∑ 𝑥𝑥𝑥𝑥 − ∑ 𝑥𝑥 ∑ 𝑥𝑥
𝑟𝑟 =
�(𝑛𝑛 ∑ 𝑥𝑥 2 − (∑ 𝑥𝑥)2 )(𝑛𝑛 ∑ 𝑥𝑥 2 − (∑ 𝑥𝑥)2 )
As we have already seen a linear function takes the form of y = a + bx. Using regression analysis ‘a’ and
‘b’ can be found by using the following formulae:

𝑏𝑏 =
𝑛𝑛 ∑ 𝑥𝑥 2 − (∑ 𝑥𝑥)2
and

∑ 𝑥𝑥 ∑ 𝑥𝑥
𝑎𝑎 = − 𝑏𝑏
𝑛𝑛 𝑛𝑛
Where a = fixed cost
b = variable cost per unit
x = output
y = total cost
LECTURE EXAMPLE 1: LINEAR REGRESSION
The total costs incurred at various output levels in a factory have been measured as follows:
Output Total cost
(units) ($)
26 6,566
30 6,510
33 6,800
44 6,985
48 7,380
50 7,310

lOMoARcPSD|15213202
SOLUTION
Output Total cost
(units) ($)
(x) (y) xy x2 y2
26 6,566
30 6,510
33 6,800
44 6,985
48 7,380
50 7,310
231 41,551
What is the linear function for these variables?
What is the correlation coefficient?
What is the coefficient of determination?

lOMoARcPSD|15213202
LECTURE EXAMPLE 2: COST AND REVENUE FORECASTS USING LINEAR REGRESSION
Using the above cost equation estimate what costs would be at an output level of 40 units?
Similarly, if we were told that the forecast equation for sales volume is given as:
Sales = 4,500 + 200Q
where Q = the quarter number (Q=1 is the first quarter of year 1)
what volume of sales would be forecast for quarter 3 of year 4?
1.2.3 Advantages of regression analysis

 It takes all pairs of data into consideration unlike the high-low method that just uses two
 It gives a statistically accurate link between the two variables
1.2.4 Disadvantages of regression analysis

 It assumes that there is a linear relationship between the two variables
 It may suggest a cause and effect relationship where in fact there isn’t one (just because two
variables are plotted against one another doesn’t mean that they are related)
1.3 Time series analysis

A time series is simply a set of data observed over a period of time. For example, sales patterns by day,
by week, by month, by year etc.
A time series (TS) forecast identifies four components from a series of past figures recorded over time
and then uses them to forecast the future:
 Trend (T) = the underlying long-term movement over time in the historic data. This can be
determined by a process of moving averages (taking consecutive averages of a range of data).
For example, there has been a general upward trend in house prices over the last five years.
 Seasonal Variation (S) = short term periodic fluctuations in the historic values. This can be
determined by using either the additive or the proportional models. For example, ice cream
sales are higher in Summer than in Winter.
 Cyclical Variation (C) = longer term fluctuations caused by such factors as economic
activity/cycles.
 Random Variation (R) = unpredictable fluctuations such as an act of nature.
You will not be asked to analyse cyclical and random variations. Therefore, we will focus on trends and
seasonal variations in the forecast of future data. There are two models that we can use to determine
the forecast time series.

lOMoARcPSD|15213202
1.3.1 Additive model

This is used where the components are assumed to add together to give the time series. The
components of the Time Series are quoted in actual (absolute) terms/values.
TS = T + S
LECTURE EXAMPLE 3: ADDITIVE MODEL
The trend equation for forecasting sales (A) for quarter (B) is A= 12.2 + 1.3B
Quarter 3 has a seasonal adjustment factor of +1.6 using the additive model.
What is the time series forecast for Q3?
SOLUTION
1.3.2 Multiplicative (or proportional) model

This is used where the components are considered as multiplying together to give the TS. The
components of the Time Series are quoted as a % or fraction of the trend (T).
TS = T × S
LECTURE EXAMPLE 4: MULTIPLICATIVE MODEL
Forecast sales for the next quarter are $200,000 and the seasonal variation is 0.76
Using the multiplicative model, what is the underlying trend?
SOLUTION
TS = T × S

lOMoARcPSD|15213202
1.3.3 Determining the trend

The additive model assumes that the seasonal variations are independent of the trend. The
multiplicative model assumes the seasonal variations are linked to the size of the trend.
ILLUSTRATION: IDENTIFYING THE TREND
Patterns Co has the following historic data of its quarterly sales over the last three years:
Year Quarter Sales
1 1 $60,000
2 $144,000
3 $198,000
4 $240,000
2 1 $72,000
2 $180,000
3 $228,000
4 $262,000
3 1 $106,000
2 $200,000
3 $252,000
4 $286,000
There are three ways of determining the trend in the above data:
 Preparing a graph
 Moving averages
 Linear regression
Preparing a graph
Using the data on the previous page, we can construct a time series graph.
Sales
350
300
250
200
$'000
150 Sales
100
50
0
YR1 YR1 YR1 YR1 YR2 YR2 YR2 YR2 YR3 YR3 YR3 YR3
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

lOMoARcPSD|15213202
Moving averages
STEPS
Step 1: Calculate the moving averages.
Step 2: Centre the moving averages (only needed if using an even number for the averages) to
give the trend.
Step 3: Calculate seasonal variations (either additive or multiplicative basis).
Step 4: Forecast.
First, we need to decide how many periods to include in the average. In this example we are given
quarterly results for different years. Working out the average for each four quarter range seems most
appropriate.
We then work out an average over each four-quarter cycle and in doing so any seasonal distortions
should be eliminated, leaving us with an estimation of the underlying trend.
The first average is worked out for quarters 1, 2, 3 and 4 for year 1, the second for quarters 2, 3 and 4
for year 1 and quarter 1 for year 2 and so on.
LECTURE EXAMPLE 5: ADDITIVE MODEL

Forecast the sales figures for year 4 based on the previous illustration.
Moving Centred Moving Seasonal
Year Quarter Sales (TS) Average Average (T) Variation
(TS-T)
1 1 $60,000
2 $144,000
$160,500
3 $198,000 $162,000 +$36,000
$163,500
4 $240,000 $168,000 +$72,000
$172,500
2 1 $72,000 $176,250 –$104,250
$180,000
2 $180,000 $182,750 –$2,750
$185,500
3 $228,000 $189,750 +38,250
$194,000
4 $262,000 $196,500 +$65,500
$199,000
3 1 $106,000 $202,000 –$96,000
$205,000
2 $200,000 $208,000 –$8,000
$211,000
3 $252,000
4 $286,000
4 1

lOMoARcPSD|15213202
The average has been calculated over an even number of periods and so it does not line up against an
individual quarter.
So a second moving average of two is taken. The centred moving average is the trend. So from
quarter 3 of year 1 to quarter 2 of year 3 the trend has moved from $162,000 to $208,000.
Having calculated the trend, we then calculate the seasonal variation for each quarter, which is the
difference between the sales figure and the centre moving average.
By summarising the seasonal variation column we have the following:
Quarter 1 Quarter 2 Quarter 3 Quarter 4
Year 1
Year 2
Year 3
Average
It is now possible to forecast the year 4 sales using the trend movement and seasonal fluctuations we
have calculated.
ILLUSTRATION: MULTIPLICATIVE MODEL

Moving Centred Moving Seasonal
Year Quarter Sales (TS) Average Average (T) Variation
(TS÷T)
1 1 $60,000
2 $144,000
$160,500
3 $198,000 $162,000 122%
$163,500
4 $240,000 $168,000 143%
$172,500
2 1 $72,000 $176,250 41%
$180,000
2 $180,000 $182,750 98%
$185,500
3 $228,000 $189,750 120%
$194,000
4 $262,000 $196,500 133%
$199,000
3 1 $106,000 $202,000 52%
$205,000
2 $200,000 $208,000 96%
$211,000
3 $252,000 $214,571
4 $286,000 $221,142
4 1 $107,025 $227,713 47%
2 $227,255 $234,284 97%
3 $291,435 $240,855 121%
4 $341,448 $247,426 138%

lOMoARcPSD|15213202
Using the multiplicative model:

We can summarise the seasonal variations as follows:
Year 1 – – 122% 143%
Year 2 41% 98% 120% 133%
Year 3 52% 96% – –
Average 47% 97% 121% 138%
Finally, we can forecast the sales (time series) for year 4 (see bold figures in the above table).
Linear regression
Here, we can use the linear equation y = a + bx, where y is the dependent variable (i.e. the actual
results) and x is the independent variable, which will be periods of time.
ILLUSTRATION: LINEAR REGRESSION
Using our earlier data:

Year Quarter Period (x) Sales (y) xy x2
$000
1 1 1 60 60 1
2 2 144 288 4
3 3 198 594 9
4 4 240 960 16
2 1 5 72 360 25
2 6 180 1,080 36
3 7 228 1,596 49
4 8 262 2,096 64
3 1 9 106 954 81
2 10 200 2,000 100
3 11 252 2,772 121
4 12 286 3,432 144
78 2,228 16,192 650
𝑏𝑏 =
𝑛𝑛 ∑ 𝑥𝑥 2 − (∑ 𝑥𝑥 )2
(12 × 16,192) − (78 × 2,228)

=
(12 × 650) − 782
20,520
=
1,716
𝑏𝑏 = 11.96
𝑎𝑎 = Y� − 𝑏𝑏X�
2,228 78
= − (11.96 × )
12 12
= 185.67 – 77.74
𝑎𝑎 = 107.9

lOMoARcPSD|15213202
Therefore Y = 107.9 + 11.96X

Using this equation, we can predict the trend values (y) for the next few quarters:
y = 107.9 + 11.96X
Period (X) (TREND)
13 263.38
14 275.34
15 287.3
16 299.25
These figures will then need to be adjusted for the seasonal variations either using the additive or
multiplicative models.
There are a number of problems with using regression analysis in time series analysis:
 Assumes the historic trends will continue into the future
 Becomes less reliable if you go outside the ranges of existing observations
 Seasonal variations may not be consistent into the future.
 Assumes there is an identifiable relationship
1.4 Index numbers

An index number series measures the relative changes in the volume or value of an item over time.
Common examples include the FTSE 100 index and Retail Price Index (RPI) or Consumer Price Index
(CPI).
1.4.1 Price indices

All index number series show the relative or percentage changes over time. They compare the price in
one period to the price in another period – called the base year.
The index in the base year is always 100. The base year should be a typical time period with no unusual
or extreme circumstances.
Formula for simple price index = 100 * P1/P0
Where P1 = Price in the current year, and Po = Price in the base year.
Therefore, we could index the following prices into a series with 2011 as the base year.
Year 2011 2012 2013 2014 2015 2016
Price $56 $61 $65 $71 $77 $82
Index 100 109 116 127 138 146
71/56 × 100 = 127

In 2012, prices were 9% higher than in 2011.
In 2014, prices were 27% higher than in 2011.
1.4.2 Quantity indices

A quantity index is calculated in a similar way to a price index, with a focus on volumes rather than
prices.
Formula for simple quantity index = 100 * Q1/Q0
Year 2011 2012 2013 2014 2015 2016
Volumes (‘000) 370 420 450 490 510 535
Index 100 114 122 132 138 145

lOMoARcPSD|15213202
Interpretation
In 2012, volumes were 14% higher than in 2011.
In 2014, volumes were 32% higher than in 2011.
1.5 Computer spreadsheets

The role of a computer spreadsheet system is to allow the manipulation and presentation of data in a
clear and understandable format to aid planning, decision making and control.
The features of a computer spreadsheet system include the ability to create charts, use colours and
boarders, tabs for multiple sheets, flexible sizes and functions.
Computer spreadsheet systems now have more than two hundred and fifty functions, but some of the
most commonly used in Management Accounting are as follows:
 SUM = adds all the numbers in a range of cells
 AVERAGE = calculates the average of all numbers in a range of cells
 IF = checks if a condition is met, and returns one value if true and another value if false
 HYPERLINK = creates a shortcut or jump that opens a document stored elsewhere
 COUNT = counts the number of cells that contain numbers
 MAX = returns the largest value in a set of values
 SUMIF = adds the cells specified by a given condition or criteria
 PMT = calculates payment for loan with constant payments and constant interest rate
 STDEV = calculates the standard deviation based on a sample
1.5.1 Uses of computer spreadsheets

 Calculate the fixed and variable cost using high-low analysis
 Calculate expected values
 Calculate a correlation coefficient and a coefficient of determination
 Calculate the fixed and variable cost using linear regression
 Calculate optimal inventory reorder levels with and without discounts
 Reapportion service cost centre costs to production cost centres
 Prepare and flex budgets
 Calculate variances
 Cost-volume-profit analysis
 Determine optimal solution in a single and multi-limiting factor situation

lOMoARcPSD|15213202
25
Summarising and analysing

data
1 Expected values
An expected value is a long run average. It is the weighted average of a probability distribution.
1.1 Formula for an expected value

𝑬𝑬(𝑿𝑿) = expected value = probability × outcome
Expected value (EV) = ∑𝑝𝑝𝑥𝑥
Where ∑ = sum of
𝑝𝑝 = probability of the outcome occurring
𝑥𝑥 = outcome
Expected values are best used where there are a number of possible outcomes from a single event,
with each outcome assigned a probability of occurring.
LECTURE EXAMPLE 1: EXPECTED VALUES
A football team is playing in a cup tournament:

Outcome Winnings Probability
Winner $1,000,000 45%
Runner-up $500,000 35%
Semi-finalist $100,000 20%
Required:
What is the expected value of the team's winnings?

lOMoARcPSD|15213202
26 3: Su mmari s i n g an d a n a l y s i ng d a t a A C C A MA
SOLUTION
1.2 Expected value tables

An expected value table can be used to consider the outcome of a range of possible events.
ILLUSTRATION
An ice cream salesman wants to determine how many choc ices to take onto his van every day. Daily
customer demand could be 20 choc ices (20% probability), 30 choc ices (30% probability), 40 choc ices
(40% probability) and 50 choc ices (10% probability). The salesman buys the choc ices for 50c and sells
them for $1. Any choc ices which are not sold have to be thrown away at the end of that day.
What is the optimum level of choc ices to buy?
An Expected Value table should be set up, calculating the daily profit in each case (Revenue less Cost).
An Expected Value can then be calculated for each possible outcome.
Customer Demand Buy 20 Buy 30 Buy 40 Buy 50
20 (20% probability) $10 $5 $nil ($5)
30 (30% probability) $10 $15 $10 $5
40 (40% probability) $10 $15 $20 $15
50 (10% probability) $10 $15 $20 $25
Expected Value $10 $13 $13 $9
e.g. if he buys 40, 𝐸𝐸𝐸𝐸 = (0.2 × 𝑛𝑛𝑛𝑛𝑛𝑛) + (0.3 × 10) + (0.4 × 20) + (0.1 × 20) = 13
The salesman will be indifferent between buying 30 and 40 choc ices.

lOMoARcPSD|15213202
A C C A MA 3: Su mma ri s i n g a n d a n a l y s i ng d a t a 27
1.3 Limitations of expected values

 Expected values give a long run average result and are therefore inappropriate for one-off
decisions.
 Expected values ignore the spread of possible returns (i.e. risk) since it is averaging outcomes.
 Relies on the accuracy of the probabilities.
2 Averages and distributions

There are three measures of average that you need to be familiar with for this exam: the mean, mode
and median. You also need to be familiar with the standard deviation, which is a measure of the
spread of data.
2.1 Mean for ungrouped data

A simple mean (average) is calculated as;
∑ 𝑥𝑥
𝑥𝑥̅ = 𝑛𝑛
For example, if the quarterly sales for XYZ plc are given as:
Q1 1,500
Q2 2,200
Q3 2,400
Q4 2,600
1,500+2,200+2,400+2,600
Then the mean (𝑥𝑥̅ ) would be 4
= 2,175
The mean is the weighted average figure for a population.

∑ 𝑓𝑓𝑥𝑥
𝑥𝑥̅ = ∑ 𝑓𝑓
Where 𝑥𝑥 = value
𝑓𝑓 = frequency
𝑛𝑛 = no of items in population
If looking at the height of children in a class where there are more than one child of each observed height:
Height in cm (𝓍𝓍) Frequency (𝑓𝑓) 𝑓𝑓𝓍𝓍
160 3 480
165 4 660
168 2 336
172 3 516
12 1,992
1,992
𝑥𝑥̅ = = 𝟏𝟏𝟏𝟏𝟏𝟏
12

lOMoARcPSD|15213202
2.2 Mean for grouped data

The formula is the same as above:
∑ 𝑓𝑓𝑥𝑥
𝑥𝑥̅ = ∑ 𝑓𝑓
but we use the ‘midpoint’ for 𝑥𝑥 to calculate the mean.
ILLUSTRATION
In the town of Intuit, a survey of 1,360 out of 50,000 residents was performed to determine annual
consumption of potatoes:
Midpoint No of residents
No. of potatoes consumed 𝒙𝒙 𝒇𝒇 𝒇𝒇𝒙𝒙
0 ≤ 50 25 10 250
50 ≤ 100 75 11 825
100 ≤ 150 125 93 11,625
150 ≤ 200 175 262 45,850
200 ≤ 250 225 423 95,175
250 ≤ 300 275 370 101,750
300 ≤ 350 325 121 39,325
350 ≤ 400 375 48 18,000
400 ≤ 450 425 22 9,350
1,360 322,150
Therefore the mean number of potatoes consumed in a year:

322,150
=
1,360
= 𝟐𝟐𝟐𝟐𝟐𝟐 potatoes.
2.3 Mode
The mode is the most frequently occurring item in a population. For an ungrouped set of data, this is
simply the most frequently occurring item in the list.
2.4 Median
The median is simply the value of the middle item.
For ungrouped data, the data should be arranged in order.
If there is an odd number of items, the median can be determined very simply.
If there is an even number of items, the median is calculated by taking the mean/average of the two
middle items.

lOMoARcPSD|15213202
ILLUSTRATION
The following numbers represent the number of goals scored by a football team in the first nine games
of the season:
1, 5, 2, 2, 3, 4, 8, 2, 1
The median here can be determined by first rearranging the data:
1, 1, 2, 2, 2, 3, 4, 5, 8
Therefore, the median is 2, the middle item.
In the next game (the 10th), the team scores 3 goals. Therefore, the data can be arranged:
1, 1, 2, 2, 2, 3, 3, 4, 5, 8
Since there is no ‘middle’ item, the median is taken as the mean of the 5th and 6th item: 2.5.
2.5 Standard deviation

To gain more meaningful information about the spread of data, we should look at the
standard deviation (𝝈𝝈). This measures the average spread of the data around the mean.
[Note: 𝜎𝜎 2 is known as the ‘variance’ ─ this may also be asked for in the examination and measures the
total spread of a population rather than average spread.]
The higher the standard deviation, the more widely dispersed the data is, on average.
For ungrouped data:
∑(𝑥𝑥−𝑥𝑥̅ )2
𝜎𝜎 = �
𝑛𝑛
Where 𝜎𝜎 = standard deviation

𝑥𝑥 = value
𝑥𝑥̅ = mean
𝑛𝑛 = number of observations
LECTURE EXAMPLE 2: STANDARD DEVIATION 1
Calculate 𝜎𝜎 from the example about consumption of potatoes we used above.

Quarter
𝑥𝑥 𝑥𝑥 − 𝑥𝑥̅ (𝑥𝑥 − 𝑥𝑥̅ )2
1 1,500 –675 455,625
2 2,200 25 625
3 2,400 225 50,625
4 2,600 425 180,625
687,500

lOMoARcPSD|15213202
SOLUTION
For a frequency distribution the formula becomes

∑ 𝑓𝑓𝑥𝑥 2
𝜎𝜎 = � ∑ 𝑓𝑓
− 𝑥𝑥̅ 2
Where 𝜎𝜎 = standard deviation

𝑓𝑓 = frequency
𝑥𝑥 = value
𝑥𝑥̅ = mean
LECTURE EXAMPLE 3: STANDARD DEVIATION 2
Calculate 𝜎𝜎 from the following table, where the mean is 237.

No of potatoes Midpoint No of residents
consumed 𝑥𝑥 𝑓𝑓 𝑥𝑥 2 𝑓𝑓𝑥𝑥 2
0 ≤ 50 25 10 625 6,250
50 ≤ 100 75 11 5,625 61,875
100 ≤ 150 125 93 15,625 1,453,125
150 ≤ 200 175 262 30,625 8,023,750
200 ≤ 250 225 423 50,625 21,414,375
250 ≤ 300 275 370 75,625 27,981,250
300 ≤ 350 325 121 105,625 12,780,625
350 ≤ 400 375 48 140,625 6,750,000
400 ≤ 450 425 22 180,625 3,973,750
1,360 605,625 82,445,000
SOLUTION

lOMoARcPSD|15213202
2.6 Coefficient of variation

This is a relative measure of dispersion, calculated as the standard deviation as a percentage of the
mean. It is used for comparing different sets of data to establish which is the most widely dispersed.
The higher the percentage, the higher the dispersion of the given data.
Formula
𝜎𝜎
Coefficient of variation =
𝑥𝑥̅
× 100%
ILLUSTRATION
The coefficient of variation for the example above =

67
237
× 100
= 𝟐𝟐𝟐𝟐. 𝟐𝟐%
2.7 The normal distribution

The normal distribution is a symmetrical frequency distribution. Due to the population being
symmetrical the:
Mean = Mode = Median
If you were to look at the distribution of the height of all adult males in the UK, it would almost
certainly follow a normal distribution, with an average of, say, 5ft 8 inches.
50% 50%
𝜇𝜇 = 5ft 8’ 𝜎𝜎 = 4’
Note: 𝜇𝜇 denotes the mean and 𝜎𝜎 denotes standard deviation.
The total area under the curve represents 100% of the population. Because of the symmetrical nature
of the curve, it is assumed that 50% of the population lies above the average and 50% below.
As the majority of people’s heights lie on or near to the mean, there is a larger proportion of males
with a height between 5ft 6in and 5ft 10in than those with a height of between 6ft 2in and 6ft 6 in.
Any area, and hence any probability, may be looked up using Normal Distribution tables.
The distance that a piece of data (x) lies from the mean in a normal distribution is referred to by the
number of standard deviations from the mean it represents. This is known as a ‘Z-score’:
𝑥𝑥 − 𝜇𝜇
𝑍𝑍 =
𝜎𝜎
The width of the curve is measured in terms of the standard deviation (𝜎𝜎).
Even though the normal distribution curve reaches to infinity, for practical purposes, we limit its range
to 6 standard deviations. Therefore, the heights of most adult males range between
𝜇𝜇 − 3𝜎𝜎 = 5𝑓𝑓𝑓𝑓 8’ − (3 × 4’) = 4𝑓𝑓𝑓𝑓 8’
And 𝜇𝜇 + 3𝜎𝜎 = 5𝑓𝑓𝑓𝑓 8’ + (3 × 4’) = 6𝑓𝑓𝑓𝑓 8’

lOMoARcPSD|15213202
ILLUSTRATIONS
(a)
47.5%
𝜇𝜇 1.96 𝜎𝜎
From tables, 0.475 (47½%) of the population lie within 1.96 Z’s of the mean. Therefore, using
our height example, this would mean that 2½% of the population are taller than
5ft 8’ + 1.96 × 4’ = 6ft 3.84’.
Because of the symmetrical nature of the curve, we could also conclude that 95% of the
population have a height between 5ft 8’ ± 1.96 × 4’ = 5ft 0.15’ and 6ft 3.84’.
(b)
34.13%
1 𝜎𝜎
Using tables, 0.3413 (or 34.13%) of the population lies within 1 standard deviation above the
mean i.e. between 5ft 8’ and (5ft 8’ + 1 × 4’) = 6ft.
This would also mean that 15.87% of the population are taller than 6ft.

lOMoARcPSD|15213202
33
Costing
1 Cost classification
1.1 Production costs
Production costs are all costs incurred in actually producing the product or service:
 Materials e.g. motor, metal, any other material used in the production process
 Labour e.g. pay to the production line workers, supervisor’s salary
 Overheads e.g. fixed design fee, factory rent and power for the production line
When valuing output and inventories we only include production costs.
1.2 Non-production costs

Non-production costs are any cost which is not a production cost:
 Administrative e.g. head office running costs
 Selling e.g. advertising campaign
 Distribution e.g. transport costs from the factory to the customer
 Finance e.g. interest payments on borrowings
1.3 Direct costs

Direct costs are any cost directly incurred in the production of the product or service.
 Direct materials e.g. a motor and metal
 Direct labour e.g. assembly workers who are paid for each unit produced
 Direct expenses e.g. a hire of a machine for a particular job
The total of all of the direct costs are known as the PRIME COST.

lOMoARcPSD|15213202
34 4: Co s t i n g A C C A MA
1.4 Indirect costs

Indirect costs are any cost which is not directly incurred in the production of the product or service.
 Indirect materials e.g. pallets
 Indirect labour e.g. supervisor’s salary
 Indirect expenses e.g. factory rent and power for the production line
2 Cost behaviour
2.1 Fixed costs
These are costs which do not change with the level of activity i.e. they vary with time rather than
production.
Examples of fixed costs are rent and head office costs.
Total Cost/
cost unit
$ $
Level of
Level of
activity
activity
2.2 Stepped fixed costs

These are costs which do not change with the level of activity up to a certain point. Once the activity
level exceeds this point they will increase, but then remain stable again until activity levels exceed
another critical point.
An example of a stepped fixed cost is supervisor salary where once the output goes above a certain
level a second supervisor will need to be employed.
Total
cost
$
Level of
activity

lOMoARcPSD|15213202
A C C A MA 4: Co s t i n g 35
2.3 Variable costs

These are costs which do change with the level of activity (e.g. units produced).
Examples of variable costs are motor, metal, assembly workers’ pay and transport costs.
Total Cost/
unit
cost
$
$
Level of Level of
activity activity
2.4 Semi-variable costs

Some costs will consist of a fixed and variable element e.g. your electricity bill. These are sometimes
referred to as semi-variable (or semi-fixed or mixed) costs.
Total
cost
$
Level of
activity

lOMoARcPSD|15213202
2.5 High-low method

A common requirement is to identify what the fixed and variable elements of a cost are. This can be
done using either of the following two techniques that will be seen later:
 High-low method
 Linear regression (covered in Chapter 2)
SCENARIO 1: HIGH-LOW ANALYSIS – CONSTANT FIXED AND VARIABLE COSTS
STEPS
Step 1: Select the highest and lowest activity levels, and their associated total costs.
(Note: do not take the highest and lowest costs)
Step 2: Find the variable cost/unit.
Cost at high level of activity – Cost at low level of activity
Variable cost/unit =
High level of activity – Low level of activity
Step 3: Find the fixed cost, using either the high or low activity level.
TOTAL COST (TC) = FIXED COST (FC) + VARIABLE COST (VC)
∴ FC = TC – VC
LECTURE EXAMPLE 1: HIGH-LOW (CONSTANT FIXED COSTS AND VARIABLE COSTS PER UNIT)
The total costs incurred at various output levels in a factory have been measured as follows:
Output Total cost
(units) ($)
26 6,566
30 6,510
33 6,800
44 6,985
48 7,380
50 7,310
Using the high-low method, identify what the fixed and variable elements of the cost are.
SOLUTION

lOMoARcPSD|15213202
SCENARIO 2: HIGH-LOW ANALYSIS – STEPPED FIXED AND CONSTANT VARIABLE COSTS
STEPS
Step 1: Select the highest and lowest activity levels, and their costs.
Step 2: Reduce the highest output cost for the increased fixed cost (i.e. pretend the step doesn’t exist).
Step 3: Find the variable cost/unit.
Adjusted cost at high level of activity – Cost at low level of activity
Variable cost/unit =
Step 4: Find the higher fixed cost, using high activity level.
Fixed cost = Total cost at high activity level – Total variable cost at high activity level
Find the lower fixed cost, using low activity level.
Fixed cost = Total cost at low activity level – Total variable cost at low activity level
Or Fixed cost = Fixed cost at high activity level – Increase in fixed costs
ILLUSTRATION: STEPPED FIXED COST WITH CONSTANT VARIABLE COST/UNIT
When a factory produces at its highest output level of 800 units its total cost is $9,000 and when it
produces at its lowest output level of 500 units its total cost is $6,900. From past experience the
management know that when production exceeds 600 units, the fixed costs increase by $900.
What are the variable and fixed costs?
STEPS
Step 1
The highest activity level is 800 units and the lowest activity level is 500 units.
Step 2
The adjusted highest activity level cost is $9,000 – $900 = $8,100.
Step 3
$8,100−$6,900
The variable cost per unit = = $4
800−500
Step 4
The highest activity level FC = $9,000 – (800 units × $4) = $5,800
The lowest activity level FC = $6,900 – (500 units × $4) = $4,900
Or $5,800 – $900 = $4,900.

lOMoARcPSD|15213202
SCENARIO 3: HIGH-LOW ANALYSIS – CONSTANT FIXED AND CHANGING VARIABLE COSTS

e.g. where economies of scale exist.
STEPS
Step 1: Select the highest and lowest activity levels, and their costs.
Step 2: Increase the highest output cost for the decreased variable cost (i.e. pretend the
reduction in VC never happened).
Step 3: Find the lowest activity variable cost/unit.
Adjusted cost at high level of activity – Cost at low level of activity
Lowest activity variable cost/unit =
Highest activity variable cost/unit = Lowest activity variable cost/unit – change in variable costs
Step 4: Find the fixed cost, using either the high or low activity level.
Fixed cost = Total cost at activity level – Total variable cost
ILLUSTRATION: CONSTANT FIXED AND CHANGING VARIABLE COSTS
When a factory produces at its highest output level of 800 units its total cost is $10,600 and when it
produces at its lowest output level of 500 units its total cost is $8,400. From past experience the
management know that when production exceeds 600 units, the variable cost per unit decrease by
$1 per unit.
What are the variable and fixed costs?
STEPS
Step 1
The highest activity level is 800 units and the lowest activity level is 500 units.
Step 2
The adjusted highest activity level cost is $10,600 + ($1 × 800 units) = $11,400.
Step 3
$11,400−$8,400
The lowest activity variable cost per unit = = $10
800−500
The highest activity variable cost per unit = $10 - $1 = $9
Step 4
The fixed cost = $10,600 – (800 units × $9) = $3,400
Or the fixed cost = $8,400 – (500 units × $10) = $3,400

lOMoARcPSD|15213202
2.5.1 Advantages and disadvantages of the high-low method
Advantages
 Simple to calculate and explain
 Only requires two pieces of data
Disadvantage
 Data points used are by definition extreme points (high and low output levels) and may not be
representative of the standard cost behaviour in between
2.6 Linear functions and equations

If you plot a series of points on a graph and they form a straight line. This is known as a linear
function. Fixed and variable costs are both examples of linear functions.
(y)
Total
cost
$
Gradient = b
Level of (x)
activity
The equation of any straight line is:

y = a + bx
where:
‘y’ is the vertical axis, that is the dependent variable. In the case of cost accounting, the 'y' is the total
cost.
'a' is the intercept with the vertical axis; that is the y value when x = 0. In the case of cost accounting,
the 'a' is the fixed cost.
'b' is the gradient/slope of the line, that is the change in y when x increases by 1 unit. In the case of
cost accounting, the 'b' is the variable cost per unit.
‘x’ is the horizontal axis, that is the independent variable. In the case of cost accounting, the 'x' is the
level of activity (usually this will be number of units produced).

lOMoARcPSD|15213202
3 Cost coding
Codes are used in accounting systems as a way of categorising transactions into groups so that
information on specific areas of the business is easier to identify and accounts are easier to prepare.
Codes can be set up in any way that a business wants. An illustration of a simple coding system is
shown below.
ILLUSTRATION: CODING TRANSACTIONS
KY Ltd uses the following coding system for its cost transactions:
Cost item Code Department Code
Stationery 258 Finance FN
Computers 624 Sales SS
Vehicles 109 Production PR
What account code would be used for the following transactions assuming that the code will show the
relevant department first?
(1) The accountant buys six new computers for his department
(2) The Production director gets a new car
SOLUTION
(1) FN624
(2) PR109
4 Cost measurement
4.1 Cost objects
Cost objects are any activity for which the management may require a separate measurement of cost
e.g. the cost of a product or service or the cost of a department.
4.2 Cost units

Cost units are units of production or service for which a cost can be measured e.g. the cost of
producing an i-pod or the charge out rate per hour for a lawyer.
For some businesses it may make sense to use a composite cost unit, where more than one variable is
taken into the measure. For example a transport company may use a tonne kilometre as its cost unit
as this will consider not only the weight carried but also the distance carried.
4.3 Cost centres

Cost centres are collecting points for costs e.g. a department, a photocopier or a project.
Some items may meet the classification of more than one of the categories above. For example, a
particular department may be set up as a cost centre but may also be a cost object.

lOMoARcPSD|15213202
5 Management of business units

If a business is split into business units (or divisions) it will need to decide what level of control to allow
those business units. Whatever managers are controlling, they will need:
 Actual information to date
 Forecast information
 Comparison of forecast information with targets
5.1 Cost centre

A cost centre is a part of the business accountable only for costs in the context of control. Managers
need information on likely costs from future decisions so decisions can be made about which suppliers
to use etc. Often service divisions will be set up as cost centres (e.g. IT).
5.2 Profit centre

A profit centre is a part of the business accountable for costs and revenues. Managers need
information to support decisions on the impact of changing prices on sales volumes.
5.3 Investment centre

An investment centre is a part of the business accountable for costs, revenues and capital investment.
Managers will be judged by the return on investment (profit divided by capital investment). They need
to understand how efficient the capital investment is being in helping them generate profits.
5.4 Revenue centre

A revenue centre is part of the business accountable only for revenues. As well as revenue
information, managers also need details of market share. A very sales-orientated business, where one
manager has key sales targets, might have this set up. A car sales business would be a possible
example.

lOMoARcPSD|15213202

lOMoARcPSD|15213202
43
Accounting for materials
1 Accounting for materials

1.1 Materials documentation
The Stores Department is normally responsible for organisations’ materials. It will control current
material levels and decide when to order more or new materials.
1.1.1 Purchase requisition

When more materials are required to be ordered, a purchase requisition is sent to the Purchasing
Department.
PURCHASE REQUISITION
Req. No. 0721
Date 06/09/17
Department/job number: D12
Suggested Supplier: Elliotts
Requested by: Charles Adams
Latest date Required 20/09/17
Quantity Code number Description Estimated Cost
Unit $
10 39550 Polypipe 100m 60.00 600.00
15 40202 Polypipe Ducting 5.00 75.00
Authorised signature: J. Henry

lOMoARcPSD|15213202
44 5: A c c o u n t i n g f o r mat e ri als A C C A MA
1.1.2 -Purchase order

The Purchasing Department will then draw up a purchase order, which is sent to the supplier. Copies
of the purchase order are also sent to Accounts Department and the Receiving Department.
Purchase Order Cathedral Supplies,

Church Road,
Our Order Ref: D12/0721 Date 11/09/17
Bishop’s Waltham
Hampshire
SO32 1EE
To: Elliotts
Claylands Road Please deliver to the above address
Swanmore Ordered by: Adam Shah
Hampshire Passed and checked by: Chris Pask
SO31 1HB Total Order Value $782.26
Quantity Code Descriptions Unit $
10 39550 Polypipe 100m 59.00 590.00
15 40202 Polypipe Ducting 5.05 75.75
Subtotal 665.75
VAT (@ 20%) 133.15
Total 798.90
1.1.3 Delivery note

When the supplier delivers the materials, a delivery note will be signed by the individual taking the
delivery in the Receiving Department.
The delivery should then be cross checked against the purchase order.
1.1.4 Goods received note

A goods received note (GRN) is then produced.
GOODS RECEIVED NOTE

No. 01749
DATE: 18/09/17 TIME: 15.40
OUR ORDER NO: D12/0721
SUPPLIER AND SUPPLIER’S DELIVERY NOTE NO: ELLIOTTS 11784
QUANTITY CODE DESCRIPTION
10 39550 Polypipe 100m

15 40202 Polypipe Ducting
Authorised signature: J. Henry
A copy of the GRN is sent to the Accounts Department, where it is matched against the purchase order.
When the supplier’s invoice is received this is also matched against the GRN and purchase order,
before it is authorised for payment.

lOMoARcPSD|15213202
A C C A MA 5: A c c o u n t i n g f o r mat e ri als 45
1.1.5 Material requisition note

When an internal department requires materials, a material requisition note will be passed to the
Stores Department.
Materials requisition note

Date required 27/09/17 Cost centre No/ Job No PN0372
Quantity Item code Description $
2 39950 Polypipe 100m 118.00
4 40202 Polypipe Ducting 20.20
Signature of requisitioning Manager/Foreman: Charles Adams Date 24/09/17
1.2 Inventory monitoring

The overall objective of inventory control is to minimise the total associated cost. Businesses should
keep accurate records to know the total amount of each item of inventory at all times. These amounts
are checked by performing inventory counts (also known as stock takes) where the physical inventory
is counted and reconciled to the book records.
The inventory will also be protected to prevent damage, deterioration and pilferage.
1.2.1 Free inventory

The term ‘free inventory’ is sometimes used to refer to the amount of inventory that is actually
available for future use in the business. It is calculated as:
Materials currently in inventory X
Add: Materials on order from suppliers X
Less: Materials allocated to customer orders (X)
Free Inventory X
1.3 Material inventory account

Inventory Account
Reference $ Reference $
Balance b/f (1) 10,340 Issues (4) 98,087
Purchases (2) 105,840 Losses (5) 1,364
Returns (3) 870 Balance c/f (6) 17,599
117,050 117,050
Reference
(1) Amount of inventory at the start of the period
(2) Total of the materials purchased during the period. In practice there would be one entry for
each individual order
(3) If materials are issued internally, but then found not to be required, they are returned
(4) Total of the materials issued during the period. In practice there would be one entry for each
individual requisition and issue

lOMoARcPSD|15213202
(5) If materials are pilfered, damaged, lost or become obsolete, their value will fall and this is
reflected here
(6) Amount of inventory at the end of the period
1.4 Ordering and holding costs

Ordering costs cover the costs of placing and receiving deliveries. Some of these costs will be fixed and
unaffected by the number of orders placed e.g. the purchasing department’s staff salaries. Other costs
will be variable e.g. a supplier’s order charge.
Holding costs cover the costs of storing and maintaining the materials. Some of these costs will be
fixed and unaffected by the number of items held e.g. the warehouse rent. Other costs will be variable
e.g. the interest lost on capital tied up in inventory.
1.5 Economic order quantity and total annual cost

The optimal reorder quantity known as the economic order quantity (EOQ) can be calculated by using
the following formula:
2Co D
EOQ=�
Ch
Where: EOQ = Economic order quantity

Co = Cost of placing one order
D = Demand per annum
Ch = Cost of holding one unit for one year
And the total annual cost (TAC) is:
Annual order cost + Annual holding cost
D Q
TAC = Co Q + Ch 2
Where: Q = Re-order quantity (i.e. the EOQ)
LECTURE EXAMPLE 1: EOQ AND TAC
Paton Co uses components at the rate of 500 units per month, which are bought in at a cost of $1.20
each from the supplier. It costs $20 each time an order is placed, regardless of the quantity ordered.
The total holding cost is 20% per annum of the value of inventory held.
What are the EOQ and TAC?

lOMoARcPSD|15213202
SOLUTION
1.5.1 Discounts
Companies will sometimes be offered discounts if they order more than a certain quantity. These are
known as bulk discounts. If discounts are available this will change the total annual purchasing cost
and so this now needs to be included in calculating the TAC:
D Q
TAC=Co + Ch + PD
Q 2
Where: P = Price per unit

The TAC will now either be minimised at the EOQ or one of the discount points. We thus need to
calculate the TAC at each point and see which is lowest.
LECTURE EXAMPLE 2: EOQ AND DISCOUNTS
Paton Co has now been offered a 5% discount on the purchase price for order quantities of 2,000 units
or more and 10% discount on the purchase price for order quantities of 3,000 units or more.
What is the optimum reorder quantity?

lOMoARcPSD|15213202
SOLUTION
1.6 Economic batch quantity

Some organisations manufacture their own inventory. This results in the gradual replenishment of
their inventory. They need to decide the size of the batch to manufacture (called the Economic Batch
Quantity (EBQ)) in order to minimise their total annual costs.
The EBQ can be calculated by using the following formula:

2Co D
� D
Ch �1 − �
R
Where: Co = Cost of setting up a batch ready to be produced
D = Demand per annum (rate of demand)
Ch = Cost of holding one unit for one year
R = Annual replenishment rate (or rate of production)
And the total annual cost (TAC) is:
Annual batch set up cost + Annual holding cost
D Q
TAC = Co + Ch (1 − D⁄R)
Q 2
Where: Q (EBQ) = Size of the batch

lOMoARcPSD|15213202
ILLUSTRATION: GRADUAL REPLENISHMENT
Moore Co manufactures components at the rate of 500 units per week. It costs $2,700 to set up the
production line for a new batch. The annual demand for this product is 10,000 units. The company
closes completely for two weeks every August, but apart from this, is open for the rest of the year.
The storage cost is $2.50 per unit for a year.
What are the EBQ and TAC?
Co = $2,700
D = 10,000 units
Ch = $2.50
R = 500 units × 50 weeks = 25,000 units
2 × 2,700 × 10,000
EBQ = � = 6,000 units
10,000
2.50 �1 − �
25,000
10,000 10,000 6,000

TAC = 2,700 × + 2.50 �1 − �
6,000 25,000 2
= 4,500 + 4,500
= $9,000
1.7 Reorder level

In practice there will be a time delay between an order being made and the materials being delivered.
This is known as the lead time. If demand is constant the total demand in the lead time, and hence the
reorder level, will be:
Reorder level = Lead time in days × Daily demand
When inventories reach this level, an order needs to be made to prevent the company running out of
this item.
ILLUSTRATION: REORDER LEVELS
Paton Co uses components at the rate of 500 units per month. Paton is open five days a week and for
50 weeks per year. It takes the supplier 12 days to deliver the goods having received an order.
What is the reorder level?
12 days × {(500 units × 12 months) / (5 days × 50 weeks)} = 288 units
So Paton should place their order when there are 288 units remaining.
1.8 Valuation of closing inventory and material issues

 FIFO – assumes that the oldest goods in inventory are sold/issued first
 LIFO – assumes that the newest items in inventory are sold/issued first
 AVCO – items taken out of inventory are assumed to consist of an average of all the items in
inventory at the time

lOMoARcPSD|15213202
We will use an illustrative example to demonstrate the impact of these techniques on both inventory
value and related gross profit.
LECTURE EXAMPLE 3: INVENTORY VALUATION METHODS (FIFO, LIFO & AVCO)

Date Cost per unit Revenue per unit
($) ($)
1st Jan opening balance 200 units 10.00
3rd Jan Purchased 150 units 10.40
5th Jan Sold 100 units 12.50
10th Jan Purchased 60 units 10.50
14th Jan Purchased 140 units 10.60
19th Jan Sold 200 units 12.75
Calculate the inventory valuation and gross profit using the FIFO, LIFO & AVCO inventory valuation
methods.
SOLUTION
(a) FIFO
Workings
No of Cost/unit Value
Date units $ $
1 Jan
3 Jan
5 Jan
10 Jan
14 Jan
19 Jan
Closing inventory
Profit calc
$
Sales
COS
Profit

lOMoARcPSD|15213202
LIFO
Date units $ $
1 Jan
3 Jan
5 Jan
10 Jan
14 Jan
19 Jan
Closing inventory
Profit calc
$
Sales
COS
Profit
AVCO (WEIGHTED AVERAGE) A new average price needs to be recalculated each time a
purchase is made at a different price to the existing average price.
Date units $ $
1 Jan
3 Jan
5 Jan
10 Jan
14 Jan
19 Jan
Closing inventory
Profit calc
$
Sales
COS
Profit
Note: In the real world, the average cost is recalculated every time a purchase is made at a different
price.

lOMoARcPSD|15213202
1.8.1 Comparing the techniques

In periods where prices are increasing (as per the example above) the following observations can be
made.
FIFO
Items issued from inventory will be deemed to be the oldest and so issued at the oldest cost (HISTORIC
COST). Closing inventory values will reflect more up to date prices. Hence the profit is likely to be
higher than that reported under the LIFO technique.
LIFO
Newest items are deemed to be issued first out of inventory. The cost of items sold will reflect the
more recent and higher cost. Closing inventory will be based on the older prices. Consequently, cost of
sales will reflect the more recent prices (ECONOMIC VALUE) and profit will be lower than under FIFO.
Weighted average
By assuming that the sales made and hence items remaining in inventory are an average of the items
at that time, this method will give an inventory valuation and profit figure in between the figures for
the other methods.
1.8.2 Advantages and disadvantages of each method

Advantages Disadvantages
FIFO Easy to understand. Issue prices out of inventory will vary.
Closing inventory is most likely to be valued Material issues from stores will be
at a figure that closely represents what it understated in periods of high inflation (and
would cost to replace it. vice versa).
It is probably what is really happening with
the inventory (i.e. it is normal to try and use
up the oldest inventory first).
LIFO Issues from stores are at a price close to Remaining inventory is assumed to be the
current market value. oldest (is this really likely?).
Issue prices out of inventory will vary.
AVCO Price changes won’t significantly distort Issue price is unlikely to reflect an actual
either inventory or profit figures. purchase price.
Issue prices out of inventory will vary, albeit
less dramatically than for the other methods.

lOMoARcPSD|15213202
53
Accounting for labour
1 Accounting for labour

1.1 Direct and indirect labour costs
KEY TERMS
 Direct labour costs are costs directly incurred in the production of the product or
service e.g. assembly workers who are paid for each unit produced.
 Indirect labour costs are any labour costs which are not directly incurred in the
production of the product or service e.g. a supervisor’s salary.
LECTURE EXAMPLE 1: DIRECT AND INDIRECT LABOUR COST
Sarah Co pays one of its direct labour employees $1,050 for a week’s work, made up as follows:
$
(1) $4 per unit for 200 units = 800
(2) An extra $2 per unit for 25 units made on Saturday = 50
(3) Bonus (part of a Group Incentive Scheme) = 200
Total $1,050
What are the direct and indirect costs of labour?

lOMoARcPSD|15213202
54 6: A c c o u n t i n g f o r l ab ou r A C C A MA
SOLUTION
1.2 Labour costs and work done

Input labour costs are the total direct and indirect labour costs.
The direct labour costs can be linked to the work done by using time sheets, job cards or piecework
tickets.
Time sheets are completed by the member of staff and show the time spent on different jobs. These
sheets will be authorised by the employee’s line manager.
Job cards are maintained for each job. When a member of staff works on a particular job they record
the time spent on that card. Thus several different employees may put time on the same job card.
Staff who are paid based upon the number of units produced (piecework) will complete a piecework
ticket or operation card, which shows the number of good units produced.
The indirect labour costs do not link directly to the work done. These are dealt with below.
1.3 Recording labour costs

1.3.1 Input costs
The journal and ledger entries to record labour input costs would be as follows:
DR Labour Account
CR Bank & Cash Account
with the net wages paid to staff
DR Labour Account
CR PAYE Account
with the income tax deducted by the company
DR Labour Account
CR National Insurance Account
with the National Insurance deducted by the company

lOMoARcPSD|15213202
A C C A MA 6: A c c o u n t i n g f o r l ab ou r 55
1.3.2 Output costs

The journal and ledger entries to record labour output costs would be as follows:
DR Work in progress Account
CR Labour Account
with the direct labour cost
DR Indirect labour Account
CR Labour Account
with the indirect labour cost
DR Overtime premium Account
CR Labour Account
with the overtime premium
DR Sick pay Account
CR Labour Account
with the sick pay
DR Idle time Account
CR Labour Account
with the cost of direct labour paid when not actually producing anything.
1.3.3 Labour account

Labour Account
Reference $ Reference $
Bank & cash (1) 89,876 Work in progress –
PAYE (2) 24,266 direct labour (4) 47,977
National Insurance (3) 9,886 indirect labour (5) 50,246
Overtime premium (6) 16,476
Sick pay (7) 2,476
Idle time (8) 6,853
124,028 124,028
Reference
(1) Net wages actually paid to staff during the period
(2) Income tax deducted by the company on behalf of the government
(3) National Insurance deducted by the company on behalf of the government
(4) Direct labour cost incurred on actual production during the period
(5) Indirect labour cost incurred during the period
(6) Overtime premium (the excess over normal pay rates) incurred during the period
(7) Sick pay cost incurred during the period
(8) Cost of direct labour paid when not actually producing anything

lOMoARcPSD|15213202
1.4 Remuneration methods

A time-based system is where you are paid for the amount of time you have worked:
Remuneration = Hours actually worked × Rate of pay per hour
A piecework system is where you are paid for the number of units you actually produce:
Remuneration = Units actually produced × Rate of pay per unit
An individual incentive scheme is where you are given an extra reward depending upon your own
individual performance. Such schemes are sometimes referred to as Bonus schemes. The extra reward
may take the form of a share of the profit or shares in the company.
A group incentive scheme is where you are given an extra reward depending upon the performance of
a group or team you are a member of e.g. a department. The extra reward may again take the form of
a share of the profit or shares in the company.
LECTURE EXAMPLE 2: INCENTIVE SCHEME
XYZ Co pays its workers at a rate of $10 per standard hour produced.
The standard time for making each of the company’s three products is as follows:
Tables 1.5 hrs
Chairs 0.8 hrs
Sofas 2.0 hrs
One worker produced the following output in January (160 working hours):
Tables 40
Chairs 100
Sofas 18
What pay would this worker receive in January?
SOLUTION

lOMoARcPSD|15213202
A C C A MA 6: A c c o u n t i n g f o r l ab ou r 57
1.5 Labour turnover costs

Number of staff replacements during the period
Labour turnover =
Average number of employees during the period
The causes of labour turnover are many and varied, but some common examples include:
 Change in personal circumstances e.g. getting married, having children or moving
 Ill health
 Retiring
 More attractive opportunity elsewhere e. g. higher pay, more convenient working hours
 Conflict with manager
 Poor career opportunities
 Dismissal for misconduct e.g. poor time keeping
Preventative costs are costs incurred in order to try and prevent staff leaving in the first place.
Examples include:
 Pension schemes (offering enhanced security)
 Welfare services e.g. a gym (keeping staff fit)
 Medical facilities e.g. on site doctor (keeping staff healthy)
 Counselling (maintaining good relationships)
Replacement costs are costs incurred once someone has left in order to replace them. Examples
include:
 Advertising job vacancies
 Selection and placement
 Training
 Lower productivity
 Increased faulty output
 Overtime pay to cover the shortfall
1.6 Labour ratios

Expected hours to make the output
Labour Efficiency Ratio =
Actual hours
Actual hours
Labour Capacity Ratio =
Planned (budgeted) hours
Expected hours to make the output
Labour Production Volume Ratio =
Planned (budgeted) hours
Labour Production Volume Ratio = Labour Efficiency Ratio × Labour Capacity Ratio

lOMoARcPSD|15213202
LECTURE EXAMPLE 3: LABOUR RATIOS
Bulldog Co planned to make 20,000 units in 100,000 hours. In the end they actually made 22,000 units
in 115,000 hours.
What are Bulldog’s labour efficiency, capacity and production volume ratios?
SOLUTION

lOMoARcPSD|15213202
59
Accounting for overheads
1 Accounting for overheads

1.1 Direct and indirect expenses
Direct expenses are always included in the cost of producing a unit of product or service.
Indirect expenses (also known as overheads) can either also be included in the cost of producing a unit
of product or service (absorption costing) or excluded from the cost of producing a unit of product or
service (marginal costing).
1.2 Absorption of overheads

While production overheads are not directly incurred in producing a unit of product or service, if we
ignore them there is a risk that the prices charged will be too low and won’t cover the total costs
incurred by the business.
We thus need to share these overheads over the units produced. This involves a three step approach:
Step 1: Allocate
Step 2: Apportion and Reapportion
Step 3: Absorb
1.2.1 Allocate
Some production overheads will relate to only one production cost centre e.g. an assembly
supervisor’s salary or the depreciation charge on a particular piece of equipment.
Putting these overhead costs against their respective cost centres is simple and known as allocation.

lOMoARcPSD|15213202
60 7: A c c o u n t i n g f o r o v e rh e ads A C C A MA
1.2.2 Apportion and Reapportion

Other production overheads will relate to more than one production cost centre e.g. factory rent or
heat and light expenses. These will need to be shared between the different cost centres using some
fair (but arbitrary) basis, such as the floor areas or volume of each cost centre.
This sharing of overhead costs between cost centres is known as apportionment.
LECTURE EXAMPLE 1: ALLOCATION AND APPORTIONMENT
Harry Co has three cost centres involved in the production of its products. These are the Assembly,
Finishing and Canteen Departments.
The production overhead for the period is $50,000 and is made up as follows:
$
Assembly Supervisor 3,000
Finishing Quality Inspector 4,500
Chef 2,500
Rent 22,000
Heat & Light 18,000
50,000
The following information is also available for each department:

Assembly Finishing Canteen
Floor Area (in square meters) 6,000 3,000 2,000
Volume (in cubic meters) 24,000 9,000 3,000
Number of employees 40 40 5
What is the production overhead for each department?
SOLUTION
Total Basis Assembly Finishing Canteen

$ $ $ $
Assembly Supervisor Allocate
Finishing Quality Inspector Allocate
Chef Allocate
Rent Floor Area
Heat & Light Volume
Overheads

lOMoARcPSD|15213202
A C C A MA 7: A c c o u n t i n g f o r o v e rh e ads 61
Some cost centres are directly involved in producing the product or service; these are known as
production cost centres e.g. assembly and finishing.
Other cost centres support these production cost centres; these are known as service cost centres e.g.
the canteen.
As the service cost centres are not directly involved in production they have no units of production
passing through them. Thus, the production overhead in service cost centres needs to be shared
across the production cost centres. This is known as reapportionment.
LECTURE EXAMPLE 2: REAPPORTIONMENT OF SERVICE DEPT OVERHEADS
What is the production overhead for each production cost centre?

$ $ $ $
Overheads
Reapportionment
Overheads
Reciprocal method
Sometimes an organisation will have more than one service cost centre and these centres will work for
each other. In these situations a special technique is used to reapportion the costs known as the
reciprocal method.
Before starting the reapportionment, the reciprocal method calculates the total amount of production
overhead to be reapportioned, including the share of other service cost centres.
LECTURE EXAMPLE 3: RECIPROCAL METHOD
Charles Co has already allocated and apportioned its overheads to its two production cost centres and
two service cost centres as follows:
Total Sawing Polishing Canteen Maintenance
$ $ $ $ $
Overheads 100,000 41,300 31,100 17,600 10,000
The Canteen spends 50% of its time servicing Sawing, 40% Polishing and 10% Maintenance, whilst the
Maintenance spends 40% of its time servicing Sawing, 40% Polishing and 20% Canteen.

lOMoARcPSD|15213202
SOLUTION

lOMoARcPSD|15213202
A C C A MA 7: A c c o u n t i n g f o r o v e rh e ads 63
1.2.3 Absorb
There is no one correct method for sharing overheads. There are six commonly used methods for
calculating an overhead absorption rate (OAR):
(1) Cost per labour hour
– the activity is mainly manual
(2) Cost per machine hour
– the activity is mainly automated
(3) Percentage of direct labour cost
– a number of different grades of labour are being used
(4) Percentage of material cost
– a number of different materials are being used
(5) Percentage of prime cost
– differing amounts of direct cost are being incurred
(6) Cost per unit
– a number of similar products are being produced
LECTURE EXAMPLE 4: OAR CALCULATION
Charles Co has the following details for its two production cost centres:
Sawing Polishing
Labour Hours 1,240 8,780
Machine Hours 5,610 2,030
What is an appropriate overhead absorption rate for each production cost centre?
SOLUTION

lOMoARcPSD|15213202
1.3 Accounting for overheads

The journal and ledger entries for manufacturing overheads incurred would be as follows:
DR Production Overheads Account
CR Bank & Cash Account
with the actual overheads incurred.
The journal and ledger entries for manufacturing overheads absorbed would be as follows:
DR Work in Progress Account
CR Production Overheads Account
with the overheads absorbed.
1.4 Under and over absorption of overheads

Production overheads are absorbed into the units of production to help in the setting of prices and to
allow us to value inventory in the accounts. We will thus need to know the figures at the start of the
period and so budgeted figures are used to calculate the OAR. This is consequently sometimes
referred to as the predetermined overhead absorption rate.
It is quite likely that the actual figures will not be the same as the predetermined/budgeted figures and
so a difference will arise, resulting in the under or over absorption of overheads.
LECTURE EXAMPLE 5: OVER AND UNDER ABSORPTION
At the end of the period Charles Co has the following actual figures for its two production cost centres:
Sawing Polishing
Labour Hours 1,190 9,121
Machine Hours 5,300 2,145
Production Overhead 54,345 45,098
What is the under- or over-absorption in each production cost centre?
SOLUTION

lOMoARcPSD|15213202
65
Absorption and marginal

costing
1 Absorption and marginal costing compared

1.1 Marginal costing
In marginal costing fixed costs for a particular period are treated as simply lump sum costs in the
statement of profit or loss each period. No attempt is made to spread them across the units that are
being produced.
1.2 Contribution
If an organisation which is already making and selling products decides to make and sell just one more
unit, it will receive one more unit’s worth of revenue and will incur one more unit’s worth of variable
costs. The fixed costs will not change.
Contribution = Revenues – Variable costs
Contribution contributes towards the fixed costs and profits of the organisation.
Thus when making decisions about increasing or decreasing production and sales, only the impact on
contribution needs to be considered. Marginal costing principles are therefore consistent with the
concept of contribution.

lOMoARcPSD|15213202
66 8: A b s o rp t i o n a nd marg i n al co s t i ng A C C A MA
ILLUSTRATION: CONTRIBUTION IN DECISION MAKING
Isabel Co currently makes three products, however due to new limits on greenhouse gas emissions;
it has been told it can only produce two products in future.
The details per unit of each product are as follows:
Matty Paddy Wally
$ $ $
Sales price 100 120 90
Variable costs (40) (50) (35)
Fixed costs (45) (60) (42)
Profit 15 10 13
Which product should Isabel stop producing?

SOLUTION
We can say that the fixed costs are not relevant to our decision since they will be incurred regardless
of whether the products are produced.
On purely financial grounds we would stop producing the product that has the lowest contribution per
unit.
Matty Paddy Wally
$ $ $
Sales price 100 120 90
Variable costs (40) (50) (35)
Contribution 60 70 55
Based on this information, Isabel Co should cease the production of product “Wally”.
1.3 Inventory valuation and profit

Marginal costing values inventory at variable production cost. Absorption costing values inventory at
variable and absorbed fixed production cost. Consequently, absorption costing will always produce a
higher inventory value than marginal costing.
Opening and closing inventory values are used in determining profit and so valuing inventories
differently will produce a different profit figure.
ILLUSTRATION: MARGINAL AND ABSORPTION COSTING INVENTORY VALUES
What are the marginal and absorption costing inventory values for Isabel Co?
Matty Paddy Wally
Marginal costing $ $ $
Inventory value (VC only) 40 50 35
Absorption costing $ $ $
Inventory value (VC + FC) 85 110 77

lOMoARcPSD|15213202
A C C A MA 8: A b s o rp t i o n a nd marg i n al co s t i ng 67
LECTURE EXAMPLE 1: AC AND MC PROFIT CALCULATIONS
Millie Co started business on 1 March making one product called the Runabout, the standard cost of
which is as follows:
$
Direct labour 5
Direct material 8
Variable production overhead 2
Fixed production overhead 5
Standard production cost $20
The fixed production overhead figure has been calculated on the basis of a budgeted normal output of
36,000 units per annum. The fixed production overhead incurred in March and April was $15,000 each
month.
Selling, distribution and administration expenses are:
Fixed $10,000 per month
Variable 15% of the sales value
The selling price per unit is $35 and the number of units produced and sold were:
March April
(Units) (Units)
Production 2,000 3,200
Sales 1,500 3,000
What is the profit or loss under absorption and marginal costing for Millie Co in March and April?
SOLUTION
Absorption costing
March April
$ $
Sales ($35 per unit)
Less cost of sales: (variable & fixed $20 per unit)
(Under)/over-absorption (see workings below)
Gross profit
Selling and distribution costs – variable
– fixed
(Loss)/Profit

lOMoARcPSD|15213202
Workings
March $
Overheads absorbed ( ×$ )
Overheads incurred
Under-absorption
April
Overheads absorbed ( ×$ )
Overheads incurred
Over-absorption
Marginal costing
March April
$ $
Sales ($35 per unit)
Less cost of sales: (variable only $15 per unit)
Less variable selling and distribution costs
Contribution
Less actual fixed production costs
Less actual fixed selling and distribution costs
(Loss)/Profit
1.3.1 Reconciliation of profits

While the formats of the absorption and marginal costing income statements differ, ultimately the
only figures that differ are the inventory values. Adjusting for these will reconcile the profits or losses
calculated under absorption and marginal costing.
If inventory levels are rising, 𝐀𝐀𝐀𝐀 𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩 > 𝑴𝑴𝑴𝑴 𝒑𝒑𝒑𝒑𝒑𝒑𝒇𝒇𝒊𝒊𝒊𝒊
If inventory levels are falling, 𝐀𝐀𝐀𝐀 𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩 < 𝑴𝑴𝑴𝑴 𝒑𝒑𝒑𝒑𝒑𝒑𝒇𝒇𝒊𝒊𝒊𝒊
The amount of the difference is 𝐌𝐌𝐩𝐩𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐩𝐩 𝐩𝐩𝐌𝐌 𝐩𝐩𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐩𝐩𝐩𝐩𝐩𝐩𝐢𝐢 (𝐮𝐮𝐌𝐌𝐩𝐩𝐩𝐩𝐮𝐮) × 𝐅𝐅𝐩𝐩𝐅𝐅𝐌𝐌𝐅𝐅 𝐎𝐎𝐀𝐀𝐎𝐎
LECTURE EXAMPLE 2: PROFIT RECONCILIATION
Reconcile the profits or losses calculated under absorption and marginal costing for Millie Co.
SOLUTION

lOMoARcPSD|15213202
A C C A MA 8: A b s o rp t i o n a nd marg i n al co s t i ng 69
1.4 Advantages and disadvantages of marginal costing

The advantages of marginal costing are the same as the disadvantages of absorption costing and vice
versa. So from a marginal costing perspective:
1.4.1 Advantages
 Better for decision-making
 Fixed costs are treated as period costs which is exactly what they are
 Profit depends only upon sales (and not production) activity and hence enables clearer
performance evaluation
1.4.2 Disadvantages
 Does not comply with Financial Reporting Standards
 All costs must be split into their fixed and variable parts
 Fixed costs are being incurred and so cannot be ignored

lOMoARcPSD|15213202

lOMoARcPSD|15213202
71
Process costing
1 Process costing
1.1 Characteristics of process costing
When the production process does not allow the individual identification of units of production,
process costing is used, such as in continuous or mass production processes e.g. tins of paint,
processed foods or chemicals.
Process costing spreads the total process costs over the total production, giving an average cost per
unit. Production normally consists of several different processes.
1.2 Losses and gains

In some processes the outputs will not equal the inputs due to things such as evaporation.
 When these losses can be foreseen they are called normal losses.
 If the actual level of loss is greater or less than what was expected, these losses and gains are
called abnormal losses and abnormal gains.
Total costs of inputs
Cost per unit of process outputs =
Normal output

lOMoARcPSD|15213202
72 9: P ro c e s s c o st i n g A C C A MA
LECTURE EXAMPLE 1: PROCESS COSTING (BASIC COST PER UNIT CALC)
DJS Co runs a factory with two process departments. The accounts for the two departments are as
follows:
Process Account – Department 1

Units $ Units $
Raw materials 1,000 10,000
Direct labour 8,000
Departmental overheads 6,000 Transfer to Department 2 1,000 24,000
1,000 24,000 1,000 24,000

Units $ Units $
Transfer from
Department 1
Additional raw materials 5,000
Direct labour 4,000
Departmental overheads 3,000 Transfer to Finished goods
What is the cost per unit for each department?

SOLUTION
1.3 Process accounts

1.3.1 Normal losses
As normal losses are expected they are valued at nil or their scrap value.
Total costs of inputs – Normal loss scrap value
Cost per unit of process outputs =
Normal output

lOMoARcPSD|15213202
A C C A MA 9: P ro c e s s c o st i n g 73
ILLUSTRATION: COST PER UNIT CALC WITH NORMAL LOSSES (ZERO SCRAP VALUE)
Now suppose DJS Co normally loses 10% of the inputs to Department 1 and 5% of the inputs to
Department 2.
What will the two process accounts look like and what is the new cost per unit for each department?
SOLUTION

Units $ Units $
Raw materials 1,000 10,000 Normal loss 100 nil
Direct labour 8,000
Departmental overheads 6,000 Transfer to Department 2 900 24,000
1,000 24,000 1,000 24,000
$24,000
Department 1: Cost per unit = = $26.67
900 units

Units $ Units $
Transfer from 900 24,000 Normal loss 45 nil
Department 1
Direct labour 4,000
Departmental overheads 3,000 Transfer to Finished goods 855 36,000
900 36,000 900 36,000
$36,000
855 units
LECTURE EXAMPLE 2: NORMAL LOSSES WITH SCRAP VALUE
Now suppose DJS Co has been offered $5 per unit for any losses.
What will the two process accounts look like and what is the new cost per unit for each department?
SOLUTION

Units $ Units $
Raw materials
Direct labour
Departmental overheads Transfer to Department 2
Department 1: Cost per unit = __________________ = $

lOMoARcPSD|15213202

Units $ Units $
Transfer from
Department 1
Additional raw materials
Direct labour
Departmental overheads Transfer to Finished goods
Department 2: Cost per unit = ____________________ = $
1.3.2 Abnormal losses and gains

Abnormal losses and gains arise if actual losses are either higher or lower than expected. They should,
in theory, not occur and are thus valued at the same cost per unit as good production in the process
account. The overall abnormal loss or gain goes through the statement of profit or loss.
LECTURE EXAMPLE 3: ABNORMAL GAINS AND LOSSES
Now suppose DJS Co has actual output from Department 1 of 860 units and 830 units from Department 2.
What will the two process accounts and the abnormal losses and gains account look like and what is
the cost per unit for each department?
SOLUTION

Units $ Units $
Department 1: Cost per unit =

Units $ Units $
Department 2: Cost per unit =

lOMoARcPSD|15213202
Abnormal losses and gains account

Units $ Units $
In Department 1 we lost 40 units which should have been worth $26.11, but instead were worth $5,
giving a loss = 40 units × ($26.11 – $5) = $844.40.
In Department 2 we gained 13 units which should have been worth $5, but instead were worth $41.91,
giving a gain = 13 units × ($41.91 – $5) = $479.83.
Hence there is an overall loss of $844.40 – $479.83 = $364.57
1.3.3 Work-in-progress
Because production is normally continuous, there is likely to be work in progress. The output of the
preceding process forms the material input of the current process.
Equivalent units of production have to be calculated when there is closing work in progress (WIP).
Then the costs incurred will need to be shared between the completed output and the closing WIP,
but more cost per unit will have been spent on the completed units than the closing WIP.
The closing WIP are changed into the equivalent number of fully completed units in order to work out
the cost per unit e.g. if there were 100 units of closing WIP 40% complete, they would be equivalent to
40 finished units.
Total input costs – Normal loss scrap value
Cost per equivalent unit of process outputs =
Equivalent number of completed output
LECTURE EXAMPLE 4: CLOSING WIP AND EQUIVALENT UNITS
NLB Co runs a business where the first process account is as follows:
Process 1 Account
Units $ Units $
Direct labour 7,100 Transfer to Department 2 800
Departmental overheads 7,100 Closing WIP 200
1,000 24,080 1,000 24,080
The closing WIP is 30% complete.

What is the cost per unit and the value of completed units and closing WIP?

lOMoARcPSD|15213202
SOLUTION
Sometimes the closing WIP will be completed to different degrees e.g. all of the raw materials may
have been put in but only half of the labour. In these situations the cost per equivalent needs to be
calculated separately for each cost component.
The steps to follow when completing the process account here are as follows:
STEPS
Step 1: Fill in the process account as much as you can first (likely to be missing monetary values
for output and WIP.
Step 2: Complete a working for the equivalent units and cost per equivalent unit.
Step 3: Do a working for the valuation of output and closing WIP (these figures should allow
the process account to be balanced off).
Step 4: Complete the process account.
ILLUSTRATION: CLOSING WIP (DIFFERENT DEGREES OF COMPLETION)
GLB Co is a firm where the first process account is as follows:
Process 1 Account
Units $ Units $
Direct labour 19,152 Transfer to Department 2
Departmental overheads 6,312 Closing WIP
3,000 51,684 3,000 51,684
Normal losses are 10% of input and have a scrap value of $1 per unit. There are 100 units of closing
WIP which are completed as follows:
Raw materials 100% complete
Direct labour 60% complete
Departmental overheads 30% complete
Complete the Process 1 Account.

lOMoARcPSD|15213202
SOLUTION
Departmental
Total Raw materials Direct labour overheads
Costs:
Inputs 51,684 26,220 19,152 6,312
Normal losses (300) (300)
Total 51,384 25,920 19,152 6,312
Equivalent units:
Normal loss 300 Nil nil nil
Transfer to Process 2 2,600 2,600 2,600 2,600
Closing WIP 100 100 60 30
Total 3,000 2,700 2,660. 2,630
Cost per equivalent unit $9.60 $7.20 $2.40
Valuations:
Transfers to Process 2 = 2,600 units × ($9.60 + $7.20 + $2.40) = $49,920
Closing WIP = (100 units × $9.60) + (60 units × $7.20) + (30 units × $2.40) = $1,464
Process 1 Account
Units $ Units $
Raw materials 3,000 26,220 300 300
Direct labour 19,152 Transfer to Department 2 2,600 49,920
Departmental overheads 6,312 Closing WIP 100 1,464
3,000 51,684 3,000 51,684
1.3.4 Weighted average and FIFO methods

If there is closing WIP in one period, then there will be opening WIP in the next period. This will impact
upon the valuations in the following period. We need to use one of two possible methods to account
for WIP.
Weighted average method

We assume that the opening WIP is mixed in with all other production e.g. chemical production. The
opening WIP costs and units are included in this period’s costs and units of production.
FIFO method
We assume that the opening WIP are completed first in the following period before any new units are
started e.g. paint production. With this method the cost of finishing the opening WIP is added to the
opening value. All of this is then added to those units started and finished in the period, in order to
arrive at the value of those units transferred out.

lOMoARcPSD|15213202
LECTURE EXAMPLE 5: FIFO AND WEIGHTED AVERAGE

Bubbles Co produces washing up liquid using a number of processes.
At the start of the period the first process had opening WIP of 800 units, these had all of the required
materials valued at $40,000 and 25% of the conversion (labour and overheads) costs valued at $7,450.
During the period 3,400 units were transferred to process 2 and there were no process losses.
$200,000 had been spent on materials and $172,000 on conversion.
At the end of the period the closing WIP was 600 units, all of the required materials and 50% of the
conversion work had been undertaken.
What is the value of the units transferred out and the closing WIP using the weighted average and
FIFO methods?
SOLUTION
WEIGHTED AVERAGE METHOD
PROCESS A/C
Units $ Units $
Opening WIP
Raw materials Transfer to Process 2
Conversion Closing WIP
Statement of equivalent units

Total Raw materials Conversion
$ $ $
Costs:
Opening WIP
Inputs
Total
Equivalent units:
Transfer to Process 2
Closing WIP
Total
Cost per equivalent unit
Valuation:
Transfers to Process 2 =
Closing WIP =
FIFO METHOD
PROCESS A/C
Units $ Units $
Opening WIP
Raw materials Transfer to Process 2
Conversion Closing WIP

lOMoARcPSD|15213202

Costs:
Inputs
Total
Equivalent units:
Finishing Opening WIP
Started & Finished
Closing WIP
Total
Cost per equivalent unit
Valuation:
Transfers to Process 2:
Opening WIP =
Started & Finished =
Total
Closing WIP =
1.4 By-products and joint products

Some processes produce more than one product e.g. the refining of crude oil, animal farming.
If one of these products has relatively little economic value it is known as a by-product e.g. saw dust
when a tree trunk is cut into planks of wood.
If the products have reasonably similar economic value then they are known as joint products e.g.
different cuts of meat when an animal is butchered.
1.4.1 Valuation of by-products and joint products

By-products are treated in the same way as normal losses and so are valued either at nil or their scrap
value.
 If by-products occur regularly then deduct the income from process costs in the process account
(i.e. as above)
 If they are a one off occurrence then the proceeds should be credited to the income statement
directly (i.e. will not appear in the process account at all).
Joint products are treated in the same way as good production in Process costing. However the costs
need to be split between the different joint products.
There is no one correct way of splitting the cost. However the joint costs are commonly shared
between the different products using one of the following bases:
 Physical quantities
 Ultimate sales value
 Sales value at the split-off point

lOMoARcPSD|15213202
1.4.2 Accounting for by-products and joint products
LECTURE EXAMPLE 6: JOINT AND BY PRODUCTS
Several Co buys 10,000 units of material and produces two joint products, A and B from a combined
process. The joint costs are as follows:
$
Direct material cost 10,000
Direct labour cost 5,000
Overheads 3,000
Total cost 18,000
The process produces 2,000 units of A which can be sold for $5 per unit and 8,000 units of B which can
be sold for $2.50 per unit.
What is the cost of A and B apportioning the joint costs using sales value and number of units and
show the process account?
SOLUTION

lOMoARcPSD|15213202
81
10
Other costing techniques
1 Job and batch costing

1.1 Characteristics of job and batch costing
KEY TERMS
 A job is a cost unit which consists of a single order or contract.
 A batch is a group of identical units produced together and are thus treated as a single
cost unit.
Job and batch costing identifies the costs separately for each cost unit. Different jobs or batches will
require different amounts of materials, labour and expenses. Thus the costs are calculated individually
for each job or batch.
1.2 Accounting for jobs and batches
LECTURE EXAMPLE 1: JOB COSTING ACCOUNTING ENTRIES
JC Co uses job costing. On 1 December, there was one uncompleted job in the factory. The job card for
this work is summarised as follows.
Job Card, Job No 123
Costs to date: $
Direct materials 630
Direct labour (120 hours) 600
Factory overhead ($2 per direct labour hour) 240
Factory cost to date 1,470

lOMoARcPSD|15213202
82 10: O t h e r c o s t i ng t e c hn i q u e s A C C A MA
During December two new jobs were started in the factory, and costs of production were as follows:
Direct materials $
Issued to: Job 123 2,390
Job 124 1,680
Job 125 3,950
Material transfers $
Job 125 to Job 124 250
Job 123 to Job 125 620
Materials returned to store $

From Job 123 870
Direct labour hours recorded

Job 123 430 hrs
Job 124 650 hrs
Job 125 280 hrs
The cost of labour hours during December was $5 per hour, and production overhead is absorbed at
the rate of $2 per direct labour hour. Jobs are delivered to customers as soon as they are completed,
and all three jobs were completed by the end of December.
Administration and marketing overheads are added to the cost of sales at the rate of 20% of factory cost.
Prepare the job accounts for each individual job and prepare the summarised job cost cards for each
job.
SOLUTION
Job accounts
JOB 123
$ $
JOB 124
$ $

lOMoARcPSD|15213202
A C C A MA 10: O t h e r c o s t i ng t e c hn i q u e s 83
JOB 125
$ $
Job cards, summarised
JOB 123 JOB 124 JOB 125

$ $ $
Materials
Labour
Production overhead
Factory cost
Admin & marketing o’hd (20%)
1.3 Establishing job and batch costs
ILLUSTRATION: JOB COSTS
P&P Co is a printing and publishing company that has just completed the production of 100,000
catalogues, of 64 pages (32 sheets of paper) each, for a customer.
Four operations are involved in the production process: photography, set-up, printing and binding.
Each page of the catalogue required a separate photographic session. Each session costs $150.
Set-up required a plate to be made for each page of the catalogue. Each plate required four hours of
labour at $7 per hour and $35 of materials. Overheads are absorbed on the basis of labour hours at an
hourly rate of $9.50.
In printing, paper costs $12 per thousand sheets. Other printing materials cost $7 per 500 catalogues.
1,000 catalogues are printed per hour of machine time. Labour and overhead costs incurred in
printing are absorbed at a rate of $62 per machine hour.
Binding costs are recovered at a rate per machine hour. The rate is $43 per hour and 2,500 catalogues
are bound per hour of machine time.
What was the cost of this job?

lOMoARcPSD|15213202
SOLUTION
$ $
Photography: 64 pages at $150 per page 9,600
Set-up
Labour:
64 plates × 4 hours per plate at $7.00 per hour 1,792
Materials:
64 plates at $35 per plate 2,240
Overhead:
64 plates × 4 hours at $9.50 per hour 2,432
6,464
Printing
Paper:
$12 38,400
100,000 catalogues × 32 sheets × 1,000
Other materials:
100,000
× $7 1,400
500
Labour and overheads:
100,000
machine hours at $62 per hour 6,200
1,000
46,000
Binding
Labour and overheads:
100,000
machine hours at $43 per hour 1,720
2,500
Total costs 63,784
2 Service and operation costing

2.1 Use of service and operation costing
Service/operation costing is used where the organisation/department is providing a service rather
than a tangible product e.g. rail companies or accountancy firms.
As with product costing, the most appropriate cost unit will vary from situation to situation. However
commonly used unit cost measures are:
 Time – for professional services
 Passenger miles – for transport services
 Bed days – for private hospitals and hotels
2.2 Analysis of service costs
ILLUSTRATION: SERVICE COSTING
Bus Service Co runs three different bus routes. Cost details are as follows:
Route
1 2 3
Number of vehicles 7 12 10
Total vehicle usage 8,000km 8,000km 8,500km
Variable operating costs (per kilometre) $0.60 $0.60 $0.56
Fixed route costs $50,400 $81,600 $68,000

lOMoARcPSD|15213202
In addition to the above, overheads are incurred and are absorbed into the cost of journeys at a
predetermined rate per kilometre. The predetermined rate for the period was based upon:
Budgeted overheads $331,800
Budgeted vehicle usage 237,000 kilometres
What is the cost per kilometre of each route?
SOLUTION
$50,400
Fixed route cost for route 1 = (7×8,000 km)
= $0.90 per kilometre
$81,600
Fixed route cost for route 2 = = $0.85 per kilometre
(12×8,000 km)
$68,000
Fixed route cost for route 3 = = $0.80 per kilometre
(10×8,500 km)
$331,800
Overhead absorption rate = 237,000 km
= $1.40 per kilometre
Route
1 2 3
$ $ $
Variable operating costs 0.60 0.60 0.56
Fixed route costs 0.90 0.85 0.80
Overheads 1.40 1.40 1.40
Total service costs per kilometre $2.90 $2.85 $2.76
3 Alternative cost accounting approaches

3.1 Traditional approach to costing
3.1.1 General recording of costs
Historically costs have been categorised by their nature, for example:
 Research & Development
 Production
 Selling
 Distribution
 Admin, Finance etc.
These have then been recorded in the accounts in the period to which they relate.
The traditional approach works well for businesses if they need to focus on high volume production
and lowering unit production costs.
3.1.2 Treatment of overheads (indirect costs) in product costing

In a traditional costing environment it is assumed that production overheads are driven by the volume
of production. Hence when absorbing overheads into the. units of the product you are making it is
common to use OARs based on ‘units of production’, ‘labour hours’ or ‘machine hours’.
This approach suits a high volume, repetitive, production process where the focus is on production of
units at low unit cost and where stockpiling is not considered a particular problem (i.e. making items
when there is no current demand is not a problem because somebody will come and buy your
products at some point).

lOMoARcPSD|15213202
3.1.3 Use of costs as a basis for setting selling prices

A traditional approach to pricing might add up all the costs of manufacturing the items (including the
absorbed overheads) and then add on a mark up in order to arrive at an acceptable selling price.
3.1.4 Pressures for change

Certain characteristics of the environment within which many businesses now operate mean new
approaches may be more relevant:
 More global competition and consumer choice
 Shorter product lives
 Inventory becoming obsolete more quickly
 Quality becoming a more critical factor
 Greater availability of information and increased speed at which it can be processed
As a reaction to this a number of techniques have developed that some businesses find help them
become more profitable and efficient.
3.2 Life cycle costing

With the shortening of product life cycles and the ever increasing need to earn profits with limited
resources, understanding the overall profitability of products over their lifetime becomes crucial.
Under the traditional classification all R&D costs incurred this year would be charged against this
year’s profits, even though the products that they relate to have not yet started generating revenue.
Life cycle costing aims to address this issue by monitoring/recording costs by product over the
different phases of the product’s life rather than on an accounting period basis. As a result the total
profitability of a product in its life can be identified.
The product life cycle considers that products go through four main phases of their life as described below.
Intro Growth Maturity Decline
Sales
Time
3.2.1 Introduction
The launch of a new product will generally have little initial demand. Marketing will be aimed at
informing customers as to the existence of the product and its benefits.
3.2.2 Growth
Competition between rival companies increases as demand grows. Products will develop, in terms of
new features. Prices will tend to fall and brand loyalty may develop.

lOMoARcPSD|15213202
3.2.3 Maturity
The longest stage in the life cycle of the most successful products. Demand reaches its limit and the
organisation must manipulate the marketing mix in order to sustain its position.
3.2.4 Decline
Demand falls as the existence of substitute products and changing tastes means that the product
either becomes a niche product or becomes obsolete
3.2.5 Uses of life cycle costing

 Provides better information as to the success of new product development. This may be
particularly important in an environment where product turnover happens fast and new
products are continually being developed.
 Gives focus on where the majority of costs are incurred in relation to a product (e.g. design and
development) and hence provides a clearer basis for cost reduction schemes.
 May focus attention on trying to extend the life cycle of a product overall whilst showing the
clear importance of a short lead time between R&D spend (no revenue being earned) and the
launch date (revenue starts to be earned).
 When forecasting costs and revenues consideration will need to be given to the stage of the life
cycle. You would expect to forecast decent growth in sales volume when a product is at the
growth stage. You will have smaller growth expectations as the product goes through to
maturity. Eventually in decline the forecast will be for falling sales.
3.2.6 Limitations of life cycle costing

 Requires more detailed analysis of costs and therefore may be time consuming/costly to
produce.
 Will not provide sufficient information for Financial Reporting purposes
3.3 Activity based costing

Commonly now products are produced in shorter production runs, to cater for the need to produce a
diverse range of products to keep customers happy. There is also more focus on things like quality
support costs (quality control checks) and indirect costs make up a larger proportion of costs than they
used to do.
Activity based costing (ABC) seeks to give a better allocation of these indirect costs by trying to
understand what truly causes these indirect costs to go up and down. It assumes that not all indirect
costs will nowadays be linked to volume of production.
ABC establishes a hierarchy of activities to help understand the ‘drivers’ of overhead costs, this
hierarchy comprises:
 Unit based – traditional drivers linked to the volume of units such as ‘units’, ‘labour hours’,
‘machine hours’.
 Batch related – typically linked to the number of batches of product produced and will include
such drivers as ‘no of production runs’, ‘quality control’ etc.
 Product sustaining – expenditure such as advertising, marketing, design that may be linked to
drivers like ‘no of product lines’.
 Facility sustaining – many of the typical head office fixed costs like rent, rates, cleaning etc.
that ABC may conclude either should be absorbed based on traditional drivers or left out of the
detailed overhead analysis and just treated as lump sum period costs.

lOMoARcPSD|15213202
3.4 Target costing

Target costing seeks to derive an acceptable level of costs, based on a selling price that has been
researched in the external market.
Target costing begins by specifying a product an organisation wishes to sell. This will involve extensive
customer analysis. The price at which the product can be sold at is then considered. This will take into
account competitor products and the expected market conditions.
From the selling price a desired margin is deducted. This leaves the cost target. An organisation will
need to meet this target if its desired margin is to be met. If it appears that this cost cannot be
achieved then the difference (shortfall) is called a cost gap.
ILLUSTRATION: TARGET COSTING
If a company has established a selling price for a new product of $200 based on desired market share
and the board of directors demands a profit margin of 20% then the target profit must be $40 (20% ×
$200). The target cost can be identified as $160 ($200 ─ $40).
The Production Manager looks at the product specification and considering the materials, labour and
overheads going into the product are likely to be $65, $90 and $20 respectively then the estimated
cost will be $175, thus creating a cost gap of $15.
A company that is using target costing should be continually looking for cost reduction since
competition is likely to put downward pressure on prices as the product goes through its life. This
contrasts with traditional approaches to costing that focus more on cost control rather than cost
reduction.
3.4.1 Use of target costing

Target costing is better suited to products at an early stage of their development or where there is
continual scope to reduce costs and/or change work practices. It will be less suited to service based
businesses or where the production process has been committed to for the long term and is not
therefore as flexible.
3.5 Total quality management (TQM)

TQM refers to an overall philosophy within organisations of ‘getting it right first time’ and ‘continuous
improvement’. It means everyone throughout the organisation striving for excellence in all products,
systems and procedures so that ultimately the customer benefits from ever improving
products/services.

lOMoARcPSD|15213202
89
11
Nature and purpose of

budgeting
1 Nature and purpose of budgeting

KEY TERM
A budget is a financial and/or quantitative plan of what an organisation intends to achieve
for a forthcoming period.
1.1 Benefits of budgeting

Budgeting brings a number of benefits:
 Control – a budget helps to control the organisation by forcing a plan to be produced
 Responsibility – a budget will identify who is responsible for what
 Integration – a budget will ensure the activities of the different parts of the organisation are
integrated together and resources are allocated appropriately
 Motivation – a budget will help to motivate staff within the organisation
 Evaluation – a budget will allow evaluation of the actual results

lOMoARcPSD|15213202
90 11: N at u re an d p u rp o s e o f bu d g e ti n g A C C A MA
1.2 Budgeting and the planning and control cycle

One significant benefit of producing budgets is that they form a basis for monitoring actual
performance and hence provide a framework through which control action can be taken.
Budget is prepared Variance analysis performed by

based on defined comparing actual results to the
corporate objectives budget (budget data may need to be
flexible and account taken of
whether or not items were
controllable or uncontrollable).
Actual results are It may also be necessary to revise
established during the the budget so that operational
budget period variances can be distinguished from
planning variances.
Action is taken This could be based on feedback

following the variance control (learn from what’s already
investigation happened) or feedforward control
(action taken to address an issue
before it has happened).
New/revised objectives
are set
1.3 Administrative procedures

 Establish the budget period
 Issue the budget manual, which lists the stages in the budgeting process
 Appoint the Budget Committee, which coordinates the process
 Identify the Budget Coordinator, who is usually an accountant, to head up the process
1.4 Budgeting process

1.4.1 Top-down budgeting
The top-down (Imposed) approach is where the budget is set by starting with the overall corporate
objectives set by the senior management and then working down through the organisation, setting
appropriate targets to ensure the higher objectives are achieved.
This can work well in small, young businesses or where there are not the skills lower down the
organisation. Also, if trying to stick to a tight budget (e.g. during economic recession) this approach
can be quite effective.
Top-down process
(1) Establish overall targets (senior management of the organisation)
(2) Identify principal budget factor
(3) Set other operational and capital budgets
(4) Review of budgets by the relevant departments to ensure they can be achieved and revise
original budget if required
(5) Review of revised budgets by senior management and either accept them or revise them
further and go back to step (4)
(6) Accept budgets, which become targets

lOMoARcPSD|15213202
A C C A MA 11: N a t u re a n d p u rp o s e o f bu d g e ti n g 91
Advantages of top-down budgeting

 Can be quicker to produce
 More consistency of plans across all departments (goal congruence)
 Greater awareness of overall resources available
Disadvantages of top-down budgeting
 Lack of participation may demotivate lower level staff
 Targets may not be as realistic at a local level
1.4.2 Bottom-up budgeting

The bottom-up (participative) approach is the reverse of top-down. The budget is set by starting with
the individual personal and departmental objectives set by the local management and then working up
through the different levels of the organisation, setting appropriate targets to ensure the lower
objectives are achieved.
Bottom-up process
(1) Identify what each department thinks it can achieve
(2) Identify principal budget factors
(3) Set other operational and capital budgets
(4) Review of budgets by senior management and either accept them, or revise them further and
send them back to departments
(5) Review of revised budgets by departments and either accept them, or revise them further and
go back to step (4)
(6) Accept budgets, which become targets
Advantages of bottom-up budgeting

 Better local knowledge may result in more accurate budgets
 Improved motivation due to participation
 Better discussion between different departments as the budgets are taken up the organisation
Disadvantages of bottom-up budgeting

 Time consuming process
 Increased likelihood of budgetary slack
 Potential lack of goal congruence if individual budgets considered in isolation
2 Budgetary control and reporting

2.1 Variances
KEY TERM
A variance is the difference between a budget figure and an actual figure for revenue or
costs.
In order to control performance in an organisation it is useful to compare actual results with a budget.
A fixed budget which is based on original budgeted volumes of sales/production can be used. However
this may not mean comparisons are made on a like for like basis, unless actual volumes are the same
as budgeted volumes.
A flexible budget will probably be used therefore, as this is a budget that has been adjusted to reflect
the actual volume of sales/production. When preparing a flexible budget, remember that fixed costs
do not need to be flexed as they are unaffected by changes in volume.

lOMoARcPSD|15213202
ILLUSTRATION: BASIC VARIANCE ANALYSIS
The standard cost of making a tennis racket is shown below:

Standard cost for a tennis racket $
Direct materials (0.3kg @ $30 per kg) 9.00
Direct labour (2hrs @ $12 per hr) 24.00
Variable production overhead (2hrs @ $4 per hr) 8.00
Variable (marginal) production cost 41.00
Contribution per unit 9.00
Selling Price 50.00
The following information relates to the production and sales for month 2.
Budget
Sales/production volume 15,000 rackets
Actual
Materials cost $165,000 for 5,600 kg
Labour cost $405,000 for 33,000 hours
Variable overhead $135,000
Revenue $885,000
Required
Calculate variances for month 2.
SOLUTION
Original fixed budget v actual results
Original Actual
budget results Variance
Sales volume (units) 15,000 18,000
$ $
Revenue 750,000 885,000 $135,000 (F)
Less costs:
Materials 135,000 165,000 $30,000 (A)
Labour 360,000 405,000 $45,000 (A)
Variable O/H 120,000 135,000 $15,000 (A)
Contribution 135,000 180,000 $45,000 (F)
The above variance analysis is meaningless since actual sales were 18,000 units and consequently you
would expect revenue and costs to be higher than in the original budget based on 15,000 units.

lOMoARcPSD|15213202
Flexible budget v actual results

Original Flexible Actual
budget budget results Variance
Sales volume (units) 15,000 18,000 18,000
$ $ $
Revenue 750,000 900,000 885,000 $15,000 (A)
Less costs:
Materials 135,000 162,000 165,000 $3,000 (A)
Labour 360,000 432,000 405,000 $27,000 (F)
Variable O/H 120,000 144,000 135,000 $9,000 (F)
Contribution 135,000 162,000 180,000 $18,000 (F)
This revised analysis gives us a better basis for comparing the performance of the organisation. Overall
it can be seen that contribution and hence profit is better than expected primarily due to the labour
and variable overhead costs being much lower than expected. Reasons for this would need to be
investigated.
2.2 Responsibility accounting

A common business structure is where the business is split into divisions or functions (responsibility
centres). The basis of the divisionalisation will usually be product or service driven.
Responsibility accounting describes the system that is set up to assess the performance of business
units/divisions.
Managers of a division will therefore tend to have responsibility for all the functions within that
division. In that respect they are often running a complete business within a larger organisation. Care
is needed to ensure that divisional managers are motivated to make decisions that are best for the
organisation as a whole and not just their part of the business.
2.3 Controllable and uncontrollable costs

KEY TERM
A controllable cost is a ‘cost which can be controlled, typically by a cost, profit or investment
centre manager’.
In a proper system of responsibility accounting budget holders must only be appraised against items of
cost/revenue that they have control over. It is not always easy to identify what is really controllable by
one person.
Items that are uncontrollable in the short term may be controllable in the longer term. For example,
rent costs may be unable to be changed in the short term (lease agreements etc.). In the longer term
more or less space could be negotiated.
A cost that is not controllable by one person may be controllable by another person:
 In another department – you’ve incurred a higher labour cost as you’ve been given inferior
materials to work with, so longer hours were needed. The purchasing manager could have
controlled this by buying better quality material.
 More senior manager – you may have departmental responsibility for operational costs and
revenues, but any capital expenditure decisions are agreed at board level.
Some uncontrollable costs may get allocated to a particular budget holder even though he has no
direct control over them. He may be in a position to influence those costs even if he doesn’t control
them.

lOMoARcPSD|15213202
2.4 Control report

A typical control report for a profit centre would include the following type of numerical comparisons:
Performance report Original
budget Flexible Actual
(fixed) budget costs Variance
Sales/production volumes 10,000 12,000 12,000
Revenue
Internal 150,000 180,000 165,000 15,000 (A)
External 250,000 300,000 320,000 20,000 (F)
400,000 480,000 485,000
Less: Controllable/directly
attributable variable costs
Material 50,000 60,000 64,000 4,000 (A)
Labour 60,000 72,000 69,000 3,000 (F)
Variable overhead 20,000 24,000 22,000 2,000 (F)
Controllable contribution 270,000 324,000 330,000 6,000 (F)
Less: Controllable/directly
attributable fixed costs
Supervisor’s salary 30,000 30,000 34,000 4,000 (A)
Controllable profit 240,000 294,000 296,000 2,000 (F)
Less: Attributable but not
controllable costs
Depreciation of divisional equipment 50,000 50,000 52,000 2,000 (A)
Less: Non attributable and non-
controllable costs
Head office central recharge 30,000 30,000 35,000 5,000 (A)
Divisional net profit 160,000 214,000 209,000 5,000 (A)
A proper report would then contain some recommendations as to what action should now be taken by
the manager of the responsibility centre.
With the above statement for example there may be advice to search around for alternative suppliers
of material since the material costs are showing an adverse variance.
3 Behavioural aspects of budgeting

3.1 Motivation
Motivation is what drives the actions of people. Therefore a motivated workforce are likely to be
acting/behaving in a way that helps the organisation achieve its goals, while at the same time
achieving personal goals of the individuals. This is known as “goal congruent” behaviour.
The main influences on motivation in a planning and control system are:
 Participation – If employees are involved in the budget setting process (bottom-up) they are
much more likely to be motivated to achieve the budgets/targets set.
 Achievability – If targets are set that are either too easy or too difficult, then this is likely to
adversely affect motivation. If they are too easy staff will drift along knowing that they will hit
target without much effort whereas if they are too hard staff will not try knowing that they will
not be able to achieve them.
 Controllability – Staff will be more motivated if their performance is only assessed against
targets that are within their control.

lOMoARcPSD|15213202
3.2 Incentive schemes

If salary or bonus is linked to “beating the budget” then there may be the tendency for the following
behaviour to occur:
 Managers might try to overinflate the budgeted costs so that when they actually end up
spending less than budget they get rewarded for it. This is known as budgetary slack.
 Managers in charge of sales budgets may underestimate the level of sales they think they can
achieve, thus making it easier for them to hit their sales targets and receive bonuses.
 As a result the reward system may encourage individuals to behave in the best interests of
themselves and not the organisation as a whole (dysfunctional behaviour).
3.3 Rewarding short-term and long-term performance

Staff are often rewarded for their contribution to the short term performance of the business, since
this is often the basis on which external investors judge a business.
A conflict can arise if achieving short term goals adversely affects long term performance. For example,
a manager may keep costs under budget for the year because he has cut staff training. He may be
rewarded for boosting current year profits. However over the longer term staff’s ability to perform
their work may suffer, affecting profits adversely.
Businesses must thus set a combination of short and long term targets for managers and staff that are
consistent with the overall strategic objectives of the organisation.
4 Flexible budgets
Performance management involves assessing the current actual performance. Looking at the current
actual performance in isolation is meaningless.
In order to get a good comparison for the actual performance it is sensible to produce a flexible
(flexed) budget that shows what the original budget would have looked like if it had been based on
the actual volume of production and sales. You then have a better like for like comparison and hence
performance assessment.
LECTURE EXAMPLE 1: FLEXIBLE BUDGET

Z Co is a family owned manufacturing company which has been run for 40 years by Dan Controle.
He believes in strict cost control and sets tough targets for his management team. Staff turnover is
very high and the company is struggling to compete against rival businesses.
The budgeted and actual results of Z Co for September were as follows. The company uses a marginal
costing system. There was no opening or closing inventories.
Fixed budget Actual
Sales and production 1,000 units 700 units
$ $ $ $
Sales 30,000 21,200
Variable cost of sales
Direct materials 10,000 6,600
Direct labour 5,000 3,800
Variable overhead 3,000 2,200
18,000 12,600
Contribution 12,000 8,600
Fixed costs 10,000 10,400
Profit/(loss) 2,000 (1,800)
Required
Prepare a budget that will be useful for management control purposes.

lOMoARcPSD|15213202
SOLUTION

lOMoARcPSD|15213202
97
12
Budget preparation
1 Budget preparation
1.1 Principal budget factor
The principal budget factor is the factor which limits what an organisation can achieve. Invariably this
will be sales. Once this budget is set the other budgets can then be calculated (once you know the
sales budget, you can work out the production budget and other resource budgets such as the labour
and materials budgets etc.).
1.2 Sales and functional budgets
LECTURE EXAMPLE 1: SALES AND FUNCTIONAL BUDGETS
Plan Co produces two products, the Good and the Bad. Data for these products is as follows:
Good Bad
Materials per unit 12kg 14kg
Labour per unit 1hr 2hrs
Maximum demand 4,300 units 3,600 units
Selling price per unit $15 $20
Inventory of finished goods:
Opening 200 100
Closing 50 nil
Plan also had 2,900 kg of materials at the start of the period and 800kg at the end of the period.
Total overheads are $17,840 and are absorbed on a labour hours basis.
Prepare budgets for sales, production, materials (usage and purchases), labour and overheads.

lOMoARcPSD|15213202
98 12: B u d g e t p re p arat i o n A C C A MA
SOLUTION

lOMoARcPSD|15213202
A C C A MA 12: B u d g e t p re p arat i o n 99
1.3 Cash budgets

A company must keep watch on its cash balances, since a lack of cash is the most common cause of
business failure. One of the most effective tools to assist in the cash management process is the
regular production of cash budgets.
KEY TERM
A cash budget is a ‘detailed budget of estimated cash inflows and outflows incorporating
both revenue and capital items’.
1.3.1 Format of cash budget

Jan Feb Mar
$ $ $
Cash receipts
Receipts from customers (W1) X X X
Proceeds from sale of assets X
Cash introduced into business X
Total cash receipts X X X
Cash Payments
Payments to suppliers X X X
Payments to employees (wages etc.) X X X
Purchase of non-current assets X
Overheads X X X
Repayment of finance X
Total cash payments X X X
Net receipts/(payments) X (X) X
Opening balance X X X
Closing balance X X X
1.3.2 Cash management

By preparing a cash budget that looks forward in time, the business will be in a position to identify
periods during which it may face either a cash shortage or a cash surplus. Action can then be taken, in
advance, to manage those periods, as follows:
Shortage
 Organise an overdraft
 Offer customer a discount to pay early
 Delay paying suppliers
 Raise other finance
Surplus
 Offer more generous terms to your customers
 Arrange to pay off some finance (e.g. loans)
 Organise to put surplus on deposit on the money markets etc.

lOMoARcPSD|15213202
LECTURE EXAMPLE 2: CASH BUDGETS 1

Jones Co started in business on 1 Jan 20X8. The following information is relevant for the first three
months of trading:
 In January $350,000 share capital was raised.
 Non-current assets were purchased for $100,000 in January. The assets are expected to last for
10 years with a zero resale value. The company has a policy of depreciating assets on a straight-
line basis.
 Sales are expected to be $80,000 in January, growing thereafter at 25% per month. Jones Co has
decided to allow its customers to take three months’ credit.
 Purchases are expected to be $50,000 in January, with 20% growth per month thereafter.
Suppliers are only prepared to initially offer Jones Co one month’s credit.
 Other costs of $20,000 are expected to be incurred on a monthly basis.
Required
Prepare a cash budget for Jones Co on a monthly basis for Jan-Apr 20X8.
SOLUTION
Jones Co – Cash budget for the four months Jan-Apr 20X8
Jan Feb Mar Apr
$ $ $ $
Cash receipts
From customers (receivables)
Share capital introduced
Total receipts
Cash payments
To suppliers (payables)
Other
Non-current assets
Total payments
Net cash flow

Opening balance
Closing balance

lOMoARcPSD|15213202
LECTURE EXAMPLE 3: CASH BUDGETS 2

The following sales are anticipated by Bloggs Co over the next six months.
Month 1 $100,000
Month 2 $110,000
Month 3 $120,000
Month 4 $130,000
Month 5 $140,000
Month 6 $150,000
 60% of sales are paid for by customers up front with cash at their face value (that is a customer
pays $1 for each $1 they have been charged).
 40% of sales are made on credit to customers who generally pay three months after being
invoiced.
In order to improve cash flow, Bloggs Co has proposed offering credit customers a 10% discount if they
pay one month after sale rather than three months.
Calculate the monthly receipts from customers for the next six months if 30% of credit customers take
up the company’s offer.
Month Month Month Month Month Month
1 2 3 4 5 6
Sales (for reference only) 100,000 110,000 120,000 130,000 140,000 150,000
Cash sales (60%)
Credit sales – 1 month
Credit sales – 3 months
Cash receipts
1.4 Master budgets

A business is likely to want to produce a summary budget of its statement of profit or loss and
statement of financial position, as this will be of particular interest to the senior managers and board
of directors.
These summary budgets are collectively referred to as the master budget. Preparation of these
budgets will be done using information from the other sales and functional budgets.

lOMoARcPSD|15213202
LECTURE EXAMPLE 4: MASTER BUDGETS
Jo Ker started up in business on 1 January 20X6 with an initial investment of $50,000 taken out of her
savings account. Jo has prepared the following forecast information for the first three months of trading:
(1) Non-current assets of $40,000 will be purchased and paid for in January 20X6. These assets are
expected to have a useful life of eight years with nil residual value.
(2) In January Jo will purchase $10,000 of inventory and will maintain this balance each month (i.e.
each month sufficient purchases will be made to replace that month’s sales).
(3) The following sales are forecast for the first three months:
 Jan 2016 $15,000
 Feb 2016 $25,000
 Mar 2016 $35,000
(4) The sales price is set to provide a margin on sales of 40%.
(5) Customers will be allowed one month’s credit. However, Jo is expecting to have to pay for
purchases from suppliers by cash on order.
(6) Other business expenses are likely to be $3,000 per month. This excludes depreciation.
(7) Jo intends to take out $2,000 each month as cash drawings.
(8) The cash forecast that Jo has already produced shows a closing cash balance at the end of the
first three months of $20,000 overdrawn.
Required
Prepare a budgeted statement of profit or loss and statement of financial position for the three
months to 31 March 20X6.
SOLUTION
Budgeted statement of profit or loss for the three months ended 31 March 20X6
$ $
Sales
Cost of sales
Gross profit
Expenses
General business expenses
Depreciation
Net profit

lOMoARcPSD|15213202
Budgeted statement of financial position at 31 March 20X6
ASSETS $ $
Non-current assets
Current assets
Inventories
Receivables
EQUITY AND LIABILITIES

Proprietor’s interest
Capital introduced
Profit for period
Less drawings
Current liabilities
Bank overdraft
1.5 ‘What if’ analysis and scenario planning

Once a budget has been produced then the users may wish to see what the impact is on the budgeted
figures if one or more of the variables in the budget is changed. This is made much easier if software
such as a spreadsheet is used to prepare the information. Consider the cash budget example from
earlier.
Jan Feb Mar Apr
$ $ $ $
Cash receipts Jan sales not received
From customers (receivables) 80,000 until April after three
Share capital introduced 350,000 months credit is taken.
Total receipts 350,000 0 0 80,000
Cash payments Just 1 month delay

To suppliers (payables) 50,000 60,000 72,000 between making the
Other 20,000 20,000 20,000 20,000 purchase and paying in
Non-current assets 100,000 cash.
Total payments 120,000 70,000 80,000 92,000

Net cash flow 230,000 (70,000) (80,000) (12,000)
Opening balance 0 230,000 160,000 80,000
Closing balance 230,000 160,000 80,000 68,000
You may remember that this budget assumed that Jones was going to offer customers three months’
credit, so the first cash in from customers was not going to arrive until April ($80,000).

lOMoARcPSD|15213202
If we consider a scenario where Jones only offers customers two months’ credit the cash budget would
be as follows (assuming only sales figures are affected).
Jan Feb Mar Apr
$ $ $ $
Jan sales not received
Cash receipts until March, April being
From customers (receivables) 80,000 100,000 25% larger as per
Share capital introduced 350,000 information in the
original example.
Total receipts 350,000 0 80,000 100,000
Cash payments
To suppliers (payables) 50,000 60,000 72,000
Other 20,000 20,000 20,000 20,000
Non-current assets 100,000
Total payments 120,000 70,000 80,000 92,000
Net cash flow 230,000 (70,000) 0 8,000
Opening balance 0 230,000 160,000 160,000
Closing balance 230,000 160,000 160,000 168,000
We can clearly see that the impact of this change is to increase the closing bank balance for March by
$80,000 and for April by $100,000 as we benefit from getting cash in from customers one month
earlier.
This sort of “what if” analysis and scenario planning allows managers to assess the impact of changing
certain key variables given that in reality many of the figures will not be known with a great deal of
certainty.
2 Capital budgeting
KEY TERMS
 Capital expenditure represents spending on acquiring non-current assets or improving
the earning capacity of any existing non-current assets. Typically things such as land and
buildings, machinery, computer equipment and vehicles would be good examples of
non-current assets.
Capital expenditure results in assets being shown on the statement of financial position
and depreciated over a period of time.
 Revenue expenditure is spending on maintaining the existing earning capacity of non-
current assets (for example repairs of a piece of capital equipment) or other
expenditure such as administration costs, finance costs and selling costs.
Capital spending by a business will often amount to a considerable amount of investment. It will
require careful planning before any final decision is made. Once a commitment is made, then the
business needs to closely monitor the spending to ensure that it does not fall outside the pre-agreed
levels.
2.1 Capital expenditure (CAPEX) budget

The issues to consider when setting a CAPEX budget include the following.
 Size of the investment – for small scale investments spending may just be incorporated into a
general annual budget, but for larger scale investments a full detailed budget may be necessary
 Time period of the spending – budgets may need to be prepared on a monthly or annual basis
or even longer (five to ten years) for some large scale investments
 Financing availability

lOMoARcPSD|15213202
2.2 Preparation of capital expenditure budget

The capital expenditure (CAPEX) budget is part of the overall budgeting process and will directly affect
cash flow, statement of financial position and statement of profit or loss.
The steps involved in the preparation of the capital expenditure budget are as follows.
 Submission of departmental CAPEX budgets to head office
 Review of departmental budgets for reasonableness in light of the overall business needs and
finance available and rejection of unnecessary expenditure
 Preparation of formal CAPEX budget, listing things like date of acquisition, amount, depreciation
policy etc.
 Integration of CAPEX budget is then integrated into the overall master budget

lOMoARcPSD|15213202

lOMoARcPSD|15213202
107
13
Discounted cash flow
1 Discounted cash flow

1.1 Compounding
If you invest money, in the future you will get back your investment plus the interest you have earned.
This can be calculated by using the following formula:
S = X [ 1+r ]n
X S
X ( 1 + r )n
where X = initial investment

S = investment’s value at the end of n periods
n = number of periods investment is held for
r = interest rate as decimal
The above formula is based on interest being calculated on a ‘compound’ basis.
1.1.1 Simple and compound interest

Simple interest refers to the interest earned on the original investment only, so that an equal amount
of interest is earned each year.
Compound interest refers to the idea that interest is calculated and paid on the original amount
invested plus any accrued interest earned and received up to that point. This will mean that the
interest earned each year will increase.

lOMoARcPSD|15213202
108 13: Di s c o u n t e d c as h f l o w A C C A MA
LECTURE EXAMPLE 1: SIMPLE AND COMPOUND INTEREST
Johnny invests $100 now (sometimes referred to as T0) for three years.
Calculate the value of the investment if the Simple interest is 10%:
Calculate the value of the investment if the Compound interest is 10%:
Visually, this can be seen:

e.g. 10% interest
T0 T1 T2 T3 T4
$100 $110 $121 $133
Interest $10 $11 $12
Note : with compound interest, you

earn “interest on your interest”
Unless you are told otherwise, assume that any interest rates you are given in the exam are
compound interest rates. Just be careful of the wording of the question.
1.1.2 Additions/withdrawals from capital

If the amount of capital increases or decreases due to additions or withdrawals, you should break the
calculation down into segments for each addition/withdrawal.
LECTURE EXAMPLE 2: WITHDRAWAL OF CAPITAL
Nick invests $400 now with compound interest at 10% but at the end of year 4 he withdraws $200, but
keeps the rest invested for another three years.
How much is there at the end of year 7?

lOMoARcPSD|15213202
A C C A MA 13: Di s c o u n t e d c as h f l o w 109
SOLUTION
1.1.3 Compounding for periods other than a whole year

In the equation S = X[1 + 𝑟𝑟]n “n” is the number of periods the investment is held for. This “period”
may or may not be a year.
LECTURE EXAMPLE 3: COMPOUNDING EACH SIX MONTH PERIOD
$1,000 is invested for three years at a 4% six monthly interest rate.

At the end of the three years, the investment will be worth:
1.1.4 Annual percentage rates (APR)

The APR is the effective annual rate of interest for a given monthly or quarterly rate. It can be
calculated using the formula:
(1 + R) = (1 + r)n
∴ R = (1 + r)n – 1
where R = APR
r = interest rate for the period
n = number of periods in a year

lOMoARcPSD|15213202
LECTURE EXAMPLE 4: APR
Calculate the effective annual rate of interest in the Illustration above.
1.1.5 Nominal rate

Sometimes the annual rate of interest is quoted as a “nominal rate” rather than an effective rate.
For example, a credit card with a 2% monthly nominal interest rate could be quoted as having a 24%
annual rate. Similarly, a card with an annual nominal rate of 12% could be quoted as having a 1%
nominal monthly rate.
LECTURE EXAMPLE 5: NOMINAL RATE
$1,000 is invested now at nominal annual interest rate of 13%, interest compounded monthly.
At the end of the first year, the investment will have grown to:

lOMoARcPSD|15213202
1.2 Discounting
1.2.1 Discounting single sums
When appraising investments we want to know what they are worth to the organisation now, so that
we can directly compare rival potential investments.
The concept of the “time value of money” is relevant here. This simply states that cash received in the
future is not worth as much to us as the same amount of cash received today. If we know how much cash
we are going to receive in the future then we will want to estimate how much this is worth to us today
(assuming that we are making our investment decision today). This is referred to as a “present value”.
X S
÷ ( 1 + r )n
Present Value Future Value
To calculate the present value of a future value we rearrange the compounding formula:
S = X[1 + 𝑟𝑟]n
1 1
Therefore, “X”, at its present value = S × (1+𝑟𝑟)𝑛𝑛 where (1+𝑟𝑟)𝑛𝑛 is known as the ‘discount factor’
This is the version of the formula you will meet in the exam:
Discount factor = (1 + r)–n
LECTURE EXAMPLE 6: DISCOUNTING SINGLE SUMS
Money Bags is expecting to receive $16,751 in six years. Interest rates will be 5% for the whole six years.
Calculate the present value of Money Bags’ receipt:
SOLUTION
In the exam you are given the discount factors for individual cash flows for whole percentages from 1%
to 20% for periods 1 to 15.
The present value of a future sum can be determined by multiplying the figure by the relevant
discount factor:
Present value = 16,751 × 0.746 = 12,496 (i.e. the same as the $12,500 above)
LECTURE EXAMPLE 7: PRESENT VALUE
We need $10,000 at the end of two years. Assuming we could earn interest at 7% p.a., how much
should we invest now?

lOMoARcPSD|15213202
SOLUTION
LECTURE EXAMPLE 8: PV WITH CHANGE IN DISCOUNT RATES
We need $10,000 at the end of three years. We can earn interest at 7% pa for the first year and 8% for
years 2 and 3. How much should we invest now?
SOLUTION
1.2.2 Discounting annuities

Some investments generate a constant return each period – an annuity. The present value of an
annuity can be calculated as ‘annual cash flow x annuity factor’ where the annuity factor is found via
the following formula:
1 1
Annuity factor (AF) = �1 − �
𝑟𝑟 [1 + 𝑟𝑟]𝑛𝑛
This is the version of the formula you will meet in the exam:
1 − (1 + 𝑟𝑟)−𝑛𝑛
𝐴𝐴𝐴𝐴 =
𝑟𝑟
In the exam you are given the discount factors for annuity cash flows for whole percentages from 1%
to 20% for periods 1 to 15.
LECTURE EXAMPLE 9: PRESENT VALUE OF ANNUITY
Henry is going to receive $150 every year for 12 years. The annual interest rate is 6%.
The present value of Henry’s annuity is:
SOLUTION

lOMoARcPSD|15213202
1.2.3 Perpetuities
Some annuities last forever – a perpetuity. The present value of a perpetuity can be calculated as
‘annual cash flow x perpetuity factor’ where the perpetuity factor is found by using the following
formula:
1
Perpetuity factor =
𝑟𝑟
(Note: for annuities and perpetuities, it is assumed that the first payment/receipt takes place in one
year/period time.)
LECTURE EXAMPLE 10: PV OF A PERPETUITY
Victoria is expecting to receive $2,000 a year forever. Interest rates are expected to remain constant at 5%.
Calculate the present value of Victoria’s perpetuity.
SOLUTION

lOMoARcPSD|15213202

lOMoARcPSD|15213202
115
14
Investment appraisal
1 Investment appraisal
1.1 Relevant cash flows
KEY TERM
A relevant cost or revenue is a future incremental cash flow.
In decision-making it is important that any decision is based upon relevant information. The correct
financial figures are the relevant costs and revenues.
For a figure to be relevant it must pass three tests:
 Future – a decision being made today cannot change the past and so only future costs are
considered. Past costs are sometimes referred to as sunk costs and are not relevant and so are
ignored e.g. the price paid for something which is already owned.
 Incremental – only those costs that are affected by the decision are relevant. Some costs are
sometimes referred to as committed costs and are not relevant and so are ignored e.g. fixed costs.
 Cash flow – these are factual and not based upon accounting conventions. Also organisations
live or die due to their cash position. So non-cash flows are not relevant e.g. depreciation.
1.2 Profit v Cash flow

When considering the businesses investment in capital assets there are generally two main types of
approach to the evaluation. Some approaches consider the profitability of the investment and some
consider the future cash flow generation of the investment. The better methods consider the future
cash flows as these represent the amounts that are actually going to be received or paid out in relation
to that investment.
Profit based approaches will be subject to whatever the individual company’s accounting policies (e.g.
for depreciation) whereas cash flow approaches will not be subject to such policies.

lOMoARcPSD|15213202
116 14: I n v e s t me n t ap p rai s al A C C A MA
1.3 Investment appraisal

The main cash based methods of investment appraisal are as follows:
 Payback period
 Discounted payback period
 Net Present Value (NPV)
 Internal Rate of Return (IRR)
1.3.1 Payback period and discounted payback period

A payback period is simply how long it takes for the net cash flows from an investment to repay the
initial investment. When the time value of money is taken into consideration it is known as a
discounted payback.
LECTURE EXAMPLE 1: PAYBACK PERIOD AND DISCOUNTED PAYBACK PERIOD
Horizon Ltd is considering a project that will require an investment in machinery of $80,000 and which
will generate an income of $15,000 in the first year, increasing by $5,000 each subsequent year.
The project is expected to last for five years and the machinery is not expected to have any residual
value. The cost of capital for Horizon is 10%.
Calculate the payback period of this project.
Calculate the discounted payback period.
SOLUTION
(a) Payback period
Annual cash flow Cumulative cash flow
$ $
Investment
First year
Second year
Third year
Fourth year
(b) Illustration of discounted payback period
Cumulative
Timing Cash flow Discount Factor Present Value PV
$ 10% $ $
0 (80,000) 1.000 (80,000) (80,000)
1 15,000 0.909 13,635 (66,365)
2 20,000 0.826 16,520 (49,845)
3 25,000 0.751 18,775 (31,070)
4 30,000 0.683 20,490 (10,580)
5 35,000 0.621 21,735 11,155
Discounted payback occurs roughly half way through the fifth year (i.e. the point at which the
cumulative cash flow turns positive).

lOMoARcPSD|15213202
A C C A MA 14: I n v e s t me n t ap p rai s al 117
Benefits of payback Drawbacks of payback

 It is simple to calculate  Ignores time value of money (unless using
discounted payback)
 Easy to understand, especially for non-  Only considers cash flows up to the payback date
accountants
 It uses relevant cash flows  May lead to short-termist decision making
 It can be used as an initial screening tool on  No clear decision rule
projects before undertaking a more detailed
review
 It (rather crudely) allows for risk in the timing
of cash flows
1.3.2 Net present value (NPV)

Most investments will involve a series of cash outflows and inflows at different points in time.
If we calculate the present value of each cash flow and then add all of the present values together, we
can calculate the Net Present Value (NPV) of the investment. Investments with a positive NPV should
be undertaken and those with a negative NPV should not.
The discount rate used will be the cost of capital (i.e. the return required by the investors).
LECTURE EXAMPLE 2: NPV
Horizon Ltd undertakes a project with the following cash flows:

Timing Cash flow
$
0 (i.e. now) (80,000)
1 15,000
2 20,000
3 25,000
4 30,000
5 35,000
Horizon’s cost of capital = 10%
SOLUTION
We can therefore discount any future cash flows and determine whether the net of the future cash
flows (net present value) is positive or negative:
Timing Cash flow Discount factor Present value
$ 10% $
NPV =

lOMoARcPSD|15213202
When the net present value has been calculated, there is a simple decision rule:
If NPV > 0 project is worthwhile
If NPV < 0 project is not worthwhile
If NPV = 0 project breaks even.
(Note: With NPV, it is assumed that all cash flows occur on the last day of the year/period except for
the initial investment.)
Benefits of NPV Drawbacks of NPV
 It allows for the time value of money  Requires a cost of capital to be estimated
 It shows the change in shareholders wealth  Calculations can be time consuming and not
easily understood by managers
 It can allow for risk
 it looks at the entire project
1.3.3 Internal rate of return (IRR)

The internal rate of return (IRR) is the discount factor which gives a zero NPV. In simple terms the IRR
tells us the actual % return that the project generates.
For a typical project that involves an initial outflow of cash followed by series of inflows, as the
discount factor increases the NPV reduces (i.e. the project becomes less attractive as the cost of
financing increases).
Estimating IRR
Find the NPV of project using the discount rate given in the question (or use an estimate if none is
given in the question)
Find the NPV of project using a second discount rate. If your NPV in step 1 is positive then you should
use a higher discount rate in step 2 (and vice versa for a negative answer in step 1)
Use the IRR formula below to estimate the IRR
𝑁𝑁𝑁𝑁𝐸𝐸𝐿𝐿
𝐼𝐼𝐼𝐼𝐼𝐼 ≈ 𝐿𝐿 + (𝐻𝐻 − 𝐿𝐿)
𝑁𝑁𝑁𝑁𝐸𝐸𝐿𝐿 − 𝑁𝑁𝑁𝑁𝐸𝐸𝐻𝐻
Where L = lower discount factor
H = higher discount factor
To determine whether or not a project should be accepted, the following rule can be used:
If IRR > cost of capital  accept project
If IRR < cost of capital  reject project

lOMoARcPSD|15213202
A C C A MA 14: I n v e s t me n t ap p rai s al 119
The diagram below illustrates how the formula above works graphically.
NPV
NPVL ≈IRR
H
0 %
L
NPV H
- IRR
LECTURE EXAMPLE 3: IRR
Calculate the approximate IRR for Horizon Ltd.
Discount Present Discount Present

Timing Cash flow Factor Value Factor Value
$ 10% $ 20% $
0 (80,000) 1.000 (80,000)
1 15,000 0.909 13,635
2 20,000 0.826 16,520
3 25,000 0.751 18,775
4 30,000 0.683 20,490
5 35,000 0.621 21,735
11,155
IRR =

lOMoARcPSD|15213202
Benefits of IRR Drawbacks of IRR

 It allows for the time value of money  It does not tell you whether to accept or
reject the proposal
 It does not require an exact cost of funds to be  It is possible to have more than one IRR
known
 As a % measure it is familiar to non-accountants
 It looks at the entire project

lOMoARcPSD|15213202
121
15
Material and labour variances
1 Standard costing systems

1.1 Standard cost
KEY TERM
Standard cost is the pre-determined estimated cost of producing a single unit of a product
or service.
The standard cost can be used to produce the fixed and flexible budgets. The standard cost may also
be compared with the actual costs and hence becomes a control technique.
The standard cost is built up by analysing both the quantities and costs of each element of producing
that product or service e.g. the amount of labour and the labour rate.
Under absorption costing the standard cost includes all of the variable costs and also a fixed overhead
per unit. Under marginal costing the standard cost includes only the variable costs.
1.2 Types of standard

Depending upon what is assumed about efficiency levels and wastage, four different standards arise:
 Basic – nothing has changed since the standard was first set
 Current – current efficiency and cost levels will be maintained
 Attainable – there will be some improvements in current efficiency and cost levels
 Ideal – an optimum level of efficiency and cost and minimisation of waste

lOMoARcPSD|15213202
122 15: M at e ri al a nd l a b o u r v a ri a n c es A C C A MA
ILLUSTRATION: STANDARD COST CARD
Gold Standard Co produces several products. Relevant details for one of these are given below.
Budgeted output for the year is expected to be 900 units. Each unit requires 40 square metres of
materials, costing $5.30 per square metre and 24 hours of Bonding Department labour, which is paid
$5.00 per hour and 15 hours of Finishing Department labour, which is paid $4.80 per hour. Other
budgeted costs and hours per annum:
Hours $
Variable overhead
Bonding Department 30,000 45,000
Finishing Department 25,000 25,000
Fixed overhead apportioned to this product:
Production 36,000
Selling, distribution and administration 27,000
Fixed overheads are recovered on a unit basis by Gold Standard.
Establish the standard cost per unit under absorption and marginal costing.
Standard absorption cost card:
$
Direct materials (40m × $5.30) 212
Direct labour:
Bonding (24 hours × $5.00) 120
Finishing (15 hours × $4.80) 72
Variable overhead:
Bonding {$45,000/30,000 hours) × 24 hours} 36
Finishing {$25,000/25,000 hours) × 15 hours} 15
Fixed production overheads ($36,000/900 units) 40
PRODUCTION COST 495
Fixed non-production overheads ($27,000/900 units) 30
TOTAL COST 525
Standard marginal cost card:

$
Direct materials (40m × $5.30) 212
Direct labour:
Bonding (24 hours × $5.00) 120
Finishing (15 hours × $4.80) 72
Variable overhead:
Bonding {$45,000/30,000 hours) × 24 hours} 36
Finishing {$25,000/25,000 hours) × 15 hours} 15
TOTAL COST (variable production cost) 455
2 Variance calculations
There are often a number of different ways that a variance (difference between actual and expected
results) can be worked out to give the same answer. The suggestions given in these notes represent
some common ways of presenting them but you may see alternatives from time to time.
When actual results are worse than you expected (costs higher or revenues lower) it is known as an
ADVERSE variance and if results are better than expected (costs lower or revenues higher) then it is a
FAVOURABLE variance.

lOMoARcPSD|15213202
A C C A MA 15: M a t e ri a l a nd l a b o u r v a ri a n c es 123
2.1 Materials
Materials total variance = difference between what the actual production output should have cost
and what it actually cost in terms of materials. It can be analysed into a price and usage variance.
Total variance = Actual production units x (actual material cost/unit – standard material cost/unit)
or, simply compare what the actual production units ‘did cost’ and ‘should cost’ in terms of materials.
Materials price variance = difference between what the materials purchased should have cost and did
cost.
Variance = actual purchases (kg) x (actual price/kg – standard price/kg)
Materials usage variance = difference between how much material should have been used and how
much material was used, valued at the standard material cost.
Variance in kg = actual production units x (actual kg/unit – standard kg/unit)
Variance in $ = variance in kg x standard cost/kg
2.2 Labour
Labour total variance = difference between what the actual production output should have cost and
what it actually cost in terms of labour. It can be analysed into a rate and efficiency variance.
Total variance = Actual production units x (actual labour cost/unit – standard labour cost/unit)
or, simply compare what the actual production units ‘did cost’ and ‘should cost’ in terms of materials.
Labour rate variance = difference between what the labour should have cost and did cost for the
hours paid for.
Variance = actual hours paid x (actual rate/hr – standard rate/hr)
Labour efficiency variance = difference between how much labour should have been used and how
much labour was used, valued at the standard labour cost.
Variance in hrs = actual production units x (actual hrs/unit – standard hrs/unit)
Variance in $ = variance in hrs x standard cost/hr
LECTURE EXAMPLE 1: DETAILED VARIANCE CALCULATIONS
Control Co makes tennis rackets. The standard cost of making a tennis racket is as follows:
$
Direct materials (0.3kg @ $30 per kg) 9
Direct labour (2hrs @ $12 per hr) 24
Variable overheads (2hrs @ $4 per hr) 8
Fixed overheads (2hrs @ $8 per hr) 16
Control Co budgets to sell these rackets at $70 each. The budgeted monthly sales and production is
15,000 rackets.
The following is the actual information for month 2.
Materials cost $165,000 for 5,600kg
Fixed overhead $260,000
Revenue $1,245,000
Calculate the month 2 materials and labour variances for Control Co using absorption costing principles.

lOMoARcPSD|15213202
SOLUTION
Materials variances
TOTAL MATERIALS
rackets $
Should cost (actual units @ standard cost per unit)
Did cost
VARIANCE
MATERIALS PRICE
kg purchased $
Should cost (kg purchased @ standard price per kg)
Did cost
VARIANCE
MATERIALS USAGE
rackets kg
Should use (units produced @ standard usage per unit)
Did use
VARIANCE in kg
Valued at the standard cost per kg
VARIANCE in $

lOMoARcPSD|15213202
A C C A MA 15: M a t e ri a l a nd l a b o u r v a ri a n c es 125
Labour variances
TOTAL LABOUR
rackets $
Did cost
VARIANCE
LABOUR RATE
Hrs PAID $
Should cost (hours paid for @ standard rate per hour)
Did cost
VARIANCE
LABOUR EFFICIENCY
rackets hrs
Should use (actual units @ standard time per unit)
Did use (actual hours WORKED)
VARIANCE in hrs
Valued at the standard cost per hr
VARIANCE in $
3 Causes of variances
3.1 Materials
Materials total variance will be caused by a combination of the causes of the price and usage
variances.
When favourable, the materials price variance could be caused by using a cheaper supplier, obtaining
an unforeseen discount, a drop in commodity prices or reducing the quality.
When favourable, the materials usage variance could be caused by using higher quality, being more
efficient, dropping quality thresholds or errors in allocating materials to the job.
3.2 Labour
Labour total variance will be caused by a combination of the causes of the rate and efficiency
variances.
When favourable, the labour rate variance could be caused by using lower grade staff, or poor
economic conditions leading to lower pay rises than anticipated.

lOMoARcPSD|15213202
When favourable, the labour efficiency variance could be caused by higher motivation, better quality
equipment or materials or errors on time sheets.
If you are given the variance but not the actual or standard figure, you can find the missing figure by
working backwards.
LECTURE EXAMPLE 2: BACKWARDS VARIANCES
Back2Front Co has an adverse labour rate variance of $416. The actual hours worked were 10,400
compared to the standard hours of 8,320. The standard rate is $5 per hour.
What was the work force actually paid per hour?
SOLUTION

lOMoARcPSD|15213202
127
16
Other variances
1.1 Variable overhead
Variable overhead total variance = difference between what the output should have cost and what it
actually cost for variable overheads. It can be analysed into an expenditure and efficiency variance.
Total variance = Actual production units x (actual var o/h cost/unit – standard var o/h cost/unit)
or, simply compare what the actual production units ‘did cost’ and ‘should cost’ in terms of variable
overheads.
Variable overhead expenditure variance = difference between what the variable overhead should
have cost and did cost for the hours that have been worked.
Variance = actual hours worked × (actual rate/hr – standard rate/hr)
Variable overhead efficiency variance = difference between how much labour should have been used
and how much labour was used to produce the actual output, valued at the standard variable
overhead cost.
Variance in hrs = actual production units × (actual hrs/unit – standard hrs/unit)
Variance in $ = variance in hrs × standard cost/hr
1.2 Fixed overhead

Fixed overhead total variance = difference between what the output should have cost and what it
actually cost for fixed overheads i.e. the under- or over-absorption of fixed overheads. It can be
analysed into an expenditure and volume variance.
Total variance = actual fixed overhead – absorbed fixed overhead

lOMoARcPSD|15213202
128 16: O t h e r v ari an c e s A C C A MA
Fixed overhead expenditure variance = difference between the budgeted and actual fixed overhead
expenditure.
Variance = Budgeted fixed o/h (£) – Actual fixed o/h (£)
Fixed overhead volume variance = difference between the actual and budgeted production volume,
valued at the standard fixed overhead cost per unit. It can be analysed into a capacity and efficiency
variance. In other words, what is the impact on our over/under absorption of producing a different
quantity of units to what we budgeted to.
Volume variance = (actual production volume – budget production volume) x FOAR per unit
where FOAR = fixed overhead absorption rate
Fixed overhead capacity variance = difference between the actual and budgeted labour hours, valued
at the standard fixed overhead cost per hour. This will help explain whether the difference in units was
caused by having more hours available than budgeted.
Capacity variance = (actual hours – budget hours) × FOAR per hr
Note that if actual hours are more than budget hours then this is FAVOURABLE from a capacity
perspective.
Fixed overhead efficiency variance = difference between how much labour should have been used
and how much labour was used, valued at the standard fixed overhead cost. This will help explain
whether the difference in units was caused by working more efficiently.
Variance in hrs = actual production units x (actual hrs/unit – standard hrs/unit)
Variance in $ = variance in hrs x FOAR per hr
1.3 Sales
Sales price variance = the impact on profit of the actual selling price being different to the budgeted
selling price, for the actual sales volume achieved.
Variance = actual sales volume × (actual selling price – budget selling price)
Sales volume variance = the impact on profit of selling a different volume to what you budgeted to
sell.
Variance = (actual sales volume – budget sales volume) x standard contribution per unit (see note)
Note
If the company is using marginal costing then use standard contribution per unit, however if they are
using absorption costing use standard profit per unit.

lOMoARcPSD|15213202
A C C A MA 16: O t h e r v ari an c e s 129
LECTURE EXAMPLE 1: DETAILED VARIANCE CALCULATIONS
Using the example of Control Co, the tennis racket manufacturer first met in Lecture Example 15.1.
The standard cost of making a tennis racket is as follows:
$
Direct materials (0.3kg @ $30 per kg) 9
Direct labour (2hrs @ $12 per hr) 24
Variable overheads (2hrs @ $4 per hr) 8
Fixed overheads (2hrs @ $8 per hr) 16
Control Co budgets to sell these rackets at $70 each. The budgeted monthly sales and production is
15,000 rackets.
The following is the actual information for month 2.
Materials cost $165,000 for 5,600kg
Fixed overhead $260,000
Revenue $1,245,000
Calculate the month 2 variances for sales, variable overheads and fixed overheads for Control Co
using absorption costing principles.
SOLUTION
Sales variances
SALES PRICE
For rackets $
Expected revenue (actual units @ standard selling
price)
Actual revenue
VARIANCE
SALES VOLUME
Rackets
Budget sales
Actual sales
VARIANCE in rackets
Valued at STANDARD PROFIT
VARIANCE IN $

lOMoARcPSD|15213202
Variable overhead variances
TOTAL VARIABLE OVERHEAD

rackets $
Did cost
VARIANCE
VARIABLE OVERHEAD EXPENDITURE

Hrs PAID $
Should cost (actual hours @ standard rate per hour)
Did cost
VARIANCE
VARIABLE OVERHEAD EFFICIENCY

rackets hrs
Did use
VARIANCE in hrs
VARIANCE in $

lOMoARcPSD|15213202
Fixed overhead variances
TOTAL FIXED OVERHEAD

rackets $
Did cost
VARIANCE
FIXED OVERHEAD EXPENDITURE

rackets $
Budgeted cost (budgeted units @ standard cost per unit)
Actual cost
VARIANCE
FIXED OVERHEAD VOLUME

Rackets
Actual production
Budget production
VARIANCE in rackets
Valued at standard cost
VARIANCE in $
FIXED OVERHEAD CAPACITY

Budgeted to take (budgeted units @ standard time
per unit)
Did take
VARIANCE in hrs
VARIANCE in $
VARIABLE OVERHEAD EFFICIENCY

rackets hrs
Did use
VARIANCE in hrs
VARIANCE in $

lOMoARcPSD|15213202
2.1 Sales
When favourable, the sales price variance could be caused by higher inflation, market shortages,
higher quality or unexpected endorsements.
When favourable, the sales volume variance could be caused by increased economic activity, lower
prices or successful advertising.
2.2 Variable overhead

Variable overhead total variance will be caused by a combination of the causes of the expenditure
and efficiency variances.
When favourable, the variable overhead expenditure variance could be caused by unanticipated
economies of scale or lower prices.
Variable overhead efficiency variance will have the same causes as the labour efficiency variance.
2.3 Fixed overhead

Fixed overhead total variance will be caused by a combination of the causes of the expenditure and
volume variances.
When favourable, the fixed overhead expenditure variance could be caused by lower price rises or
savings.
When favourable, the fixed overhead volume variance will be caused by increased production.
When favourable, the fixed overhead capacity variance will be caused by the workforce working extra
hours.
Fixed overhead efficiency variance will have the same causes as the labour efficiency variance.
2.4 Variance investigation

When deciding whether or not to investigate a variance, consider:
 Materiality – The larger the variance, the more relevant it may be to investigate
 Controllability – It is sensible to spend more time investigating variances that you have some
chance of doing something about
 Adverse or favourable – Investigate adverse variances to enable corrective action to be taken
and favourable ones so that lessons can be learned elsewhere in the organisation
 Trend or one-off – It is likely to be more cost effective to investigate variances that are an
ongoing problem rather than waste time/money on investigating one-offs
 Cost benefit – It is only worth investigating a variance if the benefit of doing so outweighs the
cost of investigation
 Interrelationship – It is important to identify what the root cause of the variances is so that the
investigation can be made as efficient as possible
We have calculated the variances separately, but one event can cause a number of different variances.

lOMoARcPSD|15213202
LECTURE EXAMPLE 2: VARIANCE CAUSE AND EFFECT
Cheap Skate Co purchased some low quality materials.

What variances could this give rise to?
SOLUTION

lOMoARcPSD|15213202

lOMoARcPSD|15213202
135
17
Variance review and control
1 Reconciliation of budgeted and actual profit

1.1 Reconciliation under absorption costing
As variances explain the difference between the budget and the actual figures for the revenue and
individual costs, the total of all of the variances will reconcile budgeted profit with actual profit.
ILLUSTRATION: BUDGET TO ACTUAL PROFIT RECONCILIATION (ABSORPTION COSTING)
Reconcile budgeted profit with actual profit under standard absorption costing for Control Co.
Profit reconciliation:
$
Budgeted profit (15,000 rackets × $13) 195,000
Sales volume variance 39,000
Flexible budgeted profit (18,000 rackets × $13) 234,000
Sales Price variance (15,000)
Favourable Adverse
Cost variances $ $
Material price variance 3,000
Material usage variance 6,000
Labour rate variance 9,000
Labour efficiency variance 36,000
Variable overhead expenditure variance 3,000
Variable overhead efficiency variance 12,000
Fixed overhead expenditure variance 20,000
Fixed overhead capacity variance 24,000
Fixed overhead efficiency variance 24,000
Total cost variances 99,000 38,000
61,000
Actual profit 280,000

lOMoARcPSD|15213202
136 17: V ari an c e re v i e w a nd c o n t ro l A C C A MA
Actual profit working:

$
Revenue 1,245,000
Materials (165,000)
Labour (405,000)
Variable overhead (135,000)
Fixed overhead (260,000)
Profit 280,000
1.2 Reconciliation under marginal costing

In marginal costing the fixed overheads are not absorbed and so the only fixed overhead variance that
is required is the fixed overhead expenditure variance.
Also in marginal costing we work in terms of contribution, not profit. Thus the sales volume variance
needs to be recalculated using the standard contribution rather than the standard profit.
ILLUSTRATION: BUDGET TO ACTUAL PROFIT RECONCILIATION (MARGINAL COSTING)

Reconcile budgeted profit with actual profit under standard marginal costing for Control Co.
REVISED SALES VOLUME VARIANCE
Rackets
Actual sales 18,000
Budget sales 15,000
Variance in rackets 3,000 (F)
Valued at STANDARD CONTRIBUTION $29
VARIANCE IN $ 87,000 (F)
Reconciliation
$
Budgeted profit (15,000 rackets × $13) 195,000
Budgeted fixed overhead (15,000 rackets × $16) 240,000
Budgeted contribution 435,000
Sales volume variance 87,000
Flexible budgeted contribution (18,000 rackets × $29) 522,000
Sales price variance (15,000)
Favourable Adverse
Cost variances $ $
Material price variance 3,000
Material usage variance 6,000
Labour rate variance 9,000
Labour efficiency variance 36,000
Variable overhead expenditure variance 3,000
Variable overhead efficiency variance 12,000
Total cost variances 51,000 18,000
33,000
Actual contribution 540,000
Less: Budgeted fixed overhead 240,000
Fixed overhead expenditure variance 20,000
260,000
Actual profit 280,000

lOMoARcPSD|15213202
A C C A MA 17: V ari a n c e re v i e w a nd c o n t ro l 137
Note. As there is no inventory, the absorption and marginal costing profits are the same.
In the above reconciliation we have both added and deducted the budgeted fixed overhead. This could
be omitted and the reconciliation would still work, however the subtotals would no longer have any
meaning.
2 Cost control and reduction

2.1 Cost control
Cost control is where costs are kept within predetermined acceptable limits. Providing the costs are
within these limits no action is deemed necessary. Variance analysis is often used as a way of giving
assurance that current costs are within acceptable limits.
2.2 Cost reduction

Cost reduction is where the current levels of cost are deemed unacceptable (even if within
predetermined limits). The aim is to continually look for ways to reduce the current level of costs.
To implement cost reduction, the organisation could look to just simply cut current spending via
spending freezes or headcount reduction etc. This can be seen as quite a negative approach as there
may not be any strategic rationale for the cuts. However it may have benefits if quick cost-saving
measures are necessary.
2.2.1 Cost reduction schemes

It is generally more effective for cost reduction schemes to be more carefully thought through and
planned.
ABC
By identifying what really causes your business overhead costs to be incurred (i.e. what drives the
costs in the cost pools) it is much easier to target areas where it may be possible to reduce costs.
Target costing
By always trying to achieve a desired profit margin and concentrating on the consumer, target costing
forces a business to continually look for ways to reduce costs, given that selling prices are likely to
reduce over the life of a product.
Business process reengineering

This is a technique where any business process is reviewed with a blank sheet of paper. The idea is
that you always look for the best (efficient) way of performing tasks given the current operating
environment, even if it is not how you perform the task at the moment. It is quite a radical approach
but does stop the business from simply assuming that the way it does things at the moment is the best
way.

lOMoARcPSD|15213202
138 17: V ari an c e re v i e w a nd c o n t ro l A C C A MA
2.3 Value analysis
KEY TERM
Value analysis is ‘A systematic inter-disciplinary examination of factors affecting the cost of
a product or service, in order to devise means of achieving the specified purpose most
economically at the required standard of quality and reliability.’
Value analysis aims to identify the lowest cost method of manufacturing a product, such that it is
capable of functioning as desired with the required level of quality and reliability. There is not a rigid
product design as essentially there is a clean sheet of paper to work with.
There are four elements/dimensions that can be considered in relation to value:
 Cost – cost of making and selling an item
 Exchange – the market price
 Use – function or purpose it fulfils
 Esteem – prestige of ownership
The principal aim is to reduce the cost value, whilst maintaining or even enhancing the exchange, use
and esteem values. It is not always easy to reduce costs while maintaining the other three aspects of
value.

lOMoARcPSD|15213202
139
18
Financial performance
measures
1 Performance measurement overview

1.1 Mission statements
KEY TERM
A mission describes the organisation’s basic function in society, in terms of the products and
services it produces for its customers. Mintzberg
A mission statement should be memorable and succinct. It should not be subject or regular changes
Mission statements should contain the following four elements:
 Purpose – why do we exist and who for?
 Strategy – how and where are we going to compete
 Behavioural standards – guide the actions of employees
 Values – what does the organisation believe in
A mission statement will guide the areas that are important to the organisation and hence the areas
where it is important to measure performance. By having a clear mission instilled into the culture,
focus is given to staff. This should help overall business performance.

lOMoARcPSD|15213202
140 18: Fi n an c i al p e rf o rman c e me as u res A C C A MA
The following flow shows the link between mission statements and key performance indicators.
Corporate mission
Overall strategic objectives
Critical success factors (CSF)
Key performance indicators (KPI)
1.2 Objectives
There will be different objectives set within an organisation. These objectives should be able to be
quantified and ideally follow SMART principles, namely:
 Specific
 Measurable
 Achievable
 Relevant
 Timebound
As we saw in Chapter 1, a business should also set strategic, tactical and operational objectives and
different performance measures will be appropriate for each type of objective.
1.3 Factors affecting achievement of objectives

1.3.1 Political climate
The political party in power will make decisions that affect the following aspects of fiscal and monetary
policy:
 Fiscal policy – government spending and taxation systems will impact the amount of money
that people have to spend so can affect company revenues
 Interest rates – affects financing costs and hence profits
 Inflation – cost budgeting and targets will be impacted, wage rises etc.
 Exchange rates – affect the relative prices of goods in two or more countries and this can have a
direct impact on sales revenues and costs if a business exports and imports.
 Corporate taxes – affects distributable profits
 Income taxes – consumers disposable incomes
 VAT – impact on consumer spending
 Government spending – job creation and direct impact if you supply the govt
 Offering tax breaks for businesses to relocate to areas of high unemployment
1.3.2 Market conditions

There may be factors affecting the specific market the organisation operates in that could affect
performance, such as:
 Number of competitors (home and overseas)
 Boom phase or recessionary phase
 Buoyancy in the stock market

lOMoARcPSD|15213202
A C C A MA 18: Fi n an c i al p e rf o rman c e me as u res 141
1.4 Critical success factors

Critical success factors (CSFs) are those areas of business performance where the company must
succeed. Once the mission and objectives of the organisation have been established, CSFs should then
be identified by considering what is crucial in terms of systems, processes and performance in order to
achieve these main objectives.
You may see CSFs categorised as:
 Monitoring – CSFs in relation to the ongoing existing business
 Building – CSFs looking into the future development of the organisation
1.5 Key performance indicators

The final stage is to design performance measures (KPIs) that lead to achievement of the CSFs and
ultimately therefore achievement of the organisation’s objectives.
If, for example, a company had an objective to increase sales volume by 10% over a three-year period
then it may identify CSFs such as:
 Produce high quality products
 High quality customer service
 On time delivery to customer
KPIs can then be designed around these CSFs and may include:
 Percentage of products returned as faulty
 Number of customer complaints
 Percentage of customer service calls answered within three rings
 Percentage of downtime on website
 Number of orders taking more than three days to arrive with the customer
2 Financial measures
2.1 Ratio analysis
KEY TERM
A ratio provides information about the relationship between different accounting figures.
We shall see several examples of ratios below. Broadly you expect the figures in ratios to be related in
some way, that both figures are influenced by the same factors or one figure is dependent on another.
To be meaningful also, ratios calculated need to be compared to something such as:
 Previous years
 Other companies
 Other divisions within this company
 Industry standards
Changes in ratios should also be explained by changes in external indicators wherever possible (e.g.
inflation, stock market performance).

lOMoARcPSD|15213202
2.2 Profitability measures

PBIT
𝐎𝐎𝐌𝐌𝐩𝐩𝐮𝐮𝐩𝐩𝐌𝐌 𝐩𝐩𝐌𝐌 𝐀𝐀𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩𝐂𝐂𝐂𝐂 𝐄𝐄𝐌𝐌𝐩𝐩𝐂𝐂𝐩𝐩𝐢𝐢𝐌𝐌𝐅𝐅 (𝐎𝐎𝐎𝐎𝐀𝐀𝐄𝐄) = TALCL
× 100%
Where TALCL = Total Assets Less Current Liabilities

This measures the return made by the organisation from the amount of available capital. It gives an
indication of how efficient the organisation is at generating profits from its capital.
To improve this measure efficiency needs to be increased.
Gross Profit
𝐆𝐆𝐩𝐩𝐩𝐩𝐮𝐮𝐮𝐮 𝐏𝐏𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩 𝐌𝐌𝐂𝐂𝐩𝐩𝐦𝐦𝐩𝐩𝐌𝐌 = × 100%
Revenue
This measures the ability of the business to sell goods for more than they cost to make. You might well
expect this ratio to remain fairly stable over time and for competitors to show similar gross margins.
To improve this measure either prices need to rise or production costs fall.
PBIT
𝐍𝐍𝐌𝐌𝐩𝐩 𝐏𝐏𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩𝐩 𝐌𝐌𝐂𝐂𝐩𝐩𝐦𝐦𝐩𝐩𝐌𝐌 = × 100%
Revenue
This measures the ability of the business to make an overall profit on the goods it sells. A low net profit
margin is not necessarily a concern, as the volume of sales and hence the total absolute profit will also
be a factor to consider.
To improve this measure either prices need to rise or overall costs fall.
Revenue
𝐀𝐀𝐮𝐮𝐮𝐮𝐌𝐌𝐩𝐩 𝐩𝐩𝐮𝐮𝐩𝐩𝐌𝐌𝐩𝐩𝐌𝐌𝐌𝐌𝐩𝐩 =
TALCL
This measure looks at how well your assets are being used to generate sales. Are you using your assets
to full potential?
2.3 Liquidity measures

Current assets
𝐀𝐀𝐮𝐮𝐩𝐩𝐩𝐩𝐌𝐌𝐌𝐌𝐩𝐩 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 =
Current liabilities
This ratio looks at the working capital of the organisation and assesses its ability to meet its short-term
debts.
To improve this ratio either current assets need to rise or current liabilities fall.
Current assets − inventories
𝐐𝐐𝐮𝐮𝐩𝐩𝐐𝐐𝐐𝐐 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 (𝐩𝐩𝐩𝐩 𝐂𝐂𝐐𝐐𝐩𝐩𝐅𝐅 𝐩𝐩𝐌𝐌𝐮𝐮𝐩𝐩) =
Current liabilities
This is considered a better measure of an organisation’s liquidity especially where inventory cannot be
turned into cash very quickly. To improve this ratio either receivables and cash need to rise or current
liabilities fall.
2.3.1 Working capital management

Cost of sales
𝐈𝐈𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐩𝐩𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐮𝐮𝐩𝐩𝐌𝐌𝐩𝐩𝐌𝐌𝐌𝐌𝐩𝐩 =
Inventories
Inventory
𝐈𝐈𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐌𝐩𝐩𝐩𝐩𝐩𝐩𝐢𝐢 𝐅𝐅𝐂𝐂𝐢𝐢𝐮𝐮 = × 365 days ∗
COS
This ratio shows how long, on average, you are holding items in inventory/
Trade receivables
𝐎𝐎𝐌𝐌𝐐𝐐𝐌𝐌𝐩𝐩𝐌𝐌𝐂𝐂𝐑𝐑𝐂𝐂𝐌𝐌𝐮𝐮 𝐐𝐐𝐩𝐩𝐂𝐂𝐂𝐂𝐌𝐌𝐐𝐐𝐩𝐩𝐩𝐩𝐩𝐩𝐌𝐌 𝐩𝐩𝐌𝐌𝐩𝐩𝐩𝐩𝐩𝐩𝐅𝐅 = × 365 days ∗
Credit turnover
This ratio shows, on average, how long your debtors take to pay you.

lOMoARcPSD|15213202
Trade payables
𝐏𝐏𝐂𝐂𝐢𝐢𝐂𝐂𝐑𝐑𝐂𝐂𝐌𝐌𝐮𝐮 𝐩𝐩𝐂𝐂𝐢𝐢𝐌𝐌𝐌𝐌𝐌𝐌𝐩𝐩 𝐩𝐩𝐌𝐌𝐩𝐩𝐩𝐩𝐩𝐩𝐅𝐅 = Credit purchases or COS × 365 days ∗ *
This ratio shows, on average, how long your company takes to pay its creditors.
2.3.2 Working capital cycle

The working capital cycle includes cash, receivables, inventories and payables. It effectively represents
the time taken to purchase inventories, then sell them and collect the cash. The length of the cycle is
determined using the above ratios.
2.4 Gearing
KEY TERM
Gearing is the extent to which a business is dependent on loans and preference shares, as
opposed to ordinary shares and reserves. This is sometimes known as FINANCIAL RISK.
Gearing ratios indicate the degree of risk attached to the company and the sensitivity of earnings and
dividends to changes in profitability and activity level.
long term debt
𝐃𝐃𝐌𝐌𝐑𝐑𝐩𝐩 𝐩𝐩𝐩𝐩 𝐌𝐌𝐞𝐞𝐮𝐮𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 = %
Equity
long term debt
𝐆𝐆𝐌𝐌𝐂𝐂𝐩𝐩𝐩𝐩𝐌𝐌𝐦𝐦 = %
Equity + long term debt
This shows what proportion of the assets of the company have been financed by lenders rather than
shareholders.
To improve this ratio either more equity needs to be raised or retained profits increased.
PBIT
𝐈𝐈𝐌𝐌𝐩𝐩𝐌𝐌𝐩𝐩𝐌𝐌𝐮𝐮𝐩𝐩 𝐐𝐐𝐩𝐩𝐌𝐌𝐌𝐌𝐩𝐩 =
Interest payable
This determines the number of times that the company can afford to pay its interest charges out of its
current year profits.
To improve this measure profits either need to improve or level of debt fall.
2.5 Divisional performance measurement

2.5.1 Return on Investment (ROI)
ROI has been the most widely used measure in divisional performance, largely due to its similarity to
ROCE and the fact that it can be calculated by taking figures from the income statement and statement
of financial position.
Should use profit before head office allocations, usually
before interest and tax, if you are assessing the
managers’ performance. If looking at the performance
of the division it may be better to include centrally
𝑑𝑑𝑛𝑛𝑑𝑑𝑛𝑛𝑑𝑑𝑛𝑛𝑑𝑑𝑛𝑛𝑎𝑎𝑛𝑛 𝑝𝑝𝑟𝑟𝑑𝑑𝑓𝑓𝑛𝑛𝑓𝑓 allocated costs as well.
𝐎𝐎𝐎𝐎𝐈𝐈 =
𝑑𝑑𝑛𝑛𝑑𝑑𝑛𝑛𝑑𝑑𝑛𝑛𝑑𝑑𝑛𝑛𝑎𝑎𝑛𝑛 𝑛𝑛𝑛𝑛𝑑𝑑𝑖𝑖𝑑𝑑𝑓𝑓𝑖𝑖𝑖𝑖𝑛𝑛𝑓𝑓
May use capital employed (TALCL) or net assets (total
assets – total liabilities) depending upon what
information is given in the question. If told to use
“average investment” in the exam you will need to
work it out as follows:
Av investment = (opening inv + closing inv)/2

lOMoARcPSD|15213202
The answer is expressed as a %.
There are a number of possible definitions of ROI, so in an exam you must follow any instructions that
the examiner gives you.
Using ROI may encourage divisional managers to make decisions that are in their best interests but not
necessarily the best interests of the company as a whole. This is referred to as dysfunctional behaviour.
For example, a manager of a division that has an existing ROI of 25% will reject a project with an ROI of
20% even if the head office target is only 16%. This is because the project would reduce the divisional
ROI (leading to reduced bonus perhaps).
2.5.2 Residual Income (RI)

This measure identifies the “net” profit of a division after having deducted a notional charge for
interest based on the amount of investment tied up in the division. This notional charge is estimated
with reference to the company’s overall cost of raising finance (referred to as ‘cost of capital’ or the
‘Weighted Average Cost of Capital (WACC)’).
$
Divisional profit (same definition as for ROI) X
Notional (imputed) interest = divisional investment × cost of capital (X)
Residual income X
If RI is positive it suggests that the division has generated a profit that is over and above that which
would be required by the capital providers. Therefore, if RI is positive the division has performed well
and value should be being added to investors.
LECTURE EXAMPLE 1: ROI V RI
Smith and Jones are divisions within a large diversified business, Zara Co. Jones was set up recently
whereas Smith has been in existence for 15 years. The following performance statements are available
for the year:
Smith Jones
$000 $000
Revenue 1,200 850
Variable costs (460) (400)
Contribution 740 450
Controllable fixed costs (incl depreciation on div assets) (200) (100)
Controllable profit 540 350
Apportioned central costs (160) (110)
Divisional net profit 380 240
Divisional net assets (@ NBV) 2,375 2,000
The overall cost of financing for the company is 10%. Currently Zara Co sets its divisions a target ROI of
14% but is considering introducing residual income into its performance measures.
Calculate the annual ROI and RI for each division.
SOLUTION

lOMoARcPSD|15213202
2.5.3 ROI v RI
Technically RI is the better method because it is linked to cost of capital and should result in fewer
dysfunctional decisions being made.
ROI is still preferred in the majority of businesses, largely because:
 It gives a % answer and people understand % returns such as ROCE.
 Interdivision comparisons are easier to do, since ROI is a relative measure not an absolute one
like RI. This makes it simpler to compare divisions of differing sizes.
 It is not felt that dysfunctional decision making happens often enough to be a real problem.
 RI does need an estimate of cost of capital to be made.
2.5.4 Difficulties with ROI and RI

Ultimately, both ROI and RI use similar information in their calculations. There are certain
flaws/difficulties with identifying the relevant information:
Which profit figure to use?

 Identifying what is controllable and what is not
 Pre or post tax figures?
 Attributable and non-attributable costs (including central spreading of overheads)
Which investment figure to use?

 Do we use opening, closing or average net assets?
 Use of statement of financial position values based on historic cost and net book value will make
comparing divisions of differing ages hard. A solution to this is to use replacement cost of assets
rather than net book value.
 How do we include those assets that are not reflected on the statement of financial position
such as intangible assets (for example, in a service or people orientated business)?

lOMoARcPSD|15213202

lOMoARcPSD|15213202
147
19
Non-financial performance
measures and performance
reporting
1 Non-financial measures
The financial success of an organisation will often depend upon non-financial factors such as people,
products, service and processes. Non-financial performance indicators (NFPIs) measure the
performance of these factors.
Commonly used areas for NFPIs include the following.
Area Performance measure

Service quality Number of complaints
Proportion of repeat bookings
On time deliveries
Customer waiting time
Production performance Set up times
Number of suppliers
Inventory days
Output per employee
Material yield %
Production schedule adherence
Output requiring reworking
Manufacturing lead times

lOMoARcPSD|15213202
148 19: N o n - fi n an c i al p e rf o rman c e me as u re s an d pe rf o rman c e re p o rt i n g A C C A MA
Area Performance measure

Marketing effectiveness Trends in market share
Sales volume growth
Customer visits per salesperson
Client contact hours per salesperson
Customer survey response information
Personnel Number of complaints received
Staff turnover
Days lost through absenteeism
Days lost through accident/sickness
Training time per employee
Feedback from staff on their managers
1.1 Advantages of non-financial performance measures

Non-financial performance measures are very useful at measuring performance in areas (people,
products, services and processes) that will indicate how a business is likely to perform in the future.
Non-financial performance measures also have the benefit of being very flexible in terms of what is
measured. This makes it easy to tailor a set of performance measures that are very relevant to an
individual business, based on what it considers as important. Financial measures tend to be slightly
more rigid/inflexible.
2 Balanced scorecard
The balanced scorecard approach to appraising performance was first put forward by Kaplan & Norton
in 1992 as a way of giving managers a comprehensive view of business performance. The aim was
essentially to not only focus on financial performance but to also consider human factors that
ultimately drive the financial performance. The information provided may include both financial and
non-financial elements therefore.

lOMoARcPSD|15213202
A C C A MA 19: N o n - fi n an c i al p e rf o rman c e me as u re s a n d pe rf o rman c e re p o rt i n g 149
There are a number of key performance indicators (KPIs) for each of the four perspectives of the
balanced scorecard.
FINANCIAL CUSTOMER
A classic set of indicators to measure What do customers (current and
whether value is being added to potential) value from us?
shareholders.
• Delivery performance in terms of
• ROCE, Return on equity time/quantity/quality
• Profit margin – Gross, Net • Complaints
• Turnover growth • % on time deliveries
• EPS • Returns rate, warranty claims %
• Retention rate
• Market share
VISION &
STRATEGY
INTERNAL BUSINESS PROCESSES INNOVATION & LEARNING

What business processes must we excel Will the business be able to create future
at in order to satisfy our customers and value?
shareholders?
• Staff turnover
• Quality control reject rate • Illness rate
• Turnaround time/Lead time • Development time for new products
• Production set up time • % revenue from products launched
in last 2 years
2.1 Use of balanced scorecard

A traditional budgeting and performance management approach will put a financial focus on the
functional performance of the business. There may not be much emphasis in looking beyond the next
budget period.
Producing budgets with the balanced scorecard in mind should force more consideration of the
underlying critical factors for the success of the business over a longer period of time. Resources
should be allocated in an effective manner based on the four dimensions of performance. It will also
ensure that financial and non-financial factors are linked.
2.2 Problems associated with the balanced scorecard

 Danger of information overload
 Short term vs long term conflicts. For example, would you spend money on R&D since this will,
in theory, help you develop new products and be innovative or do you avoid the expenditure in
order to reduce costs and have improved short term performance?

lOMoARcPSD|15213202
3 Activity, efficiency and capacity ratios

These ratios can monitor how and why output was either above or below expectations.
3.1 Activity
This measure considers whether more or less output was produced compared to the budget. Output is
often measured in “standard hours”:
𝑑𝑑𝑓𝑓𝑎𝑎𝑛𝑛𝑑𝑑𝑎𝑎𝑟𝑟𝑑𝑑 ℎ𝑑𝑑𝑜𝑜𝑟𝑟𝑑𝑑 𝑝𝑝𝑟𝑟𝑑𝑑𝑑𝑑𝑜𝑜𝑝𝑝𝑖𝑖𝑑𝑑
𝐀𝐀𝐐𝐐𝐩𝐩𝐩𝐩𝐌𝐌𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 =
𝑏𝑏𝑜𝑜𝑑𝑑𝑏𝑏𝑖𝑖𝑓𝑓𝑖𝑖𝑑𝑑 ℎ𝑑𝑑𝑜𝑜𝑟𝑟𝑑𝑑
3.2 Efficiency
This measure focuses on whether more or less output was produced than expected for the given
number of hours actually worked (i.e. was the time actually worked more productive than expected):
𝑑𝑑𝑓𝑓𝑎𝑎𝑛𝑛𝑑𝑑𝑎𝑎𝑟𝑟𝑑𝑑 ℎ𝑑𝑑𝑜𝑜𝑟𝑟𝑑𝑑 𝑝𝑝𝑟𝑟𝑑𝑑𝑑𝑑𝑜𝑜𝑝𝑝𝑖𝑖𝑑𝑑
𝐄𝐄𝐩𝐩𝐩𝐩𝐩𝐩𝐐𝐐𝐩𝐩𝐌𝐌𝐌𝐌𝐐𝐐𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 =
𝑎𝑎𝑝𝑝𝑓𝑓𝑜𝑜𝑎𝑎𝑛𝑛 ℎ𝑑𝑑𝑜𝑜𝑟𝑟𝑑𝑑 𝑤𝑤𝑑𝑑𝑟𝑟𝑤𝑤𝑖𝑖𝑑𝑑
3.3 Capacity
This measure looks at whether more or less capacity was available than budgeted (i.e. were staff able
to actually work more or less hours than budgeted):
𝑎𝑎𝑝𝑝𝑓𝑓𝑜𝑜𝑎𝑎𝑛𝑛 ℎ𝑑𝑑𝑜𝑜𝑟𝑟𝑑𝑑 𝑤𝑤𝑑𝑑𝑟𝑟𝑤𝑤𝑖𝑖𝑑𝑑
𝐀𝐀𝐂𝐂𝐩𝐩𝐂𝐂𝐐𝐐𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 =
𝑏𝑏𝑜𝑜𝑑𝑑𝑏𝑏𝑖𝑖𝑓𝑓𝑖𝑖𝑑𝑑 ℎ𝑑𝑑𝑜𝑜𝑟𝑟𝑑𝑑
Thus the ability to produce more output than budgeted (activity) is a combination of efficient working
(efficiency) and being able to find more time available than budget (capacity) such that:
𝐀𝐀𝐐𝐐𝐩𝐩𝐩𝐩𝐌𝐌𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 = 𝐄𝐄𝐩𝐩𝐩𝐩𝐩𝐩𝐐𝐐𝐩𝐩𝐌𝐌𝐌𝐌𝐐𝐐𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 × 𝐀𝐀𝐂𝐂𝐩𝐩𝐂𝐂𝐐𝐐𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩
LECTURE EXAMPLE 1: ACTIVITY, EFFICIENCY AND CAPACITY RATIOS
XYZ plc had the following information for September 2011.

Standard time per unit = 2hrs
Budgeted output = 1,000 units
Actual output = 1,050 units
Actual hours = 1,800 hours
Calculate the activity, efficiency and capacity ratios.
SOLUTION

lOMoARcPSD|15213202
4 Process and job performance measurement

4.1 Process costing
In a process costing environment there will be much standardisation as units of product will be
identical. In this type of environment it will be quite easy to set predetermined standards of
performance in areas such as:
 Material input costs
 Wastage levels (actual losses compared to normal loss percentages)
 % of time machinery is not working
4.2 Job costing

With job or contract costing there will be generally much less standardisation, as each job will be
different to the previous one and tailored to the individual customer’s needs. There will be more focus
on things such as:
 Customer satisfaction surveys
 On time delivery (particularly relevant for large scale construction contracts)
 Overall spending v budget (most relevant for very large contracts)
5 Non-profit seeking and public sector organisations

5.1 Objectives
In a non-profit seeking organisation and in the public sector where profit is not a primary focus there
will be much more focus on non-financial objectives.
In these organisations that do not have shareholders, there is usually the need to juggle many
objectives linked to the various stakeholder groups who have a vested interest in the organisation.
Multiple objectives can cause the following problems:
 It may not be possible to simultaneously achieve all objectives and some sort of prioritising may
be necessary.
 Different stakeholders may focus on different objectives and have conflicting priorities for the
organisation.
 The importance of individual objectives may change over time. For example, there may be
political pressure on certain objectives around election time.
Stakeholder views can be ascertained by questioning users of services and appointing
regulators/experts to monitor performance.
5.2 Value for money

The most common way of measuring performance in not for profit organisations and the public sector
is to identify whether they are offering value for money (VFM). The National Audit Office (NAO)
assesses VFM according to three criteria:
(1) Economy – cost of resources used (are you spending more on resources than you should?).
This relates therefore to inputs.
(2) Efficiency – outputs vs. inputs (is there more wastage than expected?)

lOMoARcPSD|15213202
(3) Effectiveness – achieving outputs or targets (even if you are being economical and efficient is
what you’re doing helping the organisation achieve its overall goals?)
The 3 Es can be applied to any business, not just the public sector. The reason they work well in the
public sector is those organisations often being restricted on the amount of finance available.
5.2.1 Economy
Variances for:
 Materials price
 Labour rate
 Variance overhead expenditure etc.
Essentially, the actual cost of any resource obtained compared to the expected cost.
5.2.2 Efficiency
Variances for:
 Materials usage
 Labour efficiency and idle time
 Variable overhead efficiency
5.2.3 Effectiveness
For objectives covering an accountancy training business some ideas include:
 Quality – pass rates, % repeat business, number of complaints
 Resource utilisation – teaching days per staff member, % training room occupancy, class size
6 Manufacturing and service businesses

6.1 Manufacturing businesses
Clearly, it is always going to be important for a manufacturing business to have targets set around
cost.
Measurement of resource utilisation will depend on what resources are used.
Resource Measure of utilisation
Materials Wastages levels (as a % of total material)
Usage variances
Direct labour Idle time
Actual to budget hours comparison
In modern times manufacturing businesses have had to look externally when setting measures of
performance. Internally-focused manufacturing usually leads to businesses producing products that
may be produced at low cost, but nobody wants those products anymore as times have moved on. A
focus on other key areas as follows has thus become more common:
 Quality of product
 Speed of delivery
 New product development

lOMoARcPSD|15213202
6.2 Service businesses

There are a few standard features that characterise a service business such as:
 Intangibility – no physical product (taste, feel, visible presence).
 Inseparability(simultaneity) – the service is usually provided at the same time as it is consumed.
 Variability/heterogeneity – lack of standardisation. The service is likely to be slightly different
each time and tailored to the needs of each individual consumer.
 Instant/Perishability – the service cannot be “stored” and used later.
Overall with a service business more of the assessment will be via external feedback on whether you
are providing the standard that the customer expects.
In a service based business the amount of material usage is likely to be small and the level of
overheads proportionately much higher. A service business might therefore need information to allow
an in depth analysis of the overheads for activity-based purposes.
Again resource utilisation measurement will depend on the resources used.
Resource Measure of utilisation
Labour Staff to customer ratios
% chargeable time for professional firms (lawyers, accountants etc.)
Tutor teaching days in a training firm
Buildings % occupancy (hotels)
Room utilisation % (training firms)
Occupied bed days (hospital)
6.2.1 Building block model

The Fitzgerald and Moon building block model (1996) indicates six key dimensions of performance in a
service business.
Included in this list are just a few suggestions of what you might consider measuring in different types
of service business:
(1) Profit/financial – profit growth, profit margins, cash flow generation
(2) Competitiveness – sales growth, market share, new business as a % of total business
(3) Flexibility – % customer orders unfulfilled due to demand peaks, ability to service changing
client requirements for timings or service specifications, ability for students to switch between
weekday and evening classes
(4) Innovation – % revenue from services launched in last two years, number of new courses
offered
(5) Resource utilisation – occupancy rates in a hotel, tutor teaching days in training business, staff
utilisation rates in a firm of accountants
(6) Excellence/Quality – industry awards achieved, world prize-winners trained

lOMoARcPSD|15213202
7 Benchmarking
KEY TERM
Benchmarking is the establishment, through data gathering, of targets and comparators,
through whose use relative levels of performance and underperformance can be identified.
By the adoption of identified best practice it is hoped that performance will improve.
Benchmarking overcomes "paradigm blindness” which is thinking, "the way we do it is the best
because this is the way we've always done it." Different types of benchmarking include:
 Historic benchmarking
 Industry/Sector benchmarking (competitive benchmarking or if done on strategic long term
measures it may be known as strategic benchmarking)
 Best-in-class benchmarking (functional benchmarking)
7.1 Advantages of benchmarking

 Challenges assumptions
 Helps cut costs (BA cabin crew v Easy Jet)
 Improve service
 Helps simplify processes
 Improves quality
 Changes behaviour
 Helps break resistance to change by demonstrating other methods of solving problems
7.2 Problems with benchmarking

 “You get what you measure”. If the basis for benchmarking is flawed, it can lead to new
strategies that are flawed rather than improved performance.
 Too much information for managers.
 Takes too much time and money to perform.
 Benchmarking will not identify the reasons for good or poor performance because it does not
compare competences directly. Managers would have to observe and understand how top-
performing organisations undertake their activities and assess if these can be imitated or
improved upon.
8 Performance reports
Once an assessment of performance has been undertaken a summary report should be produced,
listing out the performance against specified targets (usually in the form of a table). This table may
well form part of an appendix to a report, to avoid the user being initially overloaded with data.
In the main report itself a section pointing out the key observations from the performance assessment
will be useful to the user to recognise the really important aspects of the assessment.

lOMoARcPSD|15213202
155
Solutions to
Lecture examples
Chapter 1
No lecture examples.
Chapter 2
Lecture example 1
What is the linear function for these variables?
Output Total cost
(units) ($)
(x) (y) xy x2
26 6,566 170,716 676
30 6,510 195,300 900
33 6,800 224,400 1,089
44 6,985 307,340 1,936
48 7,380 354,240 2,304
50 7,310 365,500 2,500
231 41,551 1,617,496 9,405
6 × 1,617,496 − 231 × 41,551 106,695

𝑏𝑏 = = = 34.765
6 × 9,405 − 2312 3,069
41,551 231
𝑎𝑎 = − 34.765 = 5,587
6 6

lOMoARcPSD|15213202
156 So l u t i o n s t o l e ct u re e xamp l e s A C C A MA
This means the fixed cost per period is $5,587 (to the nearest $), and the variable cost per unit is
$34.77 to the nearest cent.
The linear function is thus:
Total cost = $5,587 + ($34.77 × units)
What is the correlation coefficient?
6 × 1,617,496 - 231 × 41,551
r= (6 × 9,405 - 231 )(6 × 288,423,181 - 41,551 )
2 2
106,695
r= (3,069 )(4,053,485 )
106,695
r = 111,535
r = 0.957
What is the coefficient of determination?
r2 = 0.9572
= 0.915849
Lecture example 2
We have established that TC = $5,587 + $34.77Q
Total cost = $5,587 + ($34.77 × 40) = $6,978
Quarter 3 of year 4 would be Q = 15, therefore
Sales = 4,500 + 200(15) = 7,500 units
Lecture example 3
Trend = 12.2 + 1.3(3) = 16.1
Time series forecast = 16.1 + 1.6 = 17.7
Lecture example 4
TS = T × S
200,000 = T × 0.76
Therefore, Trend = 200,000/0.76 = $263,158

lOMoARcPSD|15213202
A C C A MA So l u t i o n s t o l e ct u re e xamp l e s 157
Lecture example 5
Seasonal
Year Quarter Sales (TS) Moving Centred Moving Variation
Average Average (T) (TS–T)
1 1 $60,000
2 $144,000
$160,500
3 $198,000 $162,000 +$36,000
$163,500
4 $240,000 $168,000 +$72,000
$172,500
2 1 $72,000 $176,250 –$104,250
$180,000
2 $180,000 $182,750 –$2,750
$185,500
3 $228,000 $189,750 +38,250
$194,000
4 $262,000 $196,500 +$65,500
$199,000
3 1 $106,000 $202,000 –$96,000
$205,000
2 $200,000 $208,000 –$8,000
$211,000
3 $252,000 $214,571
4 $286,000 $221,142
4 1 $127,588 $227,713 –$100,125
2 $228,909 $234,284 –$5,375
3 $277,980 $240,855 +37,125
4 $316,176 $247,426 +68,750

Figures in bold are based on workings that follow.
Step 1: Calculate the moving averages.
Step 2: Centre the moving averages (only needed if using an even number for the averages) to
give the trend.
Step 3: Calculate seasonal variations (either additive or proportional {multiplicative basis}).
Step 4: Forecast.
Now because the average has been calculated over an even number of periods it does not line up
against an individual quarter. So a second moving average of two is taken:
The centred moving average is the trend. So from quarter 3 of year 1 to quarter 2 of year 3 the trend
has moved from $162,000 to $208,000; which is an average quarterly increase of:
($208,000−$162,000)
= $6,571 per quarter
7

lOMoARcPSD|15213202
By summarising the seasonal variation column we have the following:

Year 1 – – +$36,000 +$72,000
Year 2 –$104,250 –$2,750 +$38,250 +$65,500
Year 3 –$96,000 –$8,000 – –
Average –$100,125 –$5,375 +$37,125 +$68,750
It is now possible to forecast the year 4 sales using the trend movement and seasonal fluctuations we
have calculated (see figures in bold on the original table). For example, year 4 Q1 working would be as
follows:
Trend = 208,000 + (3 × 6,571) = 227,713 (this brings the trend forward from Q2 of year 3).
Seasonal = –100,125 (as per above)
Therefore forecast = 227,713 – 100,125 = 127,588
Chapter 3
Lecture example 1
Winnings Probability EV
$ $
1,000,000 × 0.45 = 450,000
500,000 × 0.35 = 175,000
100,000 × 0.20 = 20,000
645,000
Lecture example 2
∑(𝑥𝑥−𝑥𝑥̅ )2
𝜎𝜎 = �
𝑛𝑛
687,500
𝜎𝜎 = � 4
= 415
Lecture example 3
∑ 𝑓𝑓𝑥𝑥 2
𝜎𝜎 = � ∑ 𝑓𝑓
− 𝑥𝑥̅ 2
82,445,000
𝜎𝜎 = � 1,360
− 2372
= 67

lOMoARcPSD|15213202
Chapter 4
Lecture example 1
Output Total cost
(units) ($)
High 50 7,310
Low 26 6,566
Difference 24 744
Variable cost per unit = $744 ÷ 24 = $31

Using the high output level fixed costs can now be estimated as follows:
TC = FC + VC
Therefore FC = TC – VC = 7,310 – ($31 × 50) = $5,760
A cost equation could then be written as:
TOTAL COST = $5,760 + ($31 × no of units)
Chapter 5
Lecture example 1
Co = $20
D = 500 units × 12months = 6,000 units per annum
Ch = $1.20 @ 20% = $0.24
2 × 20 × 6,000
EOQ = � = 1,000 units
0.24
6,000 1,000
Total annual cost = �20 × � + �0.24 × � = $𝟐𝟐𝟐𝟐𝟐𝟐
1,000 2
By ordering 1,000 units of inventory whenever Paton places an order, the total annual variable
inventory costs are minimised at $240.
Lecture example 2
At the EOQ of 1,000 units (per Lecture example 1):
6,000 1,000
TAC = 20 × + 0.24 × + 1.20 × 6,000 = $𝟐𝟐, 𝟐𝟐𝟐𝟐𝟐𝟐
1,000 2
At 2,000 units:
6,000 2,000
TAC = 20 × + ((1.20 × 95%)@20%) × + (1.20 × 95%) × 6,000 = $𝟐𝟐, 𝟏𝟏𝟐𝟐𝟐𝟐
2,000 2
At 3,000 units:
6,000 3,000
TAC = 20 × + ((1.20 × 90%)@20%) × + (1.20 × 90%) × 6,000 = $𝟏𝟏, 𝟐𝟐𝟐𝟐𝟐𝟐
3,000 2
By ordering 3,000 units of inventory whenever Paton places an order, the total annual variable
inventory costs are minimised at $6,844.

lOMoARcPSD|15213202
Lecture example 3
FIFO
Workings
Date No of units Cost/unit Value
$ $
1 Jan 200 10.00 2,000
3 Jan 150 10.40 1,560
5 Jan (100) 10.00 (1,000)
10 Jan 60 10.50 630 Cost of sales
14 Jan 140 10.60 1,484 $3,040 (1,000 + 1,000 + 1,040)
(100) 10.00 (1,000)
19 Jan
(100) 10.40 (1,040)
Closing 250 2,634
inventory
Profit calc
$
Sales (100 × 12.50) + (200 × 12.75) 3,800
COS (see above) (3,040)
Profit 760
LIFO
$ $
1 Jan 200 10.00 2,000
3 Jan 150 10.40 1,560
5 Jan (100) 10.40 (1,040)
14 Jan 140 10.60 1,484 $3,154 (1,040 + 1,484 + 630)
(140) 10.60 (1,484)
19 Jan
(60) 10.50 (630)
Closing stock 250 2,520
Profit calc
$
Sales (100 × 12.50) + (200 × 12.75) 3,800
Profit 646
AVCO (WEIGHTED AVERAGE) A new average price needs to be recalculated each time a
purchase is made at a different price to the existing average price.

$ $
1 Jan 200 10.00 2,000
3 Jan 150 10.40 1,560
350 10.17 3,560
5 Jan (100) 10.17 (1,017)
14 Jan 140 10.60 1,484 $3,087 (1,017 + 2,070)
450 10.35 4,657
19 Jan (200) 10.35 (2,070)
Closing 250 2,587
inventory

lOMoARcPSD|15213202
Profit calc
$
Sales (100 × 12.50) + (200 × 12.75) 3,800
Profit 713
Chapter 6
Lecture example 1
(1) This is direct as the cost directly relates to each unit produced. We are also told that this is a
direct labour employee.
(2) This is an indirect cost; the fact that certain units were made outside normal working hours and
so paid extra, has nothing to do with the specific units.
(3) This will almost certainly be an indirect cost as it is unlikely that a Group Incentive Scheme
relates to individual items made.
So the labour cost can be analysed as follows:
$
Direct labour cost 800
Indirect labour cost 50 + 200 = 250
Total 1,050
Lecture example 2
(40 × 1.5) + (100 × 0.8) + (18 × 2.0)
This worker has produced 176 standard hours of output in his 160 hr working month (i.e. the worker
has worked 10% more efficiently than was expected ….. or the standard was not accurate enough).
This worker will receive $1,760 (176 × $10) for January.
Lecture example 3
22,000 units ×(100,000 hours/20,000 units)
Labour Efficiency Ratio = = 95.65%
115,000 hours
115,000 hours
Labour Capacity Ratio = = 115%
100,000 hours
22,000 units ×(100,000 hours/20,000 units)
Labour Production Volume Ratio = = 110%
100,000 hours
Or 95.65% × 115% = 110%

lOMoARcPSD|15213202
Chapter 5
Lecture example 1
What is the production overhead for each department?
$ $ $ $
Assembly Supervisor 3,000 Allocate 3,000
Finishing Quality Inspector 4,500 Allocate 4,500
Chef 2,500 Allocate 2,500
Rent 22,000 Floor Area 12,000 6,000 4,000
Heat & Light 18,000 Volume 12,000 4,500 1,500
Overheads 50,000 27,000 15,000 8,000
Lecture example 2
$ $ $ $ $
Overheads 50,000 27,000 15,000 8,000
No of
Reapportionment nil employees 4,000 4,000 (8,000)
Overheads 50,000 31,000 19,000 nil
Lecture example 3
Let C = the total production overhead of the Canteen
M = the total production overhead of the Maintenance
Then C = 17,600 + 0.2M
M = 10,000 + 0.1C
Thus C = 17,600 + 0.2(10,000 + 0.1C)
C = 17,600 + 2,000 + 0.02C
C – 0.02C = 19,600
0.98C = 19,600
C = 19,600 / 0.98
C = 20,000
So M = 10,000 + (0.1 × 20,000)
M = 10,000 + 2,000
M = 12,000
Total Basis Sawing Polishing Canteen Maintenance
$ $ $ $ $
Overheads 100,000 41,300 31,100 17,600 10,000
Canteen nil % given 10,000 8,000 (20,000) 2,000
Maintenance nil % given 4,800 4,800 2,400 (12,000)
Overheads 100,000 56,100 43,900 nil nil

lOMoARcPSD|15213202
Lecture example 4
It can be seen that the Sawing Department is largely automated and so using cost per machine hour to
calculate the overhead absorption rate would seem appropriate.
Sawing Production Overhead
OAR =
Machine Hours
$56,100
= 5,610 hours
= $10 per machine hour

It can be seen that the Polishing Department is largely manual and so using cost per labour hour to
calculate the overhead absorption rate would seem appropriate.
Polishing Production Overhead
OAR =
Labour Hours
$43,900
= 8,780 hours
= $5 per labour hour
Lecture example 5
Sawing Department
$
Overhead absorbed $10 × 5,300 hours = 53,000
Overhead incurred (actual amount) 54,345
Under absorbed overhead 1,345
Polishing Department
$
Overhead absorbed $5 × 9,121 hours = 45,605
Overhead incurred (actual amount) 45,098
Over absorbed overhead 507
Chapter 8
Lecture example 1
What is the profit or loss under absorption and marginal costing for Millie Co in March and April?
Absorption costing
March April
$ $
Sales ($35 per unit) 52,500 105,000
Less cost of sales: (variable & fixed $20 per unit) (30,000) (60,000)
22,500 45,000
(Under)/over-absorption (see workings below) (5,000) 1,000
Gross profit 17,500 46,000
Selling and distribution costs – variable (7,875) (15,750)
– fixed (10,000) (10,000)
(Loss)/Profit (375) 20,250

lOMoARcPSD|15213202
Workings
March
Overheads absorbed (actual × OAR (2,000 × $5) $10,000
Overheads incurred (Actual) $15,000
Under-absorption $5,000
April
Overheads absorbed (actual × OAR) (3,200 × $5) $16,000
Overheads incurred (Actual) $15,000
Over-absorption $1,000
Marginal Costing
March April
$ $
Sales ($35 per unit) 52,500 105,000
Less cost of sales: (variable only $15 per unit) (22,500) (45,000)
30,000 60,000
Less variable selling and distribution costs (7,875) (15,750)
Contribution 22,125 44,250
Less actual fixed production costs (15,000) (15,000)
Less actual fixed selling and distribution costs (10,000) (10,000)
(Loss)/Profit (2,875) 19,250
Lecture example 2
March April
$ $
Absorption costing (loss)/profit (375) 20,250
Add: Opening inventory × Fixed overhead absorption rate Nil 2,500
500 × $5
Less: Closing inventory × Fixed overhead absorption rate (2,500)
500 × $5
700 × $5 (3,500)
Marginal costing (loss)/profit (2,875) 19,250

lOMoARcPSD|15213202
Chapter 9
Lecture example 1
$24,000
Department 1: Cost per unit = = $24
1,000 units

Units $ Units $
Transfer from 1,000 24,000 Normal loss
Department 1
Direct labour 4,000
Departmental overheads 3,000 Transfer to Finished goods 1,000 36,000
1,000 36,000 1,000 36,000
$36,000
Department 2: Cost per unit = = $36
1,000 units
Lecture example 2
Units $ Units $
Raw materials 1,000 10,000 Normal loss 100 500
Direct labour 8,000
1,000 24,000 1,000 24,000
$23,500
900 units

Units $ Units $
Transfer from 900 23,500 Normal loss 45 225
Department 1
Direct labour 4,000
900 35,500 900 35,500
$35,275
855 units

lOMoARcPSD|15213202
Lecture example 3
Units $ Units $
Raw materials 1,000 10,000 Normal loss 100 500
Direct labour 8,000 Abnormal loss 40 1,044
1,000 24,000 1,000 24,000
$23,500
Department 1: Cost per unit = = $26.11 (unchanged)
900 units

Units $ Units $
Transfer from 860 22,456 Normal loss 43 215
Department 1
Additional raw materials 5,000 Abnormal gain (13) (545)
Direct labour 4,000
860 34,456 860 34,456
$34,456−$215
860 units − 43 units
Abnormal losses and gains account

Units $ Units $
Department 1 40 1,044 Department 2 13 545
Cash – scrap proceeds 27 135
Transfer to Income 364

Statement
40 1,044 40 1,044
In Department 1 we lost 40 units which should have been worth $26.11, but instead were worth $5.
Thus giving a loss = 40 units × ($26.11 – $5) = $844.40.
In Department 2 we gained 13 units which should have been worth $5, but instead were worth $41.91.
Thus giving a gain = 13 units × ($41.91 – $5) = $479.83.
Hence there is an overall loss of $844.40 – $479.83 = $364.57.

lOMoARcPSD|15213202
Lecture example 4
$24,080
The cost per equivalent unit of process outputs = = $28
800 units + (200 units @ 30%)
Process 1 Account
Units $ Units $
Direct labour 7,100 Transfer to Department 2 800 22,400
Departmental overheads 7,100 Closing WIP 200 1,680
1,000 24,080 1,000 24,080
Lecture example 5
What is the value of the units transferred out and the closing WIP using the weighted average and
FIFO methods?
WEIGHTED AVERAGE METHOD
PROCESS A/C
Units $ Units $
Opening WIP 800 47,450
Raw materials ? 200,000 Transfer to Process 2 3,400 ?
Conversion 172,000 Closing WIP 600 ?
4,000 419,450 4,000 419,450

Costs:
Opening WIP 47,450 40,000 7,450
Inputs 372,000 200,000 172,000
Total 419,450 240,000 179,450
Equivalent units:
Transfer to Process 2 3,400 3,400 3,400
Closing WIP 600 600 300
Total 4,000 4,000 3,700
Cost per equivalent unit $60.00 $48.50

Valuation:
Transfers to Process 2 = 3,400 units × ($60.00 + $48.50) = $368,900
Closing WIP = (600 units × $60.00) + (300 units × $48.50) = $50,550
FIFO METHOD
PROCESS A/C
Units $ Units $
Opening WIP 800 47,450
Raw materials 200,000 Transfer to Process 2 3,400 ?
Conversion 172,000 Closing WIP 600 ?
4,000 419,450 4,000 419,450

lOMoARcPSD|15213202

Costs:
Inputs 372,000 200,000 172,000
Total 372,000 200,000 172,000
Equivalent units:
Finishing Opening WIP 800 nil 600
Started & Finished 2,600 2,600 2,600
Closing WIP 600 600 300
Total 4,000 3,200 3,500
Cost per equivalent unit $62.50 $49.14

Valuation:
Transfers to Process 2:
Opening WIP = $47,450 + (600 units × $49.14) = $76,936
Started & Finished = 2,600 units × ($62.50 + $49.14) = $290,271
Total $367,207
Closing WIP = (600 units × $62.50) + (300 units × $49.14) = $52,243
Lecture example 6
What is the cost of A and B apportioning the joint costs using sales value and number of units and
show the process account?
Sales Value:
Product A Product B Total
Sales value $10,000 $20,000 $30,000
Cost of sales $6,000 (W1) $12,000 $18,000
10,000
W1 – 20,000
× $18,000
PROCESS A/C
Units $ Units $
Direct labour 5,000 Product A 2,000 6,000
Overheads 3,000 Product B 8,000 12,000
10,000 18,000 10,000 18,000
Number of units:
Product A Product B Total
Number of units 2,000 8,000 10,000
Cost of sales $3,600 (W2) $14,400 $18,000
2,000
W2 – 10,000
× $18,000
PROCESS A/C
Units $ Units $
Direct labour 5,000 Product A 2,000 3,600
Overheads 3,000 Product B 8,000 14,400
10,000 18,000 10,000 18,000

lOMoARcPSD|15213202
Chapter 10
Lecture example 1
Job accounts
JOB 123
$ $
Balance b/f 1,470 Job 125 a/c 620
Materials (stores a/c) 2,390 (materials transfer)
Labour (wages a/c) 2,150 Stores a/c (materials returned) 870
Production overhead (o’hd a/c) 860 Cost of sales a/c (balance) 5,380
6,870 6,870
JOB 124
$ $
Materials (stores a/c) 1,680 Cost of sales a/c (balance) 6,480
Labour (wages a/c) 3,250
Production overhead (o’hd a/c) 1,300
Job 125 a/c (materials transfer) 250
6,480 6,480
JOB 125
$ $
Materials (stores a/c) 3,950 Job 124 a/c (materials transfer) 250
Labour (wages a/c) 1,400
Production overhead (o’hd a/c) 560 Cost of sales a/c (balance) 6,280
Job 123 a/c (materials transfer) 620
6,530 6,530
Job cards, summarised

JOB 123 JOB 124 JOB 125
$ $ $
Materials 1,530* 1,930** 4,320***
Labour 2,750 3,250 1,400
Production overhead 1,100 1,300 560
Factory cost 5,380 6,480 6,280
Admin & marketing o’hd (20%) 1,076 1,296 1,256
6,456 7,776 7,536
*$(630 + 2,390 – 620 – 870)

**$(1,680 + 250)
***$(3,950 + 620 – 250)

lOMoARcPSD|15213202
Chapter 11
Lecture example 1
We need to prepare a flexible budget for 700 units.
Original Flexible
Budget Budget Actual Variances
1,000 units 700 units 700 units
$ $ $ $
Sales 30,000 21,000 21,200 200 (F)
Variable costs
Direct material 10,000 7,000 6,600 400 (F)
Direct labour 5,000 3,500 3,800 300 (A)
Variable production overhead 3,000 2,100 2,200 100 (A)
18,000 12,600 12,600 –
Contribution 12,000 8,400 8,600 200 (F)
Fixed costs 10,000 10,000 10,400 400 (A)
Profit/(loss) 2,000 (1,600) (1,800) 200 (A)
Workings
(1) Sales
$30,000 / 1,000 units = $30 selling price per unit.
Flexible budget sales 700 units @ $30 = $21,000
(2) Direct material
$10,000 / 1,000 units = $10 per unit.
Flexible budget = 700 units @ $10 = $7,000
(3) Direct labour
$5,000 / 1,000 units = $5 per unit.
(4) Production overhead
$3,000 / 1,000 units = $3 per unit.
By flexing the budget in the question above we are able to compare performance on a like for like
basis. The effect on profit of the difference between budgeted sales volume and actual sales volume
has been removed. The sales variance however is $200 (F). This means that the actual selling price
must have been different to the budgeted selling price, resulting in a $200 (F) selling price variance.
Despite this the overall performance is $200 worse than it should have been. Control of material cost
has been very good as this has been $400 better than expected but all other costs are worse than
expected. Labour and fixed costs are the worst areas which need to be brought back into line.

lOMoARcPSD|15213202
Chapter 12
Lecture example 1
Prepare budgets for sales, production, materials (usage and purchases), labour and overheads.
Good Bad
Sales Budget:
Maximum demand 4,300 units 3,600 units
Selling price per unit $15 $20
Revenue $64,500 $72,000
Production Budget: Good Bad

Sales 4,300 3,600
Closing inventory 50 nil
Less: opening inventory (200) (100)
Production 4,150 units 3,500 units
Material Usage:
Materials per unit 12 kg 14 kg
Material Usage 49,800 kg 49,000 kg
Material Purchases:
Total material usage 98,800 kg
Closing inventory 800 kg
Less: opening inventory (2,900) kg
Material Purchases 96,700 kg
Labour:
Labour per unit 1 hr 2 hrs
Labour per product 4,150 hours 7,000 hours
Total labour 11,150 hours
Overheads:
Total overhead $17,840
Total labour 11,150 hours
Overhead per labour hour $1.60
Labour per product 4,150 hours 7,000 hours
Overhead per product $6,640 $11,200

lOMoARcPSD|15213202
Lecture example 2
Prepare a cash budget for Jones Co on a monthly basis for Jan-Apr 20X8. Jan sales not received until
April after three months’ credit is taken.
Jan Feb Mar Apr
$ $ $ $ Jan sales not
Cash receipts received until
From customers (receivables) 80,000 April after
3 months’
Share capital introduced 350,000 credit is taken.
Total receipts 350,000 0 0 80,000
Cash payments Just 1 month
To suppliers (payables) 50,000 60,000 72,000 delay between
Other 20,000 20,000 20,000 20,000 making the
Non-current assets 100,000 purchase and
paying in cash.
Total payments 120,000 70,000 80,000 92,000
Net cash flow 230,000 (70,000) (80,000) (12,000)
Opening balance 0 230,000 160,000 80,000
Closing balance 230,000 160,000 80,000 68,000
Lecture example 3
Calculate the monthly receipts from customers for the next six months if 30% of credit customers take
up the company’s offer.
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6
Sales (for reference only) 100,000 110,000 120,000 130,000 140,000 150,000
Cash sales (60%) 60,000 66,000 72,000 78,000 84,000 90,000

Credit sales – 1 month
(@40% × 30% × 90% ×
10,800 11,880 12,960 14,040 15,120
previous mth sales)
10.8% × prev mth sales
Credit sales – 3 months
(@40% × 70% × sales 3
28,000 30,800 33,600
mths ago)
28% × sales 3 mths ago
Cash receipts 60,000 76,800 83,880 118,960 128,840 138,720

lOMoARcPSD|15213202
Lecture example 4
Prepare a budgeted income statement and statement of financial position for the three months to
31 March 20X6.
Budgeted Income statement for the three months ended 31 March 20X6
$ $
Sales (15,000+25,000+35,000) 75,000
Cost of sales (60% × $75,000) 45,000
Gross profit 30,000
Expenses
General business expenses (3 × $3,000) 9,000
Depreciation ({$40,000/8 years} × 3/12 1,250
10,250
Net profit 19,750
Budgeted statement of financial position at 31 March 20X6

$ $
ASSETS
Non-current assets ($40,000 less $1,250 depreciation) 38,750
Current assets
Inventories 10,000
Receivables (1 month i.e. March sales) 35,000
45,000
83,750
EQUITY AND LIABILITIES

Proprietors interest
Capital introduced 50,000
Profit for period 19,750
Less drawings (3 × $2,000) 6,000
13,750
63,750
Current liabilities
Bank overdraft 20,000
83,750
Chapter 13
Lecture example 1
Johnny invests $100 now (sometimes referred to as T0) for three years.
Simple interest of 10% will earn Johnny $10 (10% × $100) per year for three years (i.e. total interest
earned over 3 years = $30). Therefore, at the end of 3 years, the investment will be worth $130.
Compound interest of 10% will mean that Johnny’s investment will be:
S = X [1 + r]n
= $100 (1 + 0.1)3
= $133.10

lOMoARcPSD|15213202
Lecture example 2
Nick invests $400 now with compound interest at 10% but at the end of year 4 he withdraws $200, but
keeps the rest invested for another three years.
How much is there at the end of year 7?
$
S4 = 400 (1.1)4 = 586
withdrawal (200)
Balance at the end of Yr 4 = 386
S7 = 386(1.1)3 = 514
Lecture example 3
$1,000 is invested for three years at a 4% six-monthly interest rate.
At the end of the three years, the investment will be worth:
Future value (S) = X (1+r)n
= $1,000(1.04)6
= $1,265.32
Lecture example 4
(1+R) = (1+r)n
R = (1+r)n –1 = (1.04)2 – 1
= 8.16%
Lecture example 5
$1,000 is invested now at nominal annual interest rate of 13%, interest compounded monthly. At the
end of the first year, the investment will have grown to:
Nominal rate 13%
13%
Monthly rate = = 1.083%
12
∴ at the end of the first year (12 compound periods), investment = $1,000 (1.01083)12
= $1,138
Lecture example 6
Money Bags is expecting to receive $16,751 in 6 years. Interest rates will be 5% for the whole 6 years.
The present value of Money Bags’ receipt
Future Value (S) = $16,751
r = 0.05
n =6
1
So the present value, X = 16,751 × = 16,751 × 0.7462 = $12,500
(1+0.05) 6
This fraction is often referred to as the “discount factor”

lOMoARcPSD|15213202
Lecture example 7
£10,000
PV = = £8,734
(1.07) 2
Lecture example 8
£10,000
PV = = £8,012.51
(1.07)×(1.08) 2
Lecture example 9
Henry is going to receive $150 every year for 12 years. The annual interest rate is 6%.
The present value of Henry’s annuity is.
1 1
$150 × �1 − [1.06] 12 �
0.06
= $150 × 8.384 = $1,258

Similar to above, the same answer can be derived by using the cumulative present value table given
on the formulae sheet:
So PV = $150 × 8.384 = $1,258
Lecture example 10
Victoria is expecting to receive $2,000 a year for ever. Interest rates are expected to remain constant
at 5%.
The present value of Victoria’s perpetuity is
2,000
So PV = 2,000 × 1/0.05 = = $40,000
0.05
Chapter 14
Lecture example 1
Payback period
Annual cash flow Cumulative cash flow
$ $
Investment (80,000) (80,000)
First year 15,000 (65,000)
Second year 20,000 (45,000)
Third year 25,000 (20,000)
Fourth year 30,000 10,000
So the payback period is 4 years or if we assume that the cash flows come in evenly throughout each
year:
20,000 2
3+ = 3 years
30,000 3

lOMoARcPSD|15213202
Lecture example 2
Timing Cash flow Discount Factor Present Value
$ 10% $
0 (80,000) 1.000 (80,000)
1 15,000 0.909 13,635
2 20,000 0.826 16,520
3 25,000 0.751 18,775
4 30,000 0.683 20,490
5 35,000 0.621 21,735
NPV = 11,155
Lecture example 3
Calculate the approximate IRR for Horizon Ltd.
Timing Cash flow Discount Present Discount Present
Factor Value Factor Value
$ 10% $ 20% $
0 (80,000) 1.000 (80,000) 1.000 (80,000)
1 15,000 0.909 13,635 0.833 12,495
2 20,000 0.826 16,520 0.694 13,880
3 25,000 0.751 18,775 0.579 14,475
4 30,000 0.683 20,490 0.482 14,460
5 35,000 0.621 21,735 0.402 14,070
11,155 (10,620)
11,155
IRR ≈ 10 + 11,155 –(10,620)
× (20 – 10)
= 15.1%

lOMoARcPSD|15213202
Chapter 15
Lecture example 1
Materials variances
TOTAL MATERIALS
18,000 rackets $
Should cost (18,000 × $9) 162,000
Did cost 165,000
VARIANCE 3,000 (A)
MATERIALS PRICE MATERIALS USAGE

5,600 kg purchased $ 18,000 rackets kg
Should cost (5,600 × $30) 168,000 Should use (18,000 × 0.3kg) 5,400
Did cost 165,000 Did use 5,600
VARIANCE 3,000 (F) VARIANCE in kg 200 (A)
Valued at the standard cost per kg $30
VARIANCE in $ 6,000 (A)
Labour variances
TOTAL LABOUR
18,000 rackets $
Should cost (18,000 × $24) 432,000
Did cost 405,000

VARIANCE 27,000 (F)
LABOUR RATE LABOUR EFFICIENCY

33,000 hrs $ 18,000 rackets hrs
Should cost (33,000 × $12 ) 396,000 Should use (18,000 × 2 hrs) 36,000
VARIANCE 9,000 (A) VARIANCE in hrs 3,000 (F)
Valued at the standard cost per hr $12
VARIANCE in $ 36,000 (F)

lOMoARcPSD|15213202
Lecture example 2
What was the work force actually paid per hour?
LABOUR RATE
10,400 hrs $
Should cost (10,400 × $5 ) 52,000
Did cost ?
VARIANCE 416 (A)
? = 52,000 + 416 = $52,416 for 10,400 hours
So the work force was actually paid $5.04 per hour.
Chapter 16
Lecture example 1
Sales variances
SALES PRICE SALES VOLUME
For 18,000 rackets $ Rackets
Actual revenue 1,245,000 Actual sales 18,000
Expected revenue (18,000 × $70) 1,260,000 Budget sales 15,000
VARIANCE 15,000 (A) Variance in rackets 3,000 (F)

Valued at STANDARD PROFIT $13
Variable overhead variances

TOTAL VARIABLE OVERHEAD
18,000 rackets $
Should cost (18,000 × $8) 144,000
Did cost 135,000
VARIANCE 9,000 (F)
VARIABLE OVERHEAD EXPENDITURE VARIABLE OVERHEAD EFFICIENCY

33,000 hrs $ 18,000 rackets hrs
Should cost (33,000 × $4) 132,000 Should use (18,000 × 2 hrs) 36,000
VARIANCE 3,000 (A) VARIANCE in hrs 3,000 (F)
Valued at the standard cost per hr $4
VARIANCE in $ 12,000 (F)

lOMoARcPSD|15213202
Fixed overhead variances

TOTAL FIXED OVERHEAD
18,000 rackets $
Should cost (18,000 × $16) 288,000
Did cost 260,000
VARIANCE 28,000 (F)
FIXED OVERHEAD EXPENDITURE FIXED OVERHEAD VOLUME

$ Rackets
Budgeted cost (15,000 × $16) 240,000 Actual production 18,000
Actual cost 260,000 Budget production 15,000
VARIANCE 20,000 (A) Variance in rackets 3,000 (F)
Valued at standard cost $16

FIXED OVERHEAD CAPACITY FIXED OVERHEAD EFFICIENCY
hrs 18,000 rackets hrs
Did take 33,000 Should use (18,000 × 2 hrs) 36,000
Budgeted to take (15,000 × 2 hrs) 30,000 Did use 33,000
VARIANCE in hrs 3,000 (F) VARIANCE in hrs 3,000 (F)
Valued at the standard cost per hr $8 Valued at the standard cost per hr $8
VARIANCE in $ 24,000 (F) VARIANCE in $ 24,000 (F)
Lecture example 2
An adverse materials usage variance, due to needing more materials because of the poor quality.
A favourable materials price variance, due to the lower materials price.
An adverse labour efficiency variance (and variable and fixed overhead efficiency variances), due to a
drop in productivity because of the poor quality materials.
An adverse labour rate variance, due to having to pay the staff overtime for working extra hours to
deal with the poor quality materials.
An adverse fixed overhead volume variance, due to a drop in actual production because of the poor
quality materials.
An adverse sales price variance, due to the lower quality of the final product.
An adverse sales volume variance, due to the lower quality of the final product.
Chapter 17
No lecture examples.

lOMoARcPSD|15213202
Chapter 18
Lecture example 1
Calculate the annual ROI and RI for each division.
Smith Jones
ROI
× 100
Divisional net assets 2,375 2,000
16% 12%
RI
Notional interest (divisional net assets × 10%) 237.5 200
Residual Income 142.5 40
Chapter 19
Lecture example 1
Calculate the activity, efficiency and capacity ratios.
(2ℎ𝑟𝑟𝑑𝑑 𝑥𝑥 1,050 𝑜𝑜𝑛𝑛𝑛𝑛𝑓𝑓𝑑𝑑) 2,100 𝑑𝑑𝑓𝑓𝑑𝑑 ℎ𝑟𝑟𝑑𝑑 𝑝𝑝𝑟𝑟𝑑𝑑𝑑𝑑𝑜𝑜𝑝𝑝𝑖𝑖𝑑𝑑
𝐀𝐀𝐐𝐐𝐩𝐩𝐩𝐩𝐌𝐌𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 = = = 1.05 𝑑𝑑𝑟𝑟 𝟏𝟏𝟐𝟐𝟏𝟏%
(2ℎ𝑟𝑟𝑑𝑑 𝑥𝑥 1,000 𝑜𝑜𝑛𝑛𝑛𝑛𝑓𝑓𝑑𝑑) 2,000 𝑑𝑑𝑓𝑓𝑑𝑑 ℎ𝑟𝑟𝑑𝑑 𝑏𝑏𝑜𝑜𝑑𝑑𝑏𝑏𝑖𝑖𝑓𝑓𝑖𝑖𝑑𝑑
2,100 𝑑𝑑𝑓𝑓𝑑𝑑 ℎ𝑟𝑟𝑑𝑑 𝑝𝑝𝑟𝑟𝑑𝑑𝑑𝑑𝑜𝑜𝑝𝑝𝑖𝑖𝑑𝑑

𝐄𝐄𝐩𝐩𝐩𝐩𝐩𝐩𝐐𝐐𝐩𝐩𝐌𝐌𝐌𝐌𝐐𝐐𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 = = 1.167 𝑑𝑑𝑟𝑟 𝟏𝟏𝟏𝟏𝟏𝟏. 𝟐𝟐%
1,800 𝑎𝑎𝑝𝑝𝑓𝑓𝑜𝑜𝑎𝑎𝑛𝑛 ℎ𝑟𝑟𝑑𝑑
1,800 𝑎𝑎𝑝𝑝𝑓𝑓𝑜𝑜𝑎𝑎𝑛𝑛 ℎ𝑟𝑟𝑑𝑑

𝐀𝐀𝐂𝐂𝐩𝐩𝐂𝐂𝐐𝐐𝐩𝐩𝐩𝐩𝐢𝐢 𝐩𝐩𝐂𝐂𝐩𝐩𝐩𝐩𝐩𝐩 = = 0.9 𝑑𝑑𝑟𝑟 𝟗𝟗𝟐𝟐%
2,000 𝑏𝑏𝑜𝑜𝑑𝑑𝑏𝑏𝑖𝑖𝑓𝑓 ℎ𝑟𝑟𝑑𝑑
This information tells us that overall 5% more output was produced than budgeted. This was achieved
through very efficient working during the time the staff were able to work since the efficiency was
nearly 17% above standard efficiency whilst the workers were not able to work as many hours as
budgeted (only 90% of budget time was available).
This may have been due to illness, strikes or simply that there was not enough demand for the
products to require them to work more than 1,800 hours.

lOMoARcPSD|15213202
181
Formulae sheets

lOMoARcPSD|15213202
182 Fo rmu l ae s h e e t s A C C A MA

lOMoARcPSD|15213202
A C C A MA Fo rmu l ae s h e e t s 183

lOMoARcPSD|15213202

lOMoARcPSD|15213202
A C C A MA Fo rmu l ae s h e e t s 185

lOMoARcPSD|15213202

lOMoARcPSD|15213202
187
Comparison of course notes

content with study text
The table below shows where topics covered in these course notes are included within the Study Text.
The Study Text provides useful background reading however, please note that we do not think that
you need to read the study text to pass this exam. These course notes should provide all you need to
obtain a pass.
Course notes Covered in Study Text
Chapter 1: Management accounting and Chapter 1: Accounting for Management
information
1 Accounting for management Chapter 2: Sources of Data and Analysing Data
2 Planning, decision-making and control
3 Data and information
Chapter 3: Presenting Information
4 Sampling
5 Presenting information
Chapter 2: Statistical techniques Chapter 12: Forecasting techniques
1 Statistical techniques
Chapter 17: Spreadsheets
Chapter 3: Summarising and analysing data Chapter 2: Sources of Data and Analysing Data
1 Expected values
2 Averages and distributions
Chapter 4: Costing Chapter 1: Accounting for Management
1 Cost classification
2 Cost behaviour Chapter 4: Cost Classification
3 Cost coding
4 Cost measurement
5 Management of business units

lOMoARcPSD|15213202
188 Co mp ari s o n o f c o u rse n o te s c o nt e n t w i t h s t u d y t e xt A C C A MA

Chapter 5: Accounting for materials Chapter 5: Accounting for Materials
1 Accounting for materials
Chapter 6: Accounting for labour Chapter 6: Accounting for Labour
1 Accounting for labour
Chapter 7: Accounting for overheads Chapter 7: Accounting for Overheads
1 Accounting for overheads
Chapter 8: Absorption and marginal costing Chapter 8: Absorption and Marginal Costing
1 Absorption and marginal costing compared
Chapter 9: Process costing Chapter 9: Job, Batch and Process Costing
1 Process costing
Chapter 10: Other costing techniques Chapter 9: Job, Batch and Process Costing
1 Job and batch costing
2 Service and operation costing Chapter 10: Service and Operation Costing
3 Alternative cost accounting approaches
Chapter 11: Alternative Costing Principles
Chapter 11: Nature and purpose of budgeting Chapter 13: Budgeting
1 Nature and purpose of budgeting
2 Budgetary control and reporting
3 Behavioural aspects of budgeting
4 Flexible budgets
Chapter 12: Budget preparation Chapter 13: Budgeting
1 Budget preparation
2 Capital budgeting
Chapter 13: Discounted cash flow Chapter 14: Capital Budgeting
1 Discounted cash flow
Chapter 14: Investment appraisal Chapter 1: Accounting for Management
1 Investment appraisal
Chapter 14: Capital Budgeting
Chapter 15: Material and labour variances Chapter 15: Standard Costing
1 Standard costing systems
Chapter 16: Other variances Chapter 15: Standard Costing
Chapter 17: Variance review and control Chapter 15: Standard Costing
1 Reconciliation of budgeted and actual profit
2 Cost control and reduction
Chapter 18: Financial performance measures Chapter 1: Accounting for Management
1 Performance measurement overview
2 Financial measures Chapter 16: Performance Measurement

lOMoARcPSD|15213202
A C C A MA Co mp ari s o n o f c o u rse n o te s c o nt e n t w i t h s t u d y t e xt 189

Chapter 19: Non-financial performance measures Chapter 16: Performance Measurement
and performance reporting
1 Non-financial measures
2 Balanced scorecard
3 Activity, efficiency and capacity ratios
4 Process and job performance measurement
5 Non-profit seeking and public sector organisations
6 Manufacturing and service businesses
7 Benchmarking
8 Performance reports
© With thanks to Kaplan Publishing Limited for permission to reproduce excerpts from their text in these notes.
For references and acknowledgements of materials used in these notes, please see the back of the study text

lOMoARcPSD|15213202
190 Co mp ari s o n o f c o u rse n o te s c o nt e n t w i t h s t u d y t e xt A C C A MA

Acca Ma Course Notes

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Acca Ma Course Notes

Uploaded by

Copyright:

Available Formats

lOMoARcPSD|15213202

Management Accounting (Association of Chartered Certified Accountants)

StuDocu is not sponsored or endorsed by any college or university

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

No part of this publication may be reproduced, stored in a retrieval system

Any unauthorised reproduction or distribution in any form is strictly

© First Intuition Ltd, 2020

APRIL 2020 RELEASE

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

1: Management accounting and information 1

1 Accounting for management 1

3: Summarising and analysing data 25

5: Accounting for materials 43

1 Accounting for materials 43

6: Accounting for labour 53

1 Accounting for labour 53

7: Accounting for overheads 59

1 Accounting for overheads 59

8: Absorption and marginal costing 65

1 Absorption and marginal costing compared 65

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

10: Other costing techniques 81

1 Job and batch costing 81

11: Nature and purpose of budgeting 89

1 Nature and purpose of budgeting 89

12: Budget preparation 97

13: Discounted cash flow 107

1 Discounted cash flow 107

14: Investment appraisal 115

1 Investment appraisal 115

15: Material and labour variances 121

1 Standard costing systems 121

16: Other variances 127

1 Variance calculations 127

17: Variance review and control 135

1 Reconciliation of budgeted and actual profit 135

18: Financial performance measures 139

1 Performance measurement overview 139

19: Non-financial performance measures and performance reporting 147

1 Non-financial measures 147

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

Solutions to lecture examples 155

Formulae sheets 181

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

2 The Management Accounting syllabus

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

Management accounting and

1 Accounting for management

Financial Accounting Cost and Management Accounting

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

2 Planning, decision-making and control

2.1.1 Strategic planning

2.1.2 Tactical planning

2.1.3 Operational planning

3 Data and information

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

3.2.1 Qualities of good information

3.2.2 Limitations of management information

3.2.3 Uses and limitations of published information

3.3 Sources of data and information

3.3.2 External sources

Downloaded by Jerlin Preethi (jerlinruban@gmail.com)

3.4 Big data and data analytics