COST MANAGEMENT SYSTEMS ACCT 2013 STUDY GUIDE Study Period 5, 2006

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© University of South Australia 2006

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CONTENTS
WELCOME HOW TO USE THIS STUDY GUIDE TOPIC 1 TOPIC 2 TOPIC 3 TOPIC 4 TOPIC 5 TOPIC 6 TOPIC 7 TOPIC 8 TOPIC 9 TOPIC 10 TOPIC 11 PROCESS COSTING JOINT COSTING PRICING & PRODUCT MIX DECISIONS ACTIVITY BASED MANAGEMENT& MANAGING CUSTOMERS MANAGING SUPPLIERS, INVENTORY & QUALITY RESPONSIBILITY ACCOUNTING, DECENTRALIZATION & TRANSFER PRICING FINANCIAL PERFORMANCE MEASURES & REWARD SYSTEMS CONTEMPORARY APPROACHES TO MEASURING PERFORMANCE CAPITAL BUDGETING CAPITAL BUDGETING: SOME ADDITIONAL ISSUES SOCIAL AND ENVIRONMENTAL ACCOUNTING COURSE OVERVIEW

Page 5 7 9 25 35 39 47 57 54 71 77 85 93 97

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They also list the tutorial questions for each topic. the contents from your textbook of chapters 1 to 7. This course expands and extends upon ACCT2006. Basil Tucker 4 . After increasing your knowledge of costing systems. The aim of this course is to expand your knowledge of management accounting and its application in both the private and public sectors. enjoyable and useful. as is being flexible in applying your knowledge. we focus even more so on the management of costs rather than on the costing of products. a course that includes a mix of traditional and contemporary management accounting topics. ACCT2013. Understanding rather than memorising is an essential part of this course. We hope you find your studies interesting. it is desirable that you are confident of your knowledge in these topics. Topic summaries are very important because they provide you with an overview of what you need to learn and supplement references in your textbook. In addition to teaching you about some new management accounting topics. and your learning should be organized around these topic summaries. which are the cornerstone and hub of the learning for this course. that is.ACCT 2013 Cost Management Systems Introduction WELCOME Welcome to Cost Management Systems. This Study Guide is comprised of a series of eleven topic summaries. Management Accounting. we also revise and revisit from a new perspective. Therefore. the flow of costs and costing of manufacturing overhead as taught in Management Accounting. You will need to be able to adapt to varying circumstances and learn that there may be a range of alternative answers to any given situation.

Social and Environmental Accounting: Topic 11. This topic will contrast and complement your previous studies in short term or tactical decision-making from Management Accounting. we will introduce you to two contemporary performance evaluation techniques.ACCT 2013 Cost Management Systems Introduction This course has five sections: 1. you studied costing systems such as Job Costing. namely. Cost Management Systems (CMS) and Strategy: Topics 3 – 5. Responsibility Accounting and Financial Performance Measures. Finally. we consider the role management accounting can play in the determination of the social and environmental impacts of corporate policies and practices. budgeting. Costing Systems: Topics 1 and 2. Capital Budgeting: Topics 9 and 10. In Management Accounting. we study medium and long term decision-making. the Balanced Scorecard and Benchmarking. Control and Performance Evaluation: Topics 6 – 8. this course revisits the flow of costs and moreover it will teach you about some new costing techniques. In this course. Finally. In this topic. 5 . 4. to conclude this course. The term Cost Management Systems only emerged approximately 15 years ago and it encompasses techniques on how to better manage costs compared to the traditional cost control methods and techniques such as standard costing. which are two traditional control and performance evaluation topics. 5. You would have already studied budgeting and standard costing. we will look at two additional traditional topics. 2. responsibility accounting… This course will cover some CMS and Strategic Management Accounting techniques. 3. that is. namely chapter 4 of the textbook.

Then read the topic summary. Specifically.  As they arise in the topic summary.ACCT 2013 Cost Management Systems Introduction HOW TO USE THIS STUDY GUIDE You should:   Study the topics. refer again to the topic objectives and check that you have mastered each objective for the topic.  If you are having difficulty. in the sequence. that you do all of the tutorial questions. refer to “Other Text Reading”. This course applies concepts and theories to   practical situations and it is essential. 6 . as outlined on page 4. you should:    Note the Objectives for the topic. Next and most importantly read your textbook and any articles mentioned in the topic summary.  Finally. to be successful. attempt all of the tutorial questions for the topic. of this Study Guide. Organise your learning around the individual topic summaries in this Study Guide. for each topic. then.

Chapter 6 pages 198-210 & 215-219. calculate the appropriate unit costs and total costs in order to determine process transfer costs and closing balances. Resource: Other Text Reading Hansen & Mowen (2003).ACCT 2013 Cost Management Systems Topic 1 TOPIC 1 COSTING SYSTEMS: PROCESS COSTING OBJECTIVES By the end of this topic you should be able to:  Understand the concept of process costing. 3rd 7 . 4th edition. Thorne. Management Accounting: A Strategic Approach. R (2006). Morse. Management Accounting: Information for managing and creating value. K. H and Hilton. 6th Edition.  Account for and record abnormal losses using weighted average. opening and closing WIP inventories. Sydney: McGraw Hill.  Enter cost flows into appropriate accounts.  Explicate the concept of operations costing.  Calculate the cost per unit and total cost for each batch (product). South-Western. Management Accounting.  Calculate equivalent units for both FIFO and Weighted Average. including transfer costs.  Using equivalent units.  Define the term equivalent units. Davis & Hartgraves (2003).  Explain when to use a process costing system.  Describe when to use an operations costing system. Chapter 4 & Chapter 5.  Understand how to account for and record normal losses. Resource: Text Reading Langfield-Smith.  Record the cost flows for an operations costing system.

cost flows into ledger accounts.  They are involved in some of the mass production industries. the textbook refers to a number of industries as examples of the application of process costing systems. it may be appropriate to then reflect again on the survey figures. We will now. because accumulating batch costs is less onerous than collecting job costs. Later. Contrasted with job costing is process costing and organisations involved in process costing demonstrate the following characteristics:  They make their products in batches. in this topic. the accounting for process costing systems involves:  Products with the same or very similar material.  Accumulating the cost of each process. the key to a job (project) costing system is to understand the role of the underlying subsidiary ledger or job cards (sheets) as it is from here that we track the costs for each order.  In general. less “paperwork”. labour and manufacturing overhead costs. look at some example of process costing. South-Western. ACCT 2013 Cost Management Systems Topic 1 1. Chapter 6 pages 249-257. client or customer. 8 ..  They only produce one product or a small range of almost identical products. More specifically. once you have studied operations costing. in the following sections. Interestingly. Ultimately. you would have learned about job costing and how to record job costing.  More than one WIP account. and then averaging these costs across all units produced in order to get the cost of one unit.Edition. PROCESS COSTING: AN INTRODUCTION In your previous studies.  Their manufacturing generally involves a number of processes and therefore a WIP account for each process.

204 1. Using the data provided in the text. direct labour and manufacturing overhead being transferred to a WIP account or accounts then to Finished Goods and COGS. Also.204 Finished Goods 1.124 Mat’ls & Supplies Wages Payable MOH Applied Mixing 505.880 110. This example is described as basic because there is no opening or closing inventory in either of the two Work in Process accounts. let us assume that 98% of finished drink production is sold.880 Finishing 646. THE FLOW OF COSTS: A BASIC EXAMPLE Similarly to job costing. to complete the cost flows. the Mixing Dept.045.204 Cost of Goods Sold Finished Goods 1.204 20.800 1. Material and Supplies Mixing Finishing 505.880 275.124 24.024.045.400 98.045.880 Finishing Mixing Mat’ls & Supplies Wages Payable MOH Applied 646.904 1.024.300 1. namely.045.ACCT 2013 Cost Management Systems Topic 1 2.880 646.400 30. and the Finishing Dept.400 275.045. we will now look at the recording of cost flows in a basic example of process costing.300 9 .204 Finished Goods Cost of Sales Finishing 1. You should now analyse the recording of double entry into Spritz’s cost flow accounts as demonstrated below. for Spritz Soft Drinks.045. the flow of costs in process costing consists of direct material.600 646.204 Closing Balance 1.

the credit entries are demonstrated below.0 PROCESS COSTING WITH CLOSING INVENTORIES In a job cost system. 10 . WIP DM DL O/H 150. we simply add up the total of our incomplete job cost cards (sheets). the cost per unit = $400. then do not worry about the value but just record zero or some arbitrarily small amount.000 units of production then you could calculate the credit entries as follows: Equivalent units = (380. Likewise to get a value on our completed production (cost of goods manufactured).0.025641. This situation will be prevalent in organisations and industries using a Just in Time (JIT) approach to inventory management.000 finished equivalents. Therefore.000 Transfer cost Balance ??? ??? But how in a Process Costing system do we get these values because we do not have any job cost sheets? There are two answers:  Firstly.025641) = $10.000 50.  Secondly. The means to this valuation is achieved through the application of a concept called “Equivalent Units” 3.000 400. we simply add up the total of our completed job cards for the period. when the value of closing inventory is considered important then we need to find a means of valuing the inventory on hand along with the inventory which has been completed in each process.000 = $1. the closing balance = ([20.000 x 50%]) = 390. For example.000 x 50%] x $1. to value our closing inventory for Work in Progress.1 EQUIVALENT UNITS: A BASIC EXAMPLE Using the above example in 3.000 400. if you were told that the Closing WIP was 50% complete and it represented 20.ACCT 2013 Cost Management Systems Topic 1 3. if the value of our closing inventory is zero or close to zero.000/390. Using this information.000 + [20.257.000 units out of a total of 400.000 200.

This therefore raises the issue of inventory flow and whether a First in First Out (FIFO) system is being used or alternatively Weighted Average because we need to know this in order to complete our WIP process costings.0 PROCESS COSTING WITH OPENING INVENTORIES In sections 3. Weighted Average is covered in Section 4. basic example. CD drives. Using a FIFO system requires that we “track” the costs of earlier incomplete batches separately from new batches started in the current period. floppy drives. at the beginning. material usually is added at specific points of production. there was an over simplification in the 3.000 10. our example focused on the closing inventory of WIP. in proportion throughout the production process. a Weighted Average system does not attempt to distinguish the fact that batches of different periods may have slightly different costs. that is. material. the closing inventory of one period always becomes the opening inventory of the next period. The following pages incorporate this production reality by separating material from conversion in calculations using Weighted Average and FIFO. We would then assemble and install everything. in that. In reality. the manufacturing costs of one period’s production may not be the same as the next period because of increases in the costs (prices) of materials.2. Conversely.ACCT 2013 Cost Management Systems Topic 1 Process 1 Transfer to Process 2 DM DL O/H 150. the WIP inventory that is left over from the previous period (month) would be the first completed and transferred out in the next period.1 equivalent units. this type of system just pools the costs of all batches and calculates the average cost. wages and manufacturing overheads. processor boards.743 4. However. namely.0 & 3. operating & application software etc. This example assumed the three elements of cost. This would include the boxes.257 389. labour and manufacturing overhead were all proportionately consumed or applied to production.00 Balance 50.1 and FIFO is covered in Section 4. For example. but what about when there is also an opening inventory? Initially the answer is straight forward.000 200. for example. In a FIFO system. In summary. we would have had all of our material available at the beginning of assembly (processing) and we would then have applied the labour and overhead proportionately in order to build the computers.000 400.000 400. if we are going to build a batch of computers then firstly we would probably go and get (buy) all of the components we would need to assemble to make the batch. Also.1. whereas conversion costs (labour and manufacturing overhead) are usually consumed or applied evenly. 11 .

12 . it would appear as follows: Mixing Balance DM DL O/H $59. Calculate our material and conversion finished equivalents. Calculate our total costs for the closing balance of Mixing and the cost of completed production (transfer cost).150 706.270 505. Calculate our unit costs for material and conversion. if we recorded the cost data into our Mixing account.150 Balance ??? Transfer out of Mixing ??? Now. we need to perform the following five steps:     Analyse our physical flow of units.ACCT 2013 Cost Management Systems Topic 1 4. these five steps are now demonstrated on the next page using Weighted Average and then using FIFO. in order to complete our credit entries. Using the data from the Spritz example.400 30.600 706.  Record our credit entries.1 WEIGHTED AVERAGE: AN EXAMPLE At this point.880 110.

000 1. we are told.880 $706.000 Conversion 20.670 $141. importantly.000 litres is on hand at the beginning of April and that 380. Opening WIP (20.000) Closing WIP (10. 10.000 litres are still incomplete at the end of April. Therefore.000 litres) Equivalent units (litres) Direct Material 20.40) (5.600 $505.15 0 $0.00 10.000 370.40 0 $560.300 15. For Step 2. Mixing Balance DM DL $59.37) = = = $690.270 $646.000 x $1. 370.000 litres must have been started and finished in April. Using the above data is crucial to determining our equivalent units as shown in steps 1 and 2 in the table below.300 14.000 370.48 0 $146.150 $1. that 20.000 litres) Units started & completed (370.77) (10. Note how the material finished equivalents are determined separately to the conversion finished equivalents. we are told that the closing inventory of 10.850 Step 5 13 .000 litres were started “from scratch” during April.000 x $0.77 Step 3 Total cost of goods completed Cost of WIP closing balance (390.37 $59.00 0 $1.400 30.000 litres.270 505.880 Transfer out of Mixing Balance 690.000 Total Steps 1&2 Opening WIP Costs incurred during April Total cost to account for Costs per equivalent unit (litre) $54.850 Step 4 Using the above data. Of the 380.40 $4.000 litres is 100% complete (finished) for materials but only 50% complete for conversion cost. we can now complete the credit entries for the Mixing process.000 395.ACCT 2013 Cost Management Systems Topic 1 WEIGHTED AVERAGE For Step 1 and the physical flow of units.000 400.000 5.000 x $1.850 $15.

we now use the same data to construct a table for FIFO and then record our Mixing account credits 14 .150 On the next page.O/H 110.600 706.150 706.

FIFO has less “work” in step 3 but more calculations for step 4.ACCT 2013 Cost Management Systems Topic 1 4.400 $1.000 393.300 $691.000 × $1.150 Transfer out of Mixing 691.480 $0.880 $1.2 FIRST IN FIRST OUT (FIFO): AN EXAMPLE Note how compared to weighted average.050 $13.270 505.050 Balance 706.880 110.800 15.100 Step 4 Using the above data.100 Step 5 15 .000 370.000 380.300 $1.33 $141.36 $646.000 litres) Closing WIP (10.000 Steps 1& 2 Costs incurred during April Costs per equivalent unit (litre) $505.400 30. Direct Material 0 370.000 litres) Units started & completed (370.000 x $1.000 393.000 Total Opening WIP (20.000 × $0.000 5.36) $59.36) (370.150 15.000 × $0. Mixing Balance DM DL O/H $59.000 Conversion 18.270 0 $6.000 litres) Equivalent units (litres) 10.480 $625.600 706.69 Step 3 Opening Balance Previous cost of opening work in process Additional Direct Materials Additional Conversion Units started and completed in the same month Total cost of goods completed Direct material Conversion Cost of the WIP closing balance (18.69) (10.33) (5. we can now complete the credit entries for the Mixing process.

480 $146.000 × $0.500 litres) Closing WIP (10.500 × $1.270 $646.500 10.880 $706.000 365. We will now reconsider the Spritz costings using weighted average but with spoilage. 16 .150 $1.80) = Conversion 20. Referring to your textbook.000 330. the reality is that spoilage does occur including production that cannot be reworked.40) = Using the above table.375 $4.80 Cost of the WIP closing balance (10.500 of the 390.40 (350.000 $54.000 litres) Equivalent units (litres) Opening WIP Costs incurred during April Total cost to account for Costs per equivalent unit (litre) Total cost of goods completed 20.600 $505.000 litres) Units started & completed (330.000 $55.ACCT 2013 Cost Management Systems Topic 1 5.300 $3.500 (100%) 39.500 litres) Spoiled (39. This raises the question of how do we account for spoiled or lost production. SPOILAGE AND LOSSES Although organisations aim to avoid having any defective production.950 $59.000 330.400 $560.40) = Cost of the Spoilage (39.000 × $1.670 $141.000 litres of the mixture were contaminated (spoiled) and that this spoilage was detected at the 25% completion point.250 Total $59.875 5. Direct Material Opening WIP (20.875 × $0.000 $1. we can now complete the credit entries for the Mixing process assuming that the loss is an Abnormal Loss.000 400. You need to follow the same five steps as in the previous examples.40 $630.40) = (9.500 × $1. note the insertion of a row for spoiled production.900 $14.40) = (5.500 (25%) 9. however.150 $0. it continues with the Spritz soft drink example and states that 39.000 $2.

PROCESS COSTING IN SEQUENTIAL DEPARTMENTS In the previous examples on Spritz Soft Drinks. We will continue with our original example of Spritz Soft Drinks and you should refer again to the data provided in the text. Mixing Balance DM DL O/H $59.688 690.600 706.400 98.312 Transfer out of finishing Balance ??? ??? Transfer out of Mixing Balance 630.300 275.880 110.124.850 706.800 1. we will use “Weighted Average” to determine our costings. We will now look at what happens when we wish to record credit entries in the next WIP account.270 505. Otherwise the material and conversion costs are calculated as previously demonstrated.124.312 17 .124 24.900 15.ACCT 2013 Cost Management Systems Topic 1 6.400 30. Also. The process is the same five-step process as first outlined on earlier but we need to insert an additional equivalent units column (see the next page) to allocate the transfer cost from Mixing to Finishing. namely. the Finishing Department.150 Finishing Balance Transfer into Finishing DM DL O/H $35. our focus was always on the Mixing Department as it was the first WIP account.150 1.

000 (60%) 24.300 $716. Transfer Cost Opening WIP (20.000 (90% ) 36.124 24.312 $0.312 Balance 32.312 Finishing Balance Transfer into Finishing DM DL O/H $35.180.180.872 $123.688 690.124.520 (36.396 $275. 60% for material added and 90% conversion.124.092.420 $690.124. namely 100% for units transferred in.000 $26.720 $0.000 1.000 bottles.000 × $0.91 $6.000 (100%) 40.000 (40.000 18 .000 × $0.000 Total 1.000 Conversion 20.578) = $23.000 $35.224.000 bottles) Units started & completed (1.688 $1.200 $126.102 Total cost of goods completed Cost of the WIP closing balance (1.672 $32.312 1.000 bottles) Closing WIP (40.000 × $0.200.180.102) = $3.23) = $5.120 (24.000 1.578 Direct Material 20.000 × $0.23 $2.180.312 Transfer out of Finishing 1.ACCT 2013 Cost Management Systems Topic 1 Now refer to the weighted average example for the Finishing Department.092. Note the different stages of completion for the Closing WIP of 40. WEIGHTED AVERAGE FINISHING DEPT.800 1.000 1.240.236.91) = $1.000 bottles) Equivalent units Opening WIP Costs incurred during April Total cost to account for Costs per equivalent unit (litre) 20.400 98.072 $0.624 $1.300 275.124 $281.000 1.088.520 $0.000 1.

TQM and continuous improvement manufacturing practices. we now consider an example where material costs vary for each product but the conversion costs are the same for shared processes. the individual batches and products often differ in some significant aspects. In fact. In reality. In fact. all three elements may vary from batch to batch which therefore requires that batch costs be traced for each separate batch. the costing of the material can be associated with job costing. this costing system has an element of both process costing and job costing. traditional examples of process costing. as the material needs to be traced to each batch whereas the conversion is associated with each process and therefore resembles process costing. in contemporary industries with flexible processing and diverse ranges of products and services. 8.ACCT 2013 Cost Management Systems Topic 1 7. This is not dissimilar to tracing costs to jobs.  Organisations using JIT. in operations costing. Rather what we are more likely to see is that each individual batch is different to the previous in regards to some processes and/or the consumption of material. any longer. The costing system used for these process and batch production industries is an extension of process costing called Operations or Hybrid Costing. it is not always easy to find. In other words. OPERATION COSTING: AN INTRODUCTION Process Costing as already covered is based on the assumption that each batch has the same or very similar costs of material. Today. 19 . labour and overhead. OTHER ISSUES AFFECTING PROCESS COSTING  Weighted Average versus FIFO. the example used incorporates different material for each batch but the same conversion costs for each process. as you will see. labour and manufacturing overhead. In your textbook. In the next section.

500 4.ACCT 2013 Cost Management Systems Topic 1 9. Product B: 10.000 bottles of strawberry drink. uses the first two processes only. This can be done either. 9. Batch Costs Strawberry Orange $3. as shown below.1 THE CALCULATION OF BATCH COSTS Referring to the Spritz example in Chapters 4 and 5 of the text.800 $9.950 2.000 500 Direct Material Mixing Finishing Packaging Conversion Mixing Finishing Packaging Total Batch Costs $16. uses all three processes.000 20 . on a total cost per batch basis or as shown in the textbook on a unit cost per batch basis.000 900 1.250 1.000 bottles of orange drink for children.0 OPERATION COSTING: AN EXAMPLE Mixing Finishing Packaging Product A: 20.800 2. we determine our batch costs.500 1.600 8.

400 9.ACCT 2013 Cost Management Systems Topic 1 9. Be careful as this requires concentration.100 COGS 9.800 8.000 500 9.150 Finishing Transfer from Mixing Material Conversion 15. we now record our cost flows into the three Work in Process accounts.600 26.950 Transfer to Finishing 1.600 Finished Goods Transfer from Finishing Transfer from Packaging 8.000 1.500 2.600 Transfer to Finished Goods 9.150 4.100 24. namely Mixing. Mixing Material Conversion 8.400 26.250 2.150 21 .150 15.500 3.100 1.600 Transfer to Finished Goods Transfer to Packaging 16.800 900 15.000 24.900 15.900 Packaging Transfer from Finishing Material Conversion 8.2 RECORDING THE COST FLOWS Using our costing calculations. Finishing and Packaging.400 26.

TUTORIAL QUESTIONS Starting from page 208 in your textbook.55. Q5.44 and P5. in using both the weighted average and FIFO approach. SUMMARY In this topic you extended your knowledge of processing costing such that you now know a method of dealing with the costing of opening and closing inventories and how to account for spoilage. 22 . you are not required to do this. Next we consider the difficulties posed by having multiple products output from one material input and one process. You have also covered operation costing in more detail than in your prior studies.. We will look at four different options for allocating the joint costs between the different outputs.ACCT 2013 Cost Management Systems Topic 1 The cost flows on the previous page would become much more complex if we were to introduce opening and closing inventories and thus had to determine equivalent units for each batch to determine the individual batch costings etc. however. please attempt Self-Study problems 1 and 2 followed by Q5.2. P5.1.

H and Hilton. Appendix to Chapter 19. McGraw-Hill.  Record the cost flows associated with joint costing.  Allocate joint costs using the following methods: Physical Measures. Resource: Other Text Reading Hilton. R (2006). 4th edition. Constant  Gross Profit. Maher & Selto (2000). Hansen & Mowen (2003). The “Sell or Process Further Decision”. Thorne. joint process.  Evaluate the four allocation methods. South-Western. International Edition.  Calculate whether joint products should be sold or processed further. Relative Sales Value and Net Realisable Sales Value.  Allocate joint costs when there is a by-product. 6th Edition. joint cost. split-off point.ACCT 2013 Cost Management Systems Topic 2 TOPIC 2 COSTING SYSTEMS: JOINT COSTING OBJECTIVES By the end of this topic you should be able to:  Explain the terms: joint products. Chapter 17 pages 716-718. Management Accounting. Sydney: McGraw Hill. Resource: Text Reading Langfield-Smith. K. 23 . Chapter 8. separable or further processing costs and by-products. Cost Management: Strategies for Business Decisions.  Understand when to use a joint costing system. Management Accounting: Information for managing and creating value.

as demonstrated later.15 as shown below. fruit processing. For example.560 Tanning cream: sales value $3. seafood processing. Examples of joint products can be found in the following industries: petroleum. refer to page 932 of your textbook and the cocoa beans example in Exhibit 19.ACCT 2013 Cost Management Systems Topic 2 1. Joint Product costs need to be determined for reasons of inventory valuation. Split-off occurs at that point in production when the joint products become identifiable. in these industries. however. Joint products are produced when more than one product emerges simultaneously from the same production process and raw material. JOINT COSTING: AN INTRODUCTION Joint Costing is an extension of Process Costing and Operations Costing and applies to those industries which produce what are called Joint Products. Cocoa beans costing $500 per 1 tonne batch Joint production process costing $600 per tonne Cocoa butter sales value: $750 for 750 kg Split-off point Cocoa powder sales value: $500 for 250kg Separable process costs: $1. palm oil (kelapa sawit) processing… The challenge for cost accountants. is to value each of the joint products that emerge at split off. meat processing.000 for 250kg Separable process costs: $800 Total joint cost: $1100 per 1 tonne batch Instant cocoa mix sales value: $2000 for 250kg ACCT 2013 Cost Management Systems Topic 2 24 . one needs to be careful when it comes to decision-making and the sell or process further decision.

000 litres Glosso 500.000 $80.000 litres Joint Cost Joint Cost Gemo Glosso Selling Price at Split-Off $0. Gemo and Glosso. as demonstrated over the next two pages. Both Gemo and Glosso can be sold immediately at split-off point in a basic but somewhat pungent form or processed further to add a pine or lemon fragrance along with improved packaging.000 Costs after Split-off point In order to understand the ways in which we can calculate the joint cost allocations for Gemo and Glosso. Gemerling Ltd. there are four methods to be learned.0 JOINT COSTING ALLOCATION METHODS Consider the following example. Production Gemo 2. Using a joint process.40 $0.30 per litre $520.000 $40. 25 .000.2.90 Selling Price $0.875 per litre $1. We will then discuss the issues to consider when choosing between the methods. Gemerling sells its products in bulk to wholesalers. The following information is available for the month of June. manufactures the following two domestic cleaning products.

26 .000 Glosso Processing $104. Gemo Processing Detergent Joint Processing $520.000 Proportions 0.ACCT 2013 Cost Management Systems Topic 2 2. B 3 4 5 6 7 Joint Products Gemo Glosso C PHYSICAL MEASURES D Proportions =C5/$C$7 =C6/$C$7 =SUM(D5:D6) E Cost Allocation =D5*$E$7 =D6*$E$7 520000 Volume in Litres 2000000 500000 =SUM(C5:C6) Similarly to process and operations costing.000 $520. See below.000.1 THE PHYSICAL MEASURES METHOD This Physical Measures method is based on the physical features of each joint product such as weight (kilos) or volume (litres).000 As demonstrated below.000 Note that the completed production from both Gemo Processing and Glosso Processing would be transferred to Finished Goods.000 $104. the flow of costs for joint costing consists of direct material.000 2.000 $416. the joint cost calculations are easily set up in a spreadsheet.000 $40.000 $104.8 0. PHYSICAL MEASURES Joint Product Gemo Glosso Volume in Litres 2. direct labour and manufacturing overhead being transferred to a WIP account or accounts then to Finished Goods and COGS.500.000 500.000 $80.2 1 Cost Allocation $416.000 $416.

667 $93.000 0.333 $640.00 0.283.760.000 73.000 0.400.667 $173.3 THE RELATIVE SALES VALUE METHOD This method is based on the sales value of each joint product at split-off point.000 0. See the shaded area in the spreadsheet below.250.750.000 2.000 $640.000 1 E Cost Allocation $332. B 17 18 19 20 21 Joint Products Gemo Glosso C D THE RELATIVE SALES VALUE METHOD Sales Value at Split off Proportions $800.000 $650.400.000 $80.000 $2.3% Secondly.000 $466.000 $120.000 2.250 G Cost Allocation $390. B 24 25 26 27 Joint Products Gemo Glosso C D E F THE NET REALISABLE SALES VALUE METHOD Sales Revenue Separable NRV Proportions Cost $1.750 0 $650. 11 12 13 14 15 I Sales Prod’n Costs Gross Profit Gross Profit % J $2.3% 73.800 $187.000 $130.36000 $1.333 $467.2 THE CONSTANT GROSS PROFIT METHOD This method is based on each joint product having the same Gross Profit (Margin) rate.000 $40.000 $570.750. we need to calculate the Gross Margin percentage.000 $1.000 $426.667 $1. Firstly.710.000 $1. THE CONSTANT GROSS PROFIT METHOD Joint Products Gross Margin % Sales Revenue Required Gross Margin Total Cost Separable Cost Cost Allocation Gemo Glosso 73.ACCT 2013 Cost Management Systems Topic 2 2.000 $40.4 THE NET REALISABLE VALUE METHOD This method is based on the net realisable (sales) value (NRV) at split-off point for each joint product.000 27 . we allocate our joint cost to our joint products as shown below. See the shaded area in the spreadsheet below.64000 $450.000 $520.760.333 $520.000 $1.000 $80.3% $1.

000 Cost Management Systems Topic 2 3. Note in particular the argument in the text about using joint cost allocations to set cost on which prices will be determined.400. Obviously three of the four methods use sales price to set cost allocation.875 =D12*C12 =D12-E12 =500000*1. 28 .280. FORMULAE FOR THE FOUR METHODS Using a spreadsheet.000 $2.4 500000*0.00 0 1.9 =C20/$C$21 =D20*$E$21 =SUM(C19:C20) =SUM(D19:D20) 520000 Joint Products Gemo Glosso THE NET REALISABLE SALES VALUE METHOD Sales Revenue Separable Cost NRV Proportions 2000000*0.28 ACCT 2013 $2. the other products merely being lucrative ‘asides’ to your real business focus.9 =SUM(C26:C27) 40000 80000 =SUM(D26:D27) =C26-D26 =C27-D27 =SUM(E26:E27 ) =E26/$E$28 =E27/$E$28 =SUM(F26:F27) Cost Allocation =F26*$G$28 =F27*$G$28 520000 SELL OR PROCESS FURTHER Gemo Glosso Incremental =C26-C19 =C27-C20 Revenue Less Separable 40000 80000 Costs Incremental =D32-D33 =E32-E33 Profit 4.4 =C19/$C$21 =D19*$E$21 =500000*0.3 =D13*C13 =D13-E13 =SUM(D12:D13) =SUM(F12:F13) =SUM(G12:G12) Separable Cost 40000 80000 =SUM(G12:G13) Cost Allocation =D12-E12-G12 =D13-E13-G13 520000 Joint Products Gemo Glosso THE RELATIVE SALES VALUE METHOD Sales Value at Proportions Cost Allocation Split off =2000000*0. When these should be considered by-products is covered in the next section of this topic. You may decide that the bulk of the cost should be borne by a product that you are specifically in business to produce.000 $520. VALUATING THE FOUR ALLOCATION METHODS Your textbook provides you with issues to consider in selecting between the different methods presented above. Joint Products Gemo Glosso PHYSICAL MEASURES Volume in Proportions Litres 2000000 =C5/$C$7 500000 =C6/$C$7 =SUM (C5:C6) =SUM(D5:D6) Cost Allocation =D5*$E$7 =D6*$E$7 520000 Joint Products Gemo Glosso Gross Margin % =$J$15 =$J$15 THE CONSTANT GROSS PROFIT METHOD Sales Revenue Required Gross Total Cost Margin =2000000*0.000 $120. shown below are the formulae for each of the four joint costing methods.

This means that the product with the highest sales value can bear a greater proportion of the cost and should do so. On the other hand you may want to allocate these costs on the principal of ‘ability to bear’.so we have a circular calculation. 29 .

or number of tins. Continuing with the Gemerling example.000 From the above.55.39.38.000 $40.53. will centre around which option makes the greater profit: that is.000 $910. & P19. in both cases. For example. of pineapple chunks) is usually set as well 5. from a financial perspective. adds to Gemerling’s profits. TUTORIAL QUESTIONS You should now attempt E19.000 $80. and the proportion of production (for example.000 $120. P19. should a butcher sell a cut of steak as raw meat or should the butcher marinate the steak. the joint cost is irrelevant for decision-making purposes because the cost does not change. The answer to the process further question is that.000 $200. A decision-making analysis of the relevant data is provided below: SELL OR PROCESS FURTHER GEMO GLOSSO Incremental Revenue Less Separate Costs Incremental Profit $950. it is shown that processing further. DECISION-MAKING AND JOINT COSTING: THE SELL OR PROCESS FURTHER DECISION A common question regarding joint products concerns whether we should sell the product immediately at split off point or perform further processing in order to add more value to the product. 30 . we calculate the incremental revenue and incremental costs. E19. In making the process further decision. Decisions with regard to product mix also need to recognise that these products cannot exist without one another. the choice.ACCT 2013 Cost Management Systems Topic 2 Whichever method you use it is important to recognise that they are all arbitrary allocations. the volume of pineapple juice that is produced is closely tied to the weight. This decision assumes that there is demand for both products and that the butcher only has limited supplies of meat and space in which to display and store products each day. sell as raw steak or marinate.

000 litres 50.000 $10. the net realizable income of Cleano is deducted from the joint cost. The following information is available for the month of June.000 In this example. Gemerling Ltd.875 per litre $1. may also include scrap and waste that emerge at split-off point. Glosso and Cleano.  Record the by-product income (profit) as “Other Income”.000 $80.000 Selling Price $0. from a joint process manufactures the following three domestic cleaning products: Gemo. By-product example.000. in the inventory valuation process. ALLOCATING BY-PRODUCTS A joint product is called a by-product. if it is of incidental (small) value. of byproducts. Production Gemo Glosso Cleano 2.30 per litre $0.000 litres Joint Cost Joint Cost $520. There are two accounting treatments for the profit made from a by-product. Gemerling Ltd.  Deduct the by-product profit (net realizable income) from the joint cost.60 per litre Costs after Split-off point Gemo Glosso Cleano $40. Examples. We will now consider an example of this method. Cleano is considered to be a by-product.000 litres 500.ACCT 2013 Cost Management Systems Topic 2 6. Also. allocates its joint costs using the Net Realisable Value Method 31 .

000 $520.000 Now we can determine the joint cost allocations for Gemo and Glosso.710.000 $2.00 Separable Costs per Kg. Other data related to July is provided below.000 Separable Cost $40. Millers Ltd.50 $0.ACCT 2013 Cost Management Systems Topic 2 ALLOCATING BY-PRODUCTS Firstly.250 4.10 Bran 85.000 TUTORIAL QUESTION During July 2006.280.20 Treating Wheat Germ as a by-product.000 $80. The joint cost is $250 per tonne. $0.000 Sold (Kg) 140.000 $20.000 0.000 0.000 $120. During processing.250 $1. bran and wheat germ.000 $650.Cleano Separable Costs Adjusted Joint Cost $30.750. 15% of the wheat is lost.000 $10. The net realizable income from Wheat Germ is deducted from the joint cost. $1. we need to calculate the adjusted joint cost as follows: Joint Cost Less Income from Cleano .000 NRV $1.400.05 Wheat Germ 4.000 $500. Joint Products Gemo Glosso Sales Value of the Final Product $1.40 $0.00 0 Proportions Joint Cost Allocation 0.000 80. 32 . processes wheat into three products: white flour.75 $375.00 $125.25 1.000 $2.00 0 $570. allocate the joint cost using the Net Realisable Value Method.000 Selling Price per Kg. White Flour Produced (Kg) 153.000 $500.

000 85.725 SUMMARY You should now be confident in discussing the four methods of joint cost allocation.000 $34. In addition. = 285 tonne.750 $167.250 divided by 85% = 285.50) $850 (4. Joint Cost = (285 x $250 per tonne) = $71.250 The Net Realisable By-Product Income from Wheat Germ Sales Separable Costs By-Product Income $5. (the original quantity before the 15% processing loss) 285.20) E Total Joint Cost Less By-Product Income Joint Cost to be Allocated $71. based on physical units.000 Kg.70 0 $29. you should be comfortable calculating the allocation of costs using each method.250 b) c) d) d) 242.525 $65.375 (4.300 $4. In your discussion you should be able to include a description of the methods as well the issues with regard to the adoption of each.250 242.250 X $0.677 $65.525 $6.ACCT 2013 Cost Management Systems Topic 2 TUTORIAL ANSWER: MILLERS LTD.250 X $1.550 $137. constant gross profit. Now that you have extended your knowledge of product costing we will proceed to use product costs in certain decision making scenarios. In this topic we have already looked at certain product 33 .000 $15.000 $54.45 0 0.178 1.000 $187.000 4.000 Kg. a) Kilograms Produced White Flour Bran Wheat Germ Total 153. relative sales value and net realisable value.250 $5.725 f) Joint Products THE NET REALISABLE SALES VALUE METHOD Sales Revenue Separable Cost NRV Proportions Cost Allocation White Flour Bran $153.822 0.048 $11.250 $19.

mix decisions. 34 . Now we will look at other product mix decisions. when we considered whether joint products should be processed further or sold at ‘split off point’. as well as pricing issues.

6th Edition. Thorne. Chapter 20. Sydney: McGraw Hill. 2003. Resource: Text Reading Langfield-Smith. South-Western. R (2006).  Explain some major influences on pricing.  Rationalise product-mix decisions.ACCT 2013 Cost Management Systems Topic 3 TOPIC 3 PRICING & PRODUCT MIX DECISIONS OBJECTIVES By the end of this topic you should be able to:  Understand the importance of pricing. Chapter 17 pages 718-724. Chapter 6 pages 366-372 & 138-142. 3rd Edition. 4th edition. Management Accounting: Information for managing and creating value. Management Accounting: A Strategic Approach. South-Western. Management Accounting. H and Hilton. K. 35 . Morse.  Determine (calculate) prices in the context of specific pricing strategies. Resource: Other Text Reading Hansen & Mowen. Davis & Hartgraves (2003).

and then it considers the decision-making question of pricing mix. that is. how much it costs to make the product or provide the service.  Product Cost. when determining the pricing of its products and services. including:  Market Positioning. 36 . there are a number of potential influences.  Political pressure from state or federal governments.  The nature of the product or service and how much the consumer needs or desires the product. that is. PRICING: AN INTRODUCTION One of the most important decisions that some mangers have to make is to decide what price to charge for their organisation’s products or services. 2. Customer Value.  Government legislation such as the Trade Practices Act (TPA) and how the TPA’s regulatory authority the Australian Competition and Consumer Commission (ACCC) is likely to react or respond.  What competitors are currently doing or how they are likely to react. This topic looks firstly at some factors that influence pricing and its determination. PRICING: MAJOR INFLUENCES For any organisation.ACCT 2013 Cost Management Systems Topic 3 1.

Economic Value pricing. This pricing technique and variations of it are used in industries such as: “the trades”. 37 . or variable cost or full cost…  Time and Material pricing. absorption cost as in the above example. DETERMINING PRICES There exist a range of strategies that can be used to set prices including:  Cost-Plus pricing: the traditional notion of pricing was to manufacture a product then calculate its costs and finally add a mark up.20 + $2. computers… The feature of this pricing technique is that the labour rate (in this case. Alternatively.   Value-Based pricing. The Cost Plus pricing formula is: price = cost plus (mark-up x cost) Therefore the price = ($5 + $0. public accounting. direct labour $0. The labour rate that is charged by the business is $80 per hour and the materials used in servicing the vehicle cost $40. the charge for labour rather than the wage rate) includes not only the direct labour but also the manufacturing overhead and the required profit margin.80) x 150% = $12.ACCT 2013 Cost Management Systems Topic 3 3.20 and Manufacturing Overhead $2.80. legal services. Using Time and Material pricing the formula is: price = labour cost plus material cost ($80 x 3) + $40 = $280. determine the selling price for the following: a motor mechanic services a motor vehicle for three hours. For example.20 + $2. One of the issues regarding cost plus pricing is which cost to use.80) + [($5 + $0. the repair & maintenance of home appliances. medical & dental services (not including general practitioners).20 + $2. The manufacturing cost of the product is comprised of direct material $5. motor vehicle servicing & repairs. For example. landscaping & lawn mowing.80) x 50%] = $12. determine the selling price for the following: an organisation has a required return (mark-up) on a product of 75%. For example. ($5 + $0.

ACCT 2013 Cost Management Systems Topic 3 TUTORIAL QUESTIONS From page 983 of your textbook.00 0. Pricing.38.43.00 per unit to profits. in particular.47 & P20. 4. This is illustrated in the next topic when we look at customer profitability analysis. TUTORIAL QUESTIONS You should now attempt E20. it would seem that Sydney Sailing Supplies should concentrate on making the more profitable Shackles until such time as market demand is satisfied and then switch to the less profitable Cleats. PRODUCT MIX DECISIONS Product mix decisions involve maximising the use of limited resources such as time.02 hrs $50. Please refer to the Sydney Sailing Supplies example in your textbook.2 minutes (0. SUMMARY From this topic you should have a greater appreciation of decision making issues with regard to pricing methods and product mix options.00 0. For example.02 of an hour) per unit to manufacture whereas Shackles require 3 minutes (0.48. We will now focus more on strategy related decisions. P20. 38 .41 & P20. Initially. as opposed to costing. we are then informed that Cleats require 1. we are told that Sydney Sailing Supplies manufactures two products Cleats which contribute $1. was discussed in the context of a strategic approach. a revised profitability evaluation for the two products is provided below. Contribution per unit Machine hours required per unit Contribution Margin per hour Cleats $1. please attempt the Self-study problem and then P20.00 Shackles $2.00 per unit to profits and Shackles which add $2. Using this “time required” information for Cleats and Shackles. However.00 This analysis places a different perspective on the profitability of the two products and from it we can see that Cleats are more profitable by $10 per manufacturing hour compared to Shackles. The place of the next few topics in a cost management course is due to their relationship to cost management. From this information. activity based costing provides a means to costing a product but activity based management techniques are useful for managing the costs through the use of the activity analysis.05 of an hour) per unit to manufacture.05 hrs $40.

Identify value adding and non-value-adding activities.ACCT 2013 Cost Management Systems Topic 4 TOPIC 4 COST MANAGEMENT SYSTEMS & STRATEGY ACTIVITY BASED MANAGEMENT & CUSTOMER PROFITABILITY ANALYSIS OBJECTIVES By the end of this topic you should be able to:          Understand the concept of Activity Based Management. Choose root cause cost drivers. volume 32. 39 . Analyse customer profitability. vol. pages 310-307. pages 131-138 Dickinson V & Lere J (2003). Understand the concept of Supply Chain Management. Explain the terms value adding activity and non-value-adding activity. Resource: Articles Gupta M & Galloway K (2003). Industrial marketing management. Thorne. Evaluate customer performance including non-financial considerations. Resource: Text Reading Langfield-Smith. Chapter 16 pages 761-769. Problems evaluating sales representative performance? Try activity-based costing. Select appropriate performance measures for root cause cost drivers. issue 2. K. H and Hilton. 2. 4th edition. Activity based costing/management and its implications for operations management. Chapter 15 pages 693-703 & Chapter 2 pages 48-49. Comprehend the concept of Customer Relationship Management (CRM). R (2006). Technovation. Sydney: McGraw Hill. Management Accounting: Information for managing and creating value..

Chapter 10. Vernooij M & Van Triest S (2003). pages 573583. Maher & Selto (2000).ACCT 2013 Cost Management Systems Topic 4 Van Raaij E. Morse. 40 . South-Western. vol. Management Accounting. 3rd Edition. 6th Edition. Industrial marketing Management. South-Western. Davis & Hartgraves (2003). The implementation of customer profitability analysis: a case study. Hansen & Mowen (2003). Resource: Other Text Reading Hilton. McGraw-Hill. International Edition. Chapter 5 pages 193-196. Chapter 15 pages 626-629. Cost Management: Strategies for Business Decisions. 32. Management Accounting: A Strategic Approach.

ACCT 2013 Cost Management Systems Topic 4 1. For example. even though they do not add value to the customer. preparing invoices. which have been collectively referred to as either Cost Management Systems (CMS) or Strategic Management Accounting. By using ABM an organisation can improve its business performance by identifying non-value adding activities. lifestyle activity (habit). paying employee wages. ABM uses and evaluates information provided by Activity Based Costing in seeking to improve customer value by identifying opportunities to improve the efficiency of organisational processes and activities. A basic example of eliminating non valuing adding activities occurs for some people. smoking. each New Year’s Day when they promise to eliminate some non-value adding. packaging for some products… You cannot entirely 41 . A value adding activity is defined as an activity that adds value to the customer whereas a non-value adding activity does not. flexible budgets. standard costing… and their focus on controlling costs. such as budgeting. One such cost management technique is called Activity Based Management (ABM). Support Services • • • • • Human Resources Finance Legal Informaion Systems Telecommunications Value of products and services Research and Development Design Supply Manufacturing or Production Marketing Distribution Customer Service One needs to be aware that separating activities into merely two groups. what causes them (root cause drivers) and then implementing a plan to eliminate these causes or drivers. In its most simple form. ACTIVITY BASED MANAGEMENT (ABM): AN INTRODUCTION The concept of costing activities as promoted by Activity Based Costing has had a significant effect on Management Accounting. eating junk food… ABM analysis is about conducting a thorough analysis of an organisation’s value chain. namely value adding and non value adding overlooks the reality that some non valuing adding activities are essential. These techniques are focussed on managing costs as distinct from traditional techniques. For example. in that. it has spawned several new techniques. ABM methodology seeks to separate activities into two types: value adding and non-value adding. The Value Chain The following diagram is taken from page 49 of the textbook. the identification of wasted resources and the elimination of what causes them.

ACCT 2013

Cost Management Systems

Topic 4

eliminate these non value-adding processes; however you may be able to make them more efficient. Some organisations when conducting an ABM analysis rank activities on a scale from one to five. For example, level one is used for activities that irrefutably do not add value; level three is used for all essential non value adding activities and finally, level 5 is used for all activities that are clearly value adding.

2.

ACTIVITY BASED MANAGEMENT: AN EXAMPLE
You should now read the Mason and Cox example in your textbook in order to see how ABM is used to better manage costs by identifying non-value-adding activities such as correcting invoices, moving materials, inspecting moulds, welding defects etc. Most importantly, in the Mason and Cox example, Exhibit 15.4 lists a number of potential primary causes (drivers) of the various non-value-adding activities. The ultimate success of ABM centres on the organisation’s ability to manage, that is, eliminate these causes of wasted resources. Identifying the non value adding activities is not the end of ABM as the organisation must be able identify what causes the activities that waste resources and then effect a strategy to eliminate them.

TUTORIAL QUESTIONS
Starting from page 724, in your textbook, attempt Self-Study problem 1 followed by E15.26, E15.27 and P15.41.

3.

SUPPLY CHAIN MANAGEMENT (SCM): AN INTRODUCTION
Supply Chain Management is the process of streamlining the supply chain by managing costs, accelerating time-to-market of new products, and creating close relationships with suppliers and customers. Today in seeking supply chain improvements, organisations often adopt electronic commerce solutions in their pursuit for improved:  Business to Business (B2B) relationships with suppliers through improved management of inventory along with electronic transmission of purchase orders, payment of accounts and technical support.  Business to Customer (B2C) relationships by using web sites offering fast access to information, sales services, account settlement and technical support.

42

ACCT 2013

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Leveraging electronic business solutions offers benefits that include speed and much cheaper data processing, storage and retrieval costs compared to the more traditional forms of business communication and commerce.

4.0

CUSTOMER RELATIONSHIP MANAGEMENT (CRM): AN INTRODUCTION

Customer Relationship Management is by no means a new concept but what is new, since the 1990s, is the leveraging of the Internet through organisation web sites to collect and analyse data. This is done in order to better understand individual customer’s needs and purchasing patterns (data mining) and thus establish better customer relationships. Electronic Customer Relationship Management moreover aims to acquire and retain customers by offering a superior and cheaper service than traditional sales and support channels. The aim of electronic CRM is not only to acquire new customers cheaply but also to retain existing clientele bearing in mind that the cost of “winning back” lost customers, clients and consumers is deceptively expensive. CRM on the Internet comes basically at three levels:  The static site which can only provide information to the consumer.  The database and forms site which besides providing information can also retrieve information. Using these web sites, you can buy software, books, flowers, tickets etc; listen to online audio and watch multi-media. This level facilitates electronic commerce (trade).  The personalised and customised web site which is tailored to individual customer needs. These web sites include all of the services of levels 1 & 2 but moreover they may anticipate user choices and based on a customer profile can automatically recommend solutions and alternatives. Activity Based Costing, when applied to the field of CRM, provides management accountants with new costing opportunities in regards to evaluating customers and clients. In particular, it offers the opportunity to evaluate more fully the cost of different customers or groups of customers and their profitability. With this information, organisations can then better identify which customers create the highest profits and therefore the strategic question, how do we retain them? Also, which customers generate the lowest profits and what strategy can be effected to make them more profitable? Customer Profitability Analysis (CPA) identifies and analyses the costs of five groups of customer activities:  Customisation of products.  Marketing and Selling.  Distribution.

43

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 Customer Support.  Cost of Goods Sold (traditionally the sole determinant). We will now consider, in the next section, an example, of customer profitability analysis.

4.1

MANAGING CUSTOMERS: AN EXAMPLE

Please now refer to the example starting on page 766 of your textbook. There are two parts to this customer analysis; firstly the customer cost analysis and then secondly the customer profitability analysis as demonstrated below. Customer Cost Analysis Direct Customers Small Retailers Sales Order Delivery Sales Calls Complaints Research Advertising 514,500 242,000 0.00 11,400 0.00 25,000 17,640 12,100 80,000 9,600 40,000 20,300 Large Retailers 29,400 15,400 56,000 3,000 40,000 49,700

Total Costs 792,900 179,640 193,500 Customer Profitability Analysis Sales COGS Gross Profit Customer Costs Direct Customers 576,000 126,000 450,000 792,900 Small Retailers 816,000 198,000 618,000 179,640 Large Retailers 1,968,000 456,000 1,512,000 193,500

Net Profit (342,900) 438,360 1,318,500

4.2

OTHER CONSIDERATIONS
Textbook page 769, in particular Exhibit 16.15

Although the textbook example demonstrates that large retailers are the most profitable customer group, there may be other customer performance measures, used by organisations which may impact on and affect their customer analysis and evaluation. For example, a change in market share, an increase in new business, the retention rate of existing customers, the proportion of returns, the level of returns under warranty…

44

we will look at other inventory related issues such as inventory management and quality control. In the next topic.ACCT 2013 Cost Management Systems Topic 4 TUTORIAL QUESTIONS Starting from page 777. in your textbook. SUMMARY Now that you have an understanding of activity based management and the impact that activity analysis can have on the way to manage customer related costs. we need to look to suppliers and the costs that they can cause. 45 . attempt Self-Study problem 1 and C16. when we have considered supplier related costs.55.

 Use traditional approaches to inventory management including o o o order quantity.  Explain Just-In-Time (JIT). Management Accounting: Information for managing and creating value.  Understand the concept of Managing Suppliers. Sydney: McGraw Hill. Management Accounting. 4th edition. South-Western. Resource: Other Text Reading Hansen & Mowen (2003). INVENTORY AND QUALITY OBJECTIVES By the end of this topic you should be able to:  Describe Supply-Chain Management (SCM) and its significance. H and Hilton. 6th Edition.  Understand the concepts of Managing Quality and Total Quality Management (TQM)  Apply the concepts of TQM in analysing and evaluating quality. Thorne.  Explicate the key features of JIT and JIT Purchasing. 46 .  Evaluate supplier performance including non-financial considerations. Chapter 4 pages 131-134.ACCT 2013 Cost Management Systems Topic 5 TOPIC 5 COST MANAGEMENT SYSTEMS & STRATEGY MANAGING SUPPLIERS. R (2006).  Analyse supplier costs. Resource: Text Reading Langfield-Smith. K.  Comprehend the concept of inventory management. Chapter 19 pages 808-826 & Chapter 11 pages 438-455. Chapter 16 pages 746-761 & 768-775. timing of orders stock-out risk management.

in particular. receiving and inspection.  The Costs of poor quality. 47 . An organisation which can cost these activities is in a stronger position to analyse. However. ordering. managing suppliers centred. there has emerged the opportunity to cost other activities related to dealing with suppliers.ACCT 2013 Cost Management Systems Topic 5 1. around finding suppliers who were both reliable and offered a cheap purchase price. the fact that the traditional costing system struggled to provide additional information relevant to managing supplier costs. including activities such as:  The Costs of purchasing. we will now consider an example of supplier analysis.  The Costs of holding inventory.  The Costs of delivery failure. In the next section. This was a consequence of. evaluate and then manage its suppliers compared to only being able to compare purchase prices. in part.0 MANAGING SUPPLIERS: AN INTRODUCTION Traditionally. with the advent of Activity Based Costing systems.

800 $2.080 (6.400 $5.1 MANAGING SUPPLIERS: AN EXAMPLE The Hardy Saucepans example in your textbook provides us with a basic example of supplier cost analysis and it demonstrates how merely comparing supplier purchase prices can be misleading in the overall cost analysis of suppliers.340 (10.800 $2.600 $1.000 x $2) = 1. Total Supplier Costs Total Purchase Price $10.600 $2.017 Handles Ltd. which can be used to compare suppliers.000 x $2. Purchase Order Delivery Inspection Storage Rework Downtime Late Deliveries Total Supplier Costs Unit Supplier Costs Purchase Price plus Unit Supplier Costs $1.ACCT 2013 Cost Management Systems Topic 5 1.080 $1.350 $2.7636 From a financial perspective.034 $1. in this case Plastex Industries. 48 .440 $4.88 An additional technique.200 $3.68 $3. is called the Supplier Performance Index (SPI).20) = 0.340 $2. SPI is defined as Total Supplier Costs Total Purchase Price For Hardy Saucepans the SPI calculations are as follows: SPI Analysis Plastex Industries SPI = Total Supplier Costs Total Purchase Price $20.250 $1.034 $4.800 $250 $180 $250 $10. the supplier with the higher SPI is more expensive.500 $20. Supplier Cost Analysis Plastex Industries Handles Ltd.

being environmentally responsible. there may be other supplier performance measures. We will now consider an example of EOQ in section 3. called Just in Time (JIT). being a designated country of choice (federal government tenders)… TUTORIAL QUESTIONS You should now attempt P16. The first technique is a long standing method called Economic Order Quantity (EOQ) and the second method a much newer technique.1 and JIT in section 3.55. regarding the question of how much to order (order quantity).ACCT 2013 Cost Management Systems Topic 5 1. the reliability of supply. some of the costs of inventory management are frequently directly related to the quantity of materials ordered as this then in turn influences how much is stored.43 & C16. used by organisations which may impact on and affect their final purchase decision. There are two approaches. 2. In fact. on the analysis of supplier costs. of recent decades. for how long and how often orders are placed. Other considerations may include: the delivery time. a number of the costs involved inventory and its management. is the cheaper supplier.2 OTHER CONSIDERATIONS Although the textbook example demonstrates that Handles Ltd. 49 . we will now consider.2.0 MANAGING INVENTORY: AN INTRODUCTION In the previous section.

if we run our bags down to zero then production will stop as we wait for the next order to be filled which will take 2 weeks. It could be expressed in days or in bags. EOQ considers that if we place fewer orders. 50 .50 = 480 bags Also. in this case. For example. This timing is often expressed not just in days of “lead time” but also in how many.ACCT 2013 Cost Management Systems Topic 5 2. namely. related to the economic order size is the timing of when to place an order so as to reduce the risk of a “stock out” that is. EOQ = 2×4800×$60 $2.800 bags /50 weeks). From this viewpoint. Safety stock is an additional margin of safety added to the lead time. EOQ = 2× Annual Demand× Cost per Order Annual Carrying Costs per Unit Referring to the example on pages 754 . For example. we get the following calculation for the optimum order size that will minimise overall order costs and carrying costs. as order costs go down then carrying costs will go up and vice versa.1 MANAGING INVENTORY: AN EXAMPLE OF EOQ EOQ is based on the belief that inventory management is all about balancing two groups of competing costs.757 of your textbook. we derive the EOQ formula for calculating the optimum order quantity. In other words. we must purchase in larger batches and therefore we must carry (store) more materials. bags we can “run down to” before we must place an order. Based on an average usage of 96 bags per week (4. running out of stock. with regard to the replenishing of food at home before it runs out. putting more petrol into the car before it comes to a halt etc. an order needs to be placed once our material stock is run down to (2 weeks x 96 bags) = 192 bags. Moreover. The calculation above can then be further refined by the inclusion (addition) of a safety stock in order to further minimize the risk of a “stock out” occurring. In our everyday lives. we all apply the concepts of “lead time” and “stock outs”. order costs and carrying costs.

organisations using JIT would carry zero inventory at all points. that is. WIP and finished goods.45. E16.2 MANAGING INVENTORY: JUST IN TIME (JIT) Over the last four decades. A radical departure from traditional manufacturing.33. raw materials.ACCT 2013 Cost Management Systems Topic 5 2. we know from ABM that both of these costs are considered to be non-value adding. JIT philosophy has had a significant effect globally on how to manage all levels of inventory. JIT waits until purchase orders are placed and then manufactures on the basis of this actual demand.32. 51 . in a perfect world. P16. & P16. that is. often supported by extensive marketing.47. Moreover. which operates by estimating market demand and then pushing product onto the marketplace. WIP would never be stockpiled as it would flow immediately to the next process and ultimately the finished goods would be automatically delivered to the person or organisation that placed the order. manufacturing is pulled by the order. Raw materials would arrive on demand as needed by manufacturing. Although there are a number of aspects to this concept. Unlike traditional large scale manufacturing. TUTORIAL QUESTIONS You should now attempt E16. it is characterised by the view that carry costs such as storage costs and the costs of moving inventory can dominate inventory cost management.

AQL espouses that further attempts to drive down the defect rate. 52 . have become greater than the savings in failure costs.ACCT 2013 Cost Management Systems Topic 5 3. Strictly. external and appraisal costs. WIP and finished goods. warranty claims… The theory of the cost of quality is based on the belief that the costs of prevention and appraisal offset the costs of failure. Under this philosophy.  External failure. and  Ignores the costs of future lost sales when customers receive defective goods. in the next section. TQM proponents would argue that this Acceptable Quality Level (as espoused by one major automotive manufacturer)  Provides competitors with the opportunity to establish a competitive edge. namely. which will. There is also a competing viewpoint that there exists an optimal level of quality. after some optimal point.  Internal failure costs. The pursuit of quality through TQM is achieved by recognising four groups of activities that are related to quality. e. There are a number of philosophies regarding quality of which Total Quality Management (TQM) and the promotion of a corporate culture of quality and continuous improvement is popularly referred to in contemporary literature on quality. usually otherwise and organisations have to decide how they will go about maintaining quality and how much money they are prepared to spend in the pursuit of quality. look at an example of these costs and the preparation of a Cost of Quality report. These groups of costs of quality are:  Prevention costs. which minimises the total cost of quality. by now.g. e. no one would make mistakes and therefore no time or money would be lost finding. managers determine that point at which any further investment to improve quality would need be greater than the costs that could be saved from that reduced level of defects. It is a philosophy that has the objective of eliminating all defects. fixing and preventing errors. the costs of reworking defective production.  Appraisal costs. the costs of finding defects by inspecting raw material. e. those costs incurred to prevent and minimise internal. of course. the costs of sales returns.g.g.0 MANAGING QUALITY: AN INTRODUCTION In a perfect world. We will now. TQM means the improvement of quality in every way at every level of the organisation. The reality is. will cause an increase in prevention and appraisal costs.

Prevention Costs Quality Training Quality Planning Quality Reporting Quality Systems Appraisal Costs Mat’ls Inspection WIP Inspection Finished Goods Inspection Laboratory testing Internal Failure Costs Scrap in Prod’n Scrapped Finished Goods Rework Downtime External Failure Costs Warranty Out of Warranty Customer Complaints Transport losses Litigation Although a Cost of Quality report can help an organisation identify what is considered to be an optimal level of quality and it can put a dollar figure on the costs of poor quality.1 MANAGING QUALITY: AN EXAMPLE Please refer to Exhibit 16. 3.18 in your Textbook. Also. then why has it lost its impetus? Maybe. air transport (safety) etc. how ethical is this in industries such as health. there are defective products recalled for safety reasons ranging from food to motor vehicles to children’s toys to health products. If the certification of quality is a good idea.2 OTHER QUALITY CONSIDERATIONS ISO accreditation in Australia was “flavour of the month” a decade ago but has seemingly lost momentum. because it was incredibly time consuming and more about bureaucracy than proving “real” quality? 53 . how do we impute a figure on contingent litigation? In Australia.ACCT 2013 Cost Management Systems Topic 5 3. each year.

in manufacturing this is requisition cost) needs to reduce to prevent the total costs from spiralling out of control. One can also see a link between JIT and TQM—JIT relies on the quality of throughput and the quality of processes. Further cost management related to inventory comes from the traditional approach of EOQ and average usage estimates being used for order point and safety stock decisions. costs such as set up costs needed to be reduced. EOQ assumes that all elements except order quantity are constant.e. TQM provides one form of performance measurement. If the strategic approach adopted by a firm includes quality as a prime objective. We will now move on to other control and performance measurement techniques. In turn. The focus on TQM assists in this regard. Hence. if we wish to hold minimal inventory. 54 . and consequent lower set up costs meant that even the EOQ formula makes smaller batch sizes more economical. However. or taking the level of non-value adding costs caused by suppliers into consideration when selecting them. With shorter set up times production could become more responsive. The competing philosophies of TQM and AQL were also explained in this topic. The contemporary approach of JIT and TQM can be seen to relate to the EOG formula. since it provided shorter lead times. the investment in quality can provide better cost management through increasing certain costs to reduce costs overall.ACCT 2013 Cost Management Systems Topic 5 TUTORIAL QUESTIONS Attempt Self-Study problem 2 from page 779 in your textbook followed by P16. SUMMARY One way to manage costs caused by suppliers is to analyse the costs associated with suppliers according to activities performed and see whether these costs can be brought under control through either negotiating with the suppliers.54. we can see from the EOQ formula that ‘order costs’ (i.

 Comprehend new developments such as shared services and team-based structures. R (2006). Resource: Text Reading Langfield-Smith. Resource: Other Text Reading Hansen & Mowen (2003). investment centre. H and Hilton. Management Accounting: Information for managing and creating value. RESPONSIBILITY ACCOUNTING.  Describe the nature and reasons for transfer pricing. Management Accounting. Chapter 13 pages 576-582.  Define the terms responsibility centre. Sydney: McGraw Hill. Chapter 13 pages 530-533 & 544-552 and Chapter 15 pages 620-625. Thorne. 6th Edition. K. Davis & Hartgraves (2003).  Prepare hierarchical performance reports. Management Accounting: A Strategic Approach. South-Western. profit centre. AND TRANSFER PRICING OBJECTIVES By the end of this topic you should be able to:  Explain decentralization. Morse. revenue centre and cost centre.  Calculate and determine transfer prices for a range of scenarios. South-Western.  Apply different transfer pricing methods.  Utilise segmented profit statements. 4th edition. 55 . 3rd Edition. Chapter 12. its benefits and costs.ACCT 2013 Cost Management Systems Topic 6 TOPIC 6 CONTROL AND PERFORMANCE EVALUATION DECENTRALIZATION.

power and decision-making. some decentralized organisations have introduced centralized (shared) support services such as enterprise wide databases and information technology sometimes known as ERP (enterprise resource planning). Although the notion of decentralization is many decades old. 56 . however. for several reasons. DECENTRALIZATION. This devolution of power. Other organisations. CONTROL AND PERFORMANCE EVALUATION: AN INTRODUCTION This topic is the first of three topics that looks at several concepts and techniques related to control and performance evaluation. more recently.ACCT 2013 Cost Management Systems Topic 6 1. There is a range of reasons why an organisation would choose to devolve its systems and decision-making not the least of which is to speed up decision making and to let those at “the coal face” be directly responsible for their actions. prefer to decentralize these functions and devolve responsibility to branches. you would have studied budgeting and variance analysis. divisions or investment centres and allow local decision-making. decision-making and responsibility is often part of what is referred to as having “flatter structures” and team based participative management practices. 2. RESPONSIBILITY CENTRES & RELATED NEW DEVELOPMENTS Some corporations have organisational structures that revolve around a head office. Previously. which dominates all aspects of the organisation’s strategy and operations including centralization of systems. which are control and performance evaluation topics.

500 $1642 858 Northern Division $900 615 285 30 828 21 552 9 276 750 78 10 68 500 52 250 26 57 . profit centres etc. The profit statement (performance report) below is a summary of the key sections of Exhibit 12. namely. it is believed that they should only be assessed on activities. FINANCIAL PERFORMANCE REPORTS.ACCT 2013 Cost Management Systems Topic 6 3.. Note how this report uses variable costing as the preferred reporting format. Importantly the top (shaded) section lists all controllable.5 in your textbook. This is the essence of what is known as responsibility accounting. CONTROLLABILTY AND RESPONSIBILITY In measuring and evaluating the performance of the managers of investment centres.600 1027 573 Sales Variable Operating Costs Segment Contribution Margin less Fixed expenses Controllable by the Segment Manager Profit Controllable by the Segment Manager Less Fixed Traceable Expenses but Not Controllable by the Segment Manager Segment Profit Less Common Fixed Costs Net Profit before Tax Byron Bay Hotels $2. SEGMENTS. that is manager responsible revenue and expenses whereas the bottom section incorporates the items for which the segment manager should not be held responsible. the non controllable items. Company Segments Southern Division $1. We will now look at the use of a segment report which focuses on evaluating management only on what they control. costs and revenue that they have control over and not those over which they have no control such as allocated costs and traceable non controllable costs.

400 18.1.136 12.45 .340 - 5 25 .470 12.30.110 12.000 27.355 1.060 2.716 6. Below is a summary of the key features of this report and its hierarchical nature.6. E12. profit centres.100 4. This report demonstrates the connection between budgets and responsibility accounting through the presentation of a hierarchical.3.760 1.340 4.900 .26 - 600 605 1.800 1.840 1.33 and E12. revenue centres and cost centres.260 12.5 15 TUTORIAL QUESTIONS You should now attempt E12.785 1. FEBRUARY Budget Company Southern Division Northern Division Head Office Total Profit Northern Division Coffs Harbour Brisbane Newcastle Total Profit Newcastle Grounds and Maintenance Housekeeping Recreational Hospitality Food and Beverage Total Profit Food and Beverage Banquets Restaurant Kitchen Total Profit Actual Variance $70 14 100 44 10 50 26 14 $18.136 1 1 .40 40 2.2.3.760 27. 58 .246 . This report is made up of investment centres. segmented performance report.050 4. E12.1 .246 44 41 41 2.355 4.260 .030 .40 15 .ACCT 2013 Cost Management Systems Topic 6 For another example of a responsibility performance report now refer to Exhibit 12.110 6.050 2.36.025 1.

Scenario 1 External Market plus Excess Capacity. are transferred (sold) from one investment centre or profit centre to another.  Market-Based prices. The Soap Division will want to purchase at anything below market price of $1. Negotiation of transfer prices essentially depends on the bargaining power of the two parties and this is influenced by factors such as: the existence of an external market for the supplier and also whether the supplier does or does not have excess capacity.000. Approaches used include:  Direct Intervention from Head Office. and the purchaser will want to pay as close to zero as possible to minimise their cost of purchasing.  Negotiated prices.000 per tonne but because it has excess capacity anything over its cost of $700 per tonne will add to its profits. Page 585 The Industrial Division would like to sell at the market price of $1.000 per tonne. namely the seller (supplier) and purchaser. from within the same organization.0 TRANSFER PRICING: AN INTRODUCTION Transfer pricing occurs when products and services. corporate management. the lower the better as it will reduce its costs and thus increase profits.  Cost-Plus prices. 59 . which as seen from the perspective of the supplier are: 4. If the management of both entities involved. These two variables create as many as five bargaining scenarios.ACCT 2013 Cost Management Systems Topic 6 4. are evaluated and/or rewarded (get bonuses) based on their profits then this internal price will be of importance to both parties. As a consequence. the issue becomes how to set the transfer price.1 NEGOTIATION SCENARIOS Supplying Division External Market Excess Capacity Yes Yes Yes No Yes Limited No Yes No No Scenario 1 Scenario 2 Scenario 3 Scenario 4 Scenario 5 Now please refer to your textbook page 584. The supplier will want to get as high an internal price (transfer price) as possible to boost their revenue. The transfer price will be bargained between the variable cost of $700 per tonne and the market price of $1.

and you were shown how to do this. SUMMARY In this topic we revisited a topic considered in ACCT 2006. The negotiations with the Soap Division for the surplus will then follow scenario 1. Scenario 5 No External Market and no Excess Capacity (Full Capacity) Operating at full capacity. Scenario 3 External Market and Limited (restricted) Excess Capacity. TUTORIAL QUESTIONS You should now attempt E12. $910 per tonne. The transfer price will be bargained between $690 per tonne and $910 per tonne. a measure of profit in isolation does not take into consideration the level of resources utilised in its generation. The Soap Division will want to purchase at anything below its market price of $1.39.100 minus its $200 per tonne processing cost. You now should understand a variety of transfer pricing options and the implications for how transfer prices are set. Transfers of components and services between business units present more situations in which managers can influence each others results. While variance analysis can form a major element in the evaluation of cost centre and revenue centre managers. which is the Soap Division’s top price. Scenario 4 No External Market but Excess Capacity.ACCT 2013 Cost Management Systems Topic 6 Scenario 2 External Market but no Excess Capacity (Full Capacity).000 per tonne. P12. Its bargaining position is powerful and if the Soap Division rejects the offer of $1.45 and P12.46.000 per tonne then the Industrial Division will just sell on the open market for $1. While transfer prices affect the measure of profits. Yet managers usually need to 60 . its variable costs.000 per tonne and then just negotiate with the Soap Division for whatever it cannot sell at the open market price. profit centre (including investment centre) managers can have performance measures that have the potential for significant influence from the decisions of others. as the Industrial Division has an external market and is at full capacity. namely responsibility centres and the evaluation of their managers. namely. In this case. This scenario is an extension of scenario 2 in that the Industrial Division will want to sell all it can at the open market price of $1. Hence. The Industrial Division will want to sell at as high a transfer price as possible but with excess capacity anything over $690 per tonne. it will not want any other transfer price than market price. the Industrial Division will demand a minimum of $990 per tonne from the Soap Division in order to compensate for any lost contribution margin from “regular” customers. the setting of transfer prices can be a major cause of dispute and bad feeling. will add to its profits. This needs recognition.

This issue forms the major part of the material in the next topic. 61 .be held accountable for the efficient usage of resources.

Davis & Hartgraves (2003). explain Economic Value Added and Shareholder Value Added.  Distinguish between some traditional and contemporary approaches to financial performance measurement. South-Western. Chapter 13.  Describe and apply different types of reward systems.  Briefly. Management Accounting: A Strategic Approach. 62 . Resource: Other Text Reading Hansen & Mowen (2003). 3rd Edition. Management Accounting: Information for managing and creating value.  Discuss issues and difficulties related to reward systems. 6th Edition. H and Hilton. Morse. Resource: Text Reading Langfield-Smith. Thorne. R (2006). Management Accounting. Chapter 13 pages 533-544. 4th edition.ACCT 2013 Cost Management Systems Topic 7 TOPIC 7 CONTROL AND PERFORMANCE EVALUATION FINANCIAL PERFORMANCE MEASURES AND REWARD SYSTEMS OBJECTIVES By the end of this topic you should be able to:  Understand the term financial performance measurement and reasons for financial performance measurement. Sydney: McGraw Hill. South-Western.  Explain problems associated with using Return on Investment and Residual Income. Chapter 13 pages 583-590. K.  Calculate and interpret Return on Investment and Residual Income.

(Later.ACCT 2013 Cost Management Systems Topic 7 1. in particular.)  Evaluate the effectiveness of the communication of divisional goals and strategy.  Assist in the determination of management bonuses. FINANCIAL PERFORMANCE MEASURES: AN INTRODUCTION This topic is. 63 .  Identify problems and what causes them. See the shaded area below. we look at different types of reward systems. about techniques that can be used to measure and evaluate the financial performance of investment centres or divisions. in this topic. Investment Centres Profit Centres Revenue & Cost Centres Some reasons for wanting to measure and evaluate the performance of investment centres include to:  See if they are meeting their targets.

then. 64 . can encourage dysfunctional behaviour if management performance rewards are centred solely on it.000 .000.000. rather than the calculation itself.000. expenses of $750. Why would you use this formula? ROI.000. The replacement of aging assets is a particular issue here. Note that it is the way in which ROI is used that creates problems.000)/$10. ROI measures the efficiency of the usage of resources as distinct from the added wealth.000.5%.ACCT 2013 Cost Management Systems Topic 7 2. 2.1 RETURN ON INVESTMENT (ROI) Return on Investment (ROI) is defined as Profit/Investment.000. even though it exceeds the required rate of return.5% good or bad?  What if the Required Rate of Return is 6%?  How is the Required Rate of Return determined? In summary. or comparing their ROI against others. their ROI is compared with the budgeted ROI (preferably flexed for circumstances encountered during the year). Refer to the example on page 617 of your textbook and the disincentive for an investment centre manager to invest in a new project. An extension of the ROI formula is called the Du Pont formula. then it is a comparison against what it ought to be in the circumstances. These techniques are called Return on Investment (ROI) and Residual Income (RI). the managers will take steps to maximise their ROI. However if. Any ROI far in excess of the budget would then be a cause for investigation. including projects adopted and equipment replaced.000 = 2. If managers are assessed by taking a trend over time.750. For example: if an investment centre has earnings of $1. as much as an ROI below budget. for performance evaluation. This raises some questions such as:  Is 2. although traditionally popular.000 and an Investment of $10.0 TRADITIONAL FINANCIAL PERFORMANCE MEASURES OF INVESTMENT CENTRES This section looks at two traditional measures of the financial performance of investment centres. essentially. The ROI would = ($1.

000 short of what is required.3 PROBLEMS IN MEASURING PROFIT AND INVESTED CAPITAL If an investment centre and its management are to be evaluated using either ROI or RI.33 and P13.000. TUTORIAL QUESTIONS Attempt the Self-Study problem on page 636 of your textbook followed by: E13.750. Since the profit was $250. or $600. What does this mean? Is it good or bad? A positive result is considered to be an indicator of good financial performance whereas a negative result is considered to be the opposite. We can compare it with ROI to see what it tells us.2 RESIDUAL INCOME (RI) A second traditional technique is called Residual Income and it is defined as: Profit minus (Investment x Required Rate of Return) Residual Income measures the added wealth created from the additional resources allocated. Using the data from the previous example. the RI would be: ($1. there are a number of issues that need to be resolved in order to ensure that there is a consistent basis of calculation from period to period.000) = negative $350. we can ask: if the investment returned 6%. otherwise you will not be able to apply the ROI or RI calculations since you will not know what figures to use for the elements of the equation. from the outset. it needs to clearly defined how the profit and also the investment value will be calculated.000 .30. 2. then. we can see that it falls $350. in our example.000.000.38. Basically. E13. this may appear straight-forward but.000. covered in your textbook. in fact. what would the profit be? The answer is 6% of $10m.ACCT 2013 Cost Management Systems Topic 7 2. You should make sure that you are clear about the options. Initially. 65 .000.000) – (6% of $10.

3.0 CONTEMPORARY FINANCIAL PERFORMANCE MEASURES OF INVESTMENT CENTRES Contemporary financial performance measurement seeks to determine how much value has been added to an investment centre from the perspective of shareholders. We will now briefly consider two approaches to determining how shareholder added value can be measured. The EVA formula is: Net Operating Profit after tax – (Capital Employed x Weighted Average Cost of Capital). sometimes in using EVA. 66 .ACCT 2013 Cost Management Systems Topic 7 3.2 SHAREHOLDER VALUE ADDED (SVA) Another technique used to determine economic value is shareholder added value. 3. EVA uses the average cost of debt and equity called weighted average cost of capital (WACC) whereas RI has a range of notions as to what actually is the required rate of return and how to calculate it. which is determined by calculating the present value of future cash flows less the market value of the organisations debt. people substitute net cash inflow for net operating profit.1 ECONOMIC VALUE ADDED (EVA) Economic Value Added is determined from a specific interpretation of the RI formula. Also.40.35 and P13. TUTORIAL QUESTIONS You should now attempt E13.

medium and long term corporate goals is not easy. we could ask the question: who designs a company’s bonus system? Is it the shareholders? Is it the executive management? Of course. senior executives are often on short and medium term contracts which reward them for financial performance over the period of their contract. a poor evaluation system could equally motive dysfunctional behaviour as goal congruent behaviour. How does this happen? Certainly. therefore. medium and long terms.ACCT 2013 Cost Management Systems Topic 7 4. we can conclude that the bonus system and company performance are not properly aligned. 67 . motivate management personally to achieve these goals in the short. which is adopted for the purpose of additionally motivating managers but. hardly. REWARD SYSTEMS One of the reasons for conducting financial performance measurement is to determine executive bonuses. we hear of cases of abysmal company performance and senior executives receiving generous bonuses. it is the latter. Each year in the Australian media. Also. There are. concurrently. however. consequently. Is there a conflict of interest? Finally. Are bonus systems difficult to design and implement? Designing bonus systems that balance short. an incentive for planning longer than the term of the contract. The problem is exacerbated by using this performance evaluation with a reward system. several issues regarding reward systems including:  How does a company ensure that its performance measurement system accurately measures management performance?  How does a company ensure that its performance measurement system will actually motivate management to work in the best interests of the company rather than their personal interests?  Which type of reward system should a company choose? • • • Individual or Team? Money or Shares? Profit Sharing or Gainsharing? The challenge for an organization is to design and implement performance measurement systems that are aligned to improved and improving business performance and.

For ‘control’ we should expect significant influence (ie toward the positive end of the continuum).ACCT 2013 Cost Management Systems Topic 7 TUTORIAL QUESTIONS You should now attempt E13.36 and P13. which are still very widely used. 68 . In this context we need to recognise that control is not absolute control but is related to the degree of influence. since ‘influence’ is a continuum from absolutely no influence to total control. Now that you are familiar with the traditional forms of performance evaluation. we need to turn to more contemporary methods.37. Contemporary methods do not replace traditional measures but usually complement them. SUMMARY The focus of this topic has been on evaluating the control managers have over the efficient utilization of assets. often incorporating the traditional measures into more contemporary monitoring and reporting techniques.

 Identify the warning signs of problems in a performance measurement system. Chapter 14. Ballou B. 3rd Edition. Heitger D & Tabor R (2003). H and Hilton. Coming up short on non-financial performance measurement. South-Western. Nov. Thorne. different types of benchmarking and their problems. Davis & Hartgraves (2003). Resource: Articles Ittner C & Larcker D (2003).  Recognise the characteristics of a good performance measurement system. R (2006).  Understand the features of contemporary performance measurement. Management Accounting Quarterly.ACCT 2013 Cost Management Systems Topic 8 TOPIC 8 CONTROL AND PERFORMANCE EVALUATION: CONTEMPORARY APPROACHES TO MEASURING PERFORMANCE By the end of this topic you should be able to:  Discuss the weaknesses of traditional and contemporary financial performance measures. Management Accounting: A Strategic Approach. 69 . Resource: Other Text Reading Morse. Sydney: McGraw Hill. 4th edition. Management Accounting: Information for managing and creating value. Non financial performance measures in the health care industry.  Develop a balanced scorecard. Autumn. K. Harvard Business Review.  Explain the term benchmarking. Chapter 13 pages 590-593 and Chapter 9 pages 388-390. Resource: Text Reading Langfield-Smith.

Profit. Innovation. One year. ROI. In the following sections.g. Revenue.  The incorporation of continuous improvement into performance targets.  Are not clearly linked to organisational goals and strategy. CONTEMPORARY PERFORMANCE MEASUREMENT: AN INTRODUCTION Contemporary approaches to measuring performance seek to overcome the problems listed above by incorporating either all or some of the following:  The use of both financial and non-financial measures.  Benchmarking. namely. strategy and performance evaluation. rather than also being focused on what causes or drives the results. 70 . e. on time delivery…  The linking of goals. the Balanced Scorecard and Benchmarking. customer satisfaction.ACCT 2013 Cost Management Systems Topic 8 1. These criticisms include that they:  Focus only on dollar values and do not use non-financial data such as Quality. Customer Service…  Are short-term measures only. RI…  Are results or outcomes oriented.g. 2.  Neglect external benchmarking.  Are too aggregated and therefore not relevant (controllable) for most staff. we will look at two contemporary approaches to performance measurement and evaluation. E. PROBLEMS WITH FINANCIAL PERFORMANCE MEASURES Contemporary approaches to measuring performance have emerged because of weaknesses in the traditional techniques. e. quality.g.

 A Customer Perspective. THE BALANCED SCORECARD A well publicised.) The key to developing the balanced scorecard is not merely to identify the perspectives and their objectives but most importantly the inter-related KPIs and KPDs (lag and lead indicators). the scorecard needs to be developed so that it is relevant to staff at all levels of the organisation. key performance indicators (KPIs) and key performance drivers (KPDs). the environment etc. The original model of the scorecard developed by Kaplan & Norton was based on four perspectives. The Balanced Scorecard seeks to provide a balanced perspective on performance by using a mix of financial and non-financial perspectives.  A Financial Perspective. contemporary technique used for operational control is the Balanced Scorecard. and not just be constrained to the Kaplan and Norton four perspective framework. EXHIBIT 14. however. not unlike Activity Based Management (ABM). drivers.ACCT 2013 Cost Management Systems Topic 8 3. tends not to be demonstrated fully in textbooks. (Note the relationship of this with Topic 11 on Social and Environmental Accounting. This.  An Internal Process Perspective. The Balanced Scorecard. that is. 71 . ABM is focused on identifying drivers of no value adding activities whereas the Balanced Scorecard is focused on drivers of the Objectives and KPIs for each perspective. seeks to identify what causes things to happen.4 Key Performance Indicators (KPIs) Or Lag Indicators Financial Perspective Customer Perspective Internal Process Perspective Learning & Growth Perspective Key Performance Drivers (KPDs) Or Lead Indicators Note that it is quite feasible to have additional perspectives such as the community. Finally.  A Learning & Growth Perspective.

at least. for the Objectives and KPIs.4 is for a manufacturer and the second example. Systems % of lectures attended % of tutorials attended % completion of tutorial questions Frequency of participation in tutorials Attempting past exam papers Completing the assignment one week before the due date! KPDs or Lag Indicators Mid semester exam result Assignment result At first. Is it KPI (lead) or (KPD) a lag indicator? The Balanced Scorecard is not an exact instrument and this is part of the challenge to understanding it. but the more you think about it. what causes the Objective and Lag Indicators to be attained. Some people find the manufacturing example easier to understand because there is a physical product. your midterm exam results towards your objective of passing this course. is for the service sector and a bus company. Note: a lead indicator in one situation. For example. the concept of the Balanced Scorecard is not difficult to understand. in Exhibit 14.  Identify an Objective or Objectives for each perspective. sometimes the more complex it can become. if we build a basic scorecard for this course with just one perspective it might look as follows. You could develop your own scorecard for your studies or even for this course.  Identify the Drivers (KPDs or lead indicators).5. that is.  Identify an indicator or measure (KPIs or lag indicators) that will show whether an objective has been achieved. if you look at the KPDs above you could think that academic success is driven mainly by attendance at classes but where does that leave external students? 72 .ACCT 2013 Cost Management Systems Topic 8 In developing a scorecard. there are four steps or stages:  Identify the Perspectives. Pass Cost Mgt. point in time or to one person may become a lag indicator in another situation or point in time or to another person. KPIs or Lag Indicators Academic Record Perspective Attendance at classes Objective Participation in tutorials To. For example. Your textbook demonstrates two Balanced Scorecard models. Also. using the model above. the first in Exhibit 14.

 External Benchmarking. the concept itself is not because benchmarking simply means to compare oneself with others in order to find ways to improve.34. Surprisingly. e.g. • • • Competitive. by using any industry which seems suitable for comparison. Bank.g.38 73 .g. There are two main categories of benchmarking. internal and external of which the latter has three levels as described below:  Internal Benchmarking. one BHP division benchmarking with another division. BENCHMARKING Although the term “Benchmarking” is relatively new. sometimes even prospective internal benchmarking partners. such as the National Australia Bank (NAB) benchmarking against the ANZ. an organisation from the same industry.26 and P14. WestPac or Commonwealth Banks. E14.Best-In-Class. The NAB benchmarking against QANTAS or Woolworths.ACCT 2013 Cost Management Systems Topic 8 TUTORIAL QUESTIONS Attempt the Self-Study problem from page 680 in your textbook followed by: E14. for example. Industry. another organisation against which to compare and from who lessons can be learned. 4. such as the NAB benchmarking against MacQuarie Bank or the Police Credit Union or Wells Fargo. In particular. e. will not be willing to co-operate because of internal rivalry.25. this can be an issue where the benchmarking partner is a competitor. One of the challenges with benchmarking sometimes is not so much identifying a suitable benchmarking partner but rather getting co-operation and access to their information and ways of doing things. TUTORIAL QUESTIONS You should now attempt E14. a direct competitor. For example. namely. in some organisations.30 and P14. The key to organisational benchmarking is to find someone else. e.

74 .  Is controllable. SOME CHARACTERISTICS OF A GOOD PERFORMANCE MEASUREMENT SYSTEM Good performance measurement systems have a number of features and are respected by users when at the user’s level in the organisation the information:  Is simple and “makes sense”. in some organisations.14. TUTORIAL QUESTIONS You should now attempt Q4.  Is linked to strategy.  Compares favourably with realistic benchmarks and targets. Also. Another not uncommon problem with performance measurement systems is that information is not available when needed and it appears weeks or months too late.  Is received on time.  Is up to date. They then use this information in meetings as representing the “true’ state of affairs. some staff may go further and design their own “local” performance measurement system often using spreadsheets. in order.  Is not too complex or detailed. SUMMARY This topic incorporated recent developments (specifically the balanced scorecard and the issues that led to its development) into our consideration of performance evaluation techniques.12 and Q4. One element of the master budget that we have not yet covered is the capital budget. WARNING SIGNS OF PERFORMANCE MEASUREMENT PROBLEMS There are several signs or symptoms that a performance measurement system is not working properly including when staff treat official reports as “a joke” and “play games”.ACCT 2013 Cost Management Systems Topic 8 5. We do this in the next topic. Part of performance evaluation is the comparison against the budget.  Is relevant. 6. to be seen to meet targets.

3rd Edition. 6th Edition. South-Western.  Discuss assumptions. IRR. Morse. Chapter 21 and the Appendix to Chapter 21. 4th edition. Davis & Hartgraves (2003).  Comprehend the role of post completion audits. 75 . advantages and disadvantages of NPV. Payback Period and the Accounting Rate of Return. Management Accounting: A Strategic Approach. K. Management Accounting. R (2006). H and Hilton. Management Accounting: Information for managing and creating value. Chapter 18 pages 752-764.  Describe the concept of discounted cash flow (DCF) and the importance of the time value of money. Resource: Other Text Reading Hansen & Mowen (2003).ACCT 2013 Cost Management Systems Topic 9 TOPIC 9 CAPITAL BUDGETING OBJECTIVES By the end of this topic you should be able to:  Understand the term Capital Budgeting and when to use Capital Budgeting techniques. Sydney: McGraw Hill. Payback Period and the Accounting Rate of Return. Chapter 10 pages 408-423. South-Western.  Evaluate Capital Budgeting decisions by calculating Net Present Value (NPV). Resource: Text Reading Langfield-Smith. Internal Rate of Return (IRR). Thorne.  Explain the management accountant’s role in Capital Budgeting.

it can be invested and earn interest. infrastructure etc.e. The time value of money recognises that a dollar today is more valuable than a dollar in the future because. the profit of only one year. called Capital Budgeting. machinery. tactical) decision-making.. 76 . (i. we will now consider four capital budgeting techniques. We will now look at medium and long term decision making. in theory. among other things. namely. In the Appendix to Chapter 21. what distinguishes tactical decisions from capital budgeting decisions is the time period involved: the former involves decisions affecting. equipment. The fact that capital budgeting involves costs and revenues of more than one year then raises the issue of the time value of money. CAPITAL BUDGETING: AN INTRODUCTION In your previous studies in management accounting you would have learned about short term.ACCT 2013 Cost Management Systems Topic 9 1. transport. Capital Budgeting involves making decisions regarding what we know as non-current assets. In the following sections. the first two of which recognise the time value of money and make adjustments for the costs and revenue of different years through discounted cash flow (DCF). Please note also the Tables at the back of the Appendix. the purchase and replacement of plant. and the latter for two or more years. If you are unfamiliar with this concept then you should thoroughly study the Appendix to Chapter 21 with an emphasis on Present Value. In essence. you will find additional information on the concept of the time value of money.

B 2 3 4 5 6 7 8 9 D CT Scanner Decision Annual Cash Flow 0 1 .107.000 .000 .7 in your textbook demonstrate this and although the layouts are slightly different I have reproduced the second format below.751315 $137.909091 $ 166.000 C E F G H 2 3 4 5 Purchase cost of the new CT scanner Installation Cost Additional Operating Costs Additional Revenue Savings because inpatients do not have to stay as long in hospital 1 0 1 1 1 2 1 3 1 4 1 5 1 -$ 659.000 200. NET PRESENT VALUE (NPV) NPV calculates the net present value of capital projects over their lifetime and it is the first of two discounted cash flow (DCF) techniques covered in your textbook.000 . Both Exhibits 21.240 0.000 90.715 $ 183.107.629 NPV= $33.000 .107. you should now read the background information for the Monash Medical Centre and its CT scanner problem on page 1013.000 90.000 107.107.000 200.000 $ 183. B C D E F G H 2 3 4 5 6 7 8 9 0 CT Scanner Decision Annual Cash Flows 1 2 3 4 5 Purchase cost of the new CT scanner Installation Cost Additional Operating Costs Additional Revenue Savings because inpatients do not have to stay as long in hospital 585.000 107.000 $ 183.000 90.715 107.74.000 .000 90.585.000 200.000 200.000 90.000 Cost of Capital of 10% 1 -$ 659. See below.364 0.4 and 21.000 200.107.000 $ 183.000 . DCF techniques require that we distinguish cash flows for each year and they.ACCT 2013 Cost Management Systems Topic 9 2.991 0.000 90.000 .715 0.000 90.683013 $124.620921 $113.000 200.000 90.000 200.000 Once we have recorded our annual cash flows then we next total each of the columns and calculate our yearly net present values and finally the NPV for the project.000 200.107.000 $ 183.999 77 .715 .000 200. as shown below. are ideally set up in a spreadsheet.000 90. As an example.000 90.000 107.000 200.491 0.74.826446 $ 151.

) The Cost of Capital or Required Rate of Return or Hurdle Rate is the minimum financial return required by an organization from a project. how to calculate the Weighted Average Cost of Capital. whereas a negative NPV means the project should be rejected because it has not reached its cost of capital. the average cost of an organisation’s equity and debt.27 & E21. (Sometimes we use the return on an alternative investment (e. 78 . this model has been constructed in Excel and is accurate to the nth decimal place.6 1 7 Note. if you study financial management then you will study this topic and. ACCT 2013 Cost Management Systems Topic 9 A positive NPV means that wealth is added to the organization and that. Note that capital project evaluation is often complicated by many non-quantifiable influences and that these influences may be given greater priority than the financial decision. in particular. That implies that the return from the investment is less than the cost of the funding for the project. the project is viable. other projects) as the discount rate to assess whether this project will return a higher return than the alternative investment opportunity. debentures. from a financial perspective. In your studies. TUTORIAL QUESTIONS You should now attempt E21.29. that is.g the bank rate.

C 2 3 4 5 6 7 8 9 Purchase cost of the new CT scanner Installation Cost Additional Operating Costs Additional Revenue Savings because inpatients do not have to stay as long in hospital E CT Scanner Decision Annual Cash Flow 0 1 .9975% This has been solved using the Excel function called IRR If you do not use a spreadsheet to determine the IRR then a financial calculator can also automatically solve the IRR.000 .107. 79 .000 $ 183. This latter method can be most tedious.ACCT 2013 Cost Management Systems Topic 9 3.715 $ 183. rather than use a predetermined hurdle rate.000 $ 183. you have to calculate the rate of return that will give the project an NPV of zero.000 For an NPV of IRR= 0.000 200.000 90.74.107.000 90. INTERNAL RATE OF RETURN (IRR) The second DCF technique used to evaluate capital projects is called the Internal Rate of Return (IRR).000 200.107. TUTORIAL QUESTIONS You should now attempt E21.000 .715 .585.000 $ 183. however.000 200.107.000 $ 183.000 200.30 & E21.00 11.31. Spreadsheets again are ideal for this purpose along with their IRR function.000 .000 90.000 D F G H I 2 3 4 5 . Initially.000 90.000 .107.000 1 0 1 1 1 2 1 3 1 4 1 5 1 6 -$ 659.000 90. to calculate IRR you use the same spreadsheet layout as NPV.000 200. Otherwise it has to be solved using a combination of Trail and Error (guessing) and sometimes a technique called linear interpolation.

as part of their investment policy.61 years Although payback period has a number of weaknesses it is.715 $183. 80 . 5. no project will even be considered that exceeds the benchmark payback period. It should also be noted that to improve the accuracy of the payback period calculation we can use discounted cash flows for each of the years. however.000 = 3.36. it is not uncommon for organizations to use IRR and then to compare it with current borrowing rates. There are two models of the Payback Period.23 & E21. This type of payback is called Discounted Payback Period.ACCT 2013 Cost Management Systems Topic 9 4. used by some organisations in their initial screening of potential capital projects. In other words. in fact. NPV is favoured academically. COMPARING NPV AND IRR An appropriate question is which of the two DCF methods is better? NPV measures added wealth and IRR the efficiency or rate of return of the investment. THE PAYBACK PERIOD The Payback Period calculates the time it takes for the profits from an investment to cover the cost of the investment. The formula for the Payback Period with even cash flows is: The Initial Investment on the Project Annual Cash Inflow = $659. have a maximum payback period of. TUTORIAL QUESTIONS You should now attempt E21. These organisations. both of which are demonstrated in your textbook on page 1025. namely “with even cash flows” and “with uneven cash flows”. Potential projects that are inside the benchmark are then more thoroughly analysed and evaluated using techniques such as IRR and NPV. three years or five years. for example. Since IRR assumes that cash inflows during the life of the project are reinvested at the same rate as the IRR this should be taken into consideration when deciding how valid the comparison of the IRR’s for of different projects would be.

74% There are two models of the Accountants Rate of Return.715 = 7.  Post completion audits. as with other budgets.943 (dep’n) $659. it is important to realise that as an approximation its reliability declines significantly as the project lifetime gets longer and the later year profits become larger. sometimes it is used as a fast approximation for IRR.000 – 131.ACCT 2013 Cost Management Systems Topic 9 6. The management accountant can be called upon to have a key role in determining the data to be input into the formulae. 81 . This is the role of implementation audits. 7. OTHER ASPECTS OF CAPITAL BUDGETING In this course it is important for you to grasp the role of the management accountant in capital budgeting. From a cost management perspective. THE UNADJUSTED (ACCOUNTANTS) RATE OF RETURN The Accountants Rate of Return also referred to as the Unadjusted Rate of Return is calculated by the following formula. both of which are demonstrated in your textbook on pages 1026-1027.45. However. P20. We have looked at the techniques because an understanding of them assists in the provision of data that will be incorporated in the financial analysis. TUTORIAL QUESTIONS Attempt the Self-Study problem starting from page 1033 in your textbook followed by: P21. Although Accountants Rate of Return has a number of weaknesses. it is important to monitor and analyse what actually happens against the plan.47.46 and P21. namely “Investment” and “Average Investment”. You should study this section of the textbook to become familiar with:  The accountants role in capital budgeting. Average Annual Profit from the Project Investment = $183.

The next topic completes our study of DCF techniques and. such as the tax issues (e.g. It has provided a basic overview of capital budgeting techniques. 82 . Discounted Cash Flow (DCF) techniques in particular require further consideration to make you aware of some complicating issues with regard to the statement of cash flows. in particular.ACCT 2013 Cost Management Systems Topic 9 SUMMARY This topic has looked at the section of the master budget that was not studied in ACCT 2006. and tax payments are usually made the year after the revenue and expense cash flow). the calculation of incremental cash flows. depreciation is not a cash flow but the its impact on tax payments does create an incremental cash flow.

South-Western.  Calculate the direct and indirect effects of tax on discounted cash flow techniques. 6th Edition. Chapter 18 pages 765-778. Chapter 22. pages 241-252. Chapter 10 pages 423-435.  Understand the nature and difficulties of capital investments in advanced technologies Resource: Text Reading Langfield-Smith. South-Western. Davis & Hartgraves (2003). 3rd Edition. Morse. Management Accounting: A Strategic Approach. 4th edition. Thorne. Management Accounting: Information for managing and creating value. (1995) The impact of technological change on management accounting. Management Accounting (2003). 83 . Resource: Other Text Reading Hansen & Mowen. volume 6.ACCT 2013 Cost Management Systems Topic 10 TOPIC 10 CAPITAL BUDGETING OBJECTIVES By the end of this topic you should be able to:  Explain the direct and indirect effects of tax on discounted cash flow techniques. K. H and Hilton. Sydney: McGraw Hill. R (2006). issue 3. Resource: Articles Bruggeman W & Slagmulder R.  Explicate the concept of ranking  Rank capital projects. Management Accounting Research.  Answer a comprehensive question on capital budgeting.

Also. Additional Sales Less Additional Cost of Goods sold Additional Gross Profit Less Tax at 33% Cash Inflow after Tax $110. in Section 3. in the example. Later. in Australia. on credit any longer. CAPITAL BUDGETING: ADDITIONAL ISSUES The previous topic introduced capital budgeting but it ignored the effects of taxes on corporate cash flows. that is.ACCT 2013 Cost Management Systems Topic 10 1.1 TAX ON ADDITIONAL EXPENSES The effect of tax on additional expenses is to reduce the amount of tax paid to the ATO and therefore to decrease the cash outflow of the organisation because expenses are generally an allowable deduction.000 9.0 TAX ON ADDITONAL SALES The effect of tax on sales is to reduce the cash inflow into an organisation by the amount of tax paid on the sales. we will then look at a consolidated example of these individual concepts. We will now consider a series of individual examples that demonstrate the effects of tax on cash flow.500 33. Additional Expenses Tax at 33% Net Cash Outflow after Tax $30. 2. Tax has a double-edged effect on cash flow in that tax on revenue (profit) results in a Payment (cash outflow) to the Australian Taxation Office (ATO) whereas most expenses are an allowable deduction and thus reduce the amount of tax payable.000 60.500 Note that.000 50. it is assumed that all sales and costs are either collected or paid and nothing is outstanding.000 16. the company tax rate is now 30% and no longer 33%.100 84 . currently. Please refer to your textbook and the example on page 1059.900 20. Please refer to your textbook and the example on pages 1058-1059. 2.

82 4 TUTORIAL QUESTION You should now attempt E22.000 6.000 20.040 0.095 NPV @ 12%= $17.600 $13.000 Cash Outflow from Additional Wages -30.600 After Tax Cash Flows from Operations $0 $13.40 0 F 4 50.640 16.000 50.400 2. B C D Purchase of Delivery Truck Year 0 1 2 Cash Inflow from Additional Sales 50.000 20.636 $10.000 -30.78 4 $13.000 1 -40.040 0.040 0.000 -30.000 @ 33% company tax = $2.640.567 $9.1.040 0.640 16. In the example below. it is up to you to decide which layout you prefer.400 2.40 0 2.40 0 2. there is more than one way to present or format an answer.000 Tax @ 33% 0 6.640 16.000 6.000 -30. Although depreciation itself is only an accounting book entry and is not cash flow.712 $11. whereas your textbook generally uses a more concise and condensed format.000 20.040 0.7 on page 1023.000 6. 85 .2 TAX ON THE PURCHASE OF A NON-CURRENT ASSET Purchasing a non-current asset such as the textbook example of a truck on page 1059 generally involves a depreciation write off and an allowable deduction for tax purposes. The following examples all use the format first demonstrated in Exhibit 21. This is demonstrated in Exhibit 21.000 -30.600 $13.640 16. In answering capital budgeting questions.40 0 2.640 16.600 6.ACCT 2013 Cost Management Systems Topic 10 2. The calculation is based on annual depreciation of $8.000 Total Taxable Cash Flows from Operations 0 20.893 $14.324 $13. row 15 is the row.40 0 A E 3 50.797 $12. which claims the cash saving on tax from the depreciation on the truck.000 $13.600 $13.400 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 Initial Investment After Tax Cash Flows from Operations Annual Dep’n Savings Total Cash flows Cost of Capital of 12% -40.400 $13. Ultimately.42 0 $13.000 20.20 1 $13.40 0 G 5 50.25.000 0 -40. the taxation deduction however does reduce the amount of tax payable to the ATO and therefore does affect cash flow.

675 0. If this occurs then the increase in stock levels would be an additional cash outflow in year zero.322 $539 NPV @ 12% = $929 TUTORIAL QUESTION You should now attempt E22.675 0. that is year 0. the amount itself represents either under depreciation or over depreciation on the asset and what has or has not previously been claimed from the ATO.200) x 33%]. The amount of $264 is calculated as follows: [($4. This is demonstrated in Exhibit 22.33.507 $849 $1.567 $950 $1.2 demonstrated below in cell B6 below.675 $0 $1.675 0.675 $0 $1.675 $0 $1. a book loss being under depreciation can now.675 0. sometimes. Although this book profit per se is not cash flow.675 $0 $1.675 0. traded-in or scrapped.361 $605 $1.675 $0 3.675 $0 $1.893 $1.000 . 86 .404 $677 $1. A 3 4 5 6 Year Initial Investment Tax Savings from the Loss on Disposal of the old Forklift Tax Savings on Annual Operating Costs Annual Dep’n Savings Salvage Value Total Cash Flows Cost of Capital of 12% B 0 -$12.3 PROFIT OR LOSS ON DISPOSAL OF A NON CURRENT ASSET If a non-current asset is sold.675 $0 $1. be claimed from the ATO whereas a book profit.797 $1. must now be given back.$3.712 $1.675 0.675 0.452 $757 $1. Conversely. there probably will be a book profit or loss on the sale.26.200 -$8.065 $1. at sale.675 0.675 0.496 $1.000 $ 264 C 1 D 2 E F G H 6 I 7 J K 8 9 L 10 Purchase the New Forklift 3 4 5 7 8 9 10 11 12 13 14 15 $1. Both are demonstrated in your textbook with the book loss example of Exhibit 21.4 INVESTMENT IN WORKING CAPITAL At the beginning of a capital project.675 $0 $1. additional raw materials have to be purchased to increase current holdings (balances). which means too much had been claimed in previous years. 2.675 $0 $1.636 $1.675 0.536 $1.193 $1. in the final year of a project this additional inventory would probably be “run down” and put into production thus increasing cash flow in the final year.536 1 -$8. Therefore.ACCT 2013 Cost Management Systems Topic 10 2.335 $1.675 $0 $1.

960 13.000 -30.73 5 20. A B C D E 3 F 4 G 5 H 6 0 0 0.765 $13.500 Year Initial Investment After Tax Cash Flows from Operations Annual Dep’n Savings Investment Allowance 0 50.765 $13.500 3 40.000 -30.500 2 40. CAPITAL BUDGETING: A COMPREHENSIVE EXAMPLE Exhibit 22.765 $13.735 3.500 -6.000 -4.500 4 40.735 513 13.000 15.735 6.500 -4.712 $ - 0 0.765 $13.640 -$5.360 20.000 -30.000 -8.500 -6.360 1 2 3 4 5 6 13. Understanding this model is important.345 0.73 5 20.636 $ - 0 0. which in turn has two sections: Operating Cash Flows and Total Cash Flows.000 -4.500 -6.5 is a complete example of NPV.426 13.ACCT 2013 Cost Management Systems Topic 10 3.797 $ - 0 0.869 0 0.507 $ - 2 3 4 5 6 7 8 9 1 0 1 1 1 2 1 3 1 4 1 5 1 6 1 7 1 8 1 9 2 0 2 1 2 2 2 3 2 4 2 5 2 6 2 7 2 8 2 9 3 0 3 1 3 Year Cost of Overhaul Salvage Value Total Cash Flows after Tax Cost of Capital of 12% Keep the Old Equipment 0 1 2 2.000 -4.000 -3.500 -6.500 -6.500 -6.345 0 1 $ NPV@12%= $1.735 2.000 -30.000 15.000 15.376 13.000 -4.000 -2.000 -30.765 $13.000 -4.500 5 40. The presentation below is divided into three sections: Keep the Old Equipment and Purchase the New Equipment. which incorporates the various ways in which tax can impact either directly or indirectly on cash flows.000 15.000 -30.893 $ 2.000 15.000 15.000 -4.735 855 87 .600 13.735 1.765 $13.735 0 1 40.500 6 40.567 $ 0 Purchase the New Equipment Year Annual Incremental Profits from Additional Sales Annual Operating Cost Savings Annual Cost of Systems Operator Annual Marketing Analysis Costs Software Update Retraining Retag Inventory Total Taxable Cash Flows from Operations Tax @ 33% After Tax Cash Flows from Operations -5.000 -5.73 5 20.73 5 20.73 5 16.

2 3 3 3 4 3 5 3 6 3 7 3 8 3 9

Salvage Value Total Cash Flows

804 -54,556 21,985 17,695 13,431 15,161 14,248

1,440 16,030

Cost of Capital of 12%

1 -$54,556

0.893 $19,63 3

0.797 $14,10 3

0.712 $9,563

0.636 $9,642

0.567 $8,127

0.507 $8,127

NPV @ 12% =

88

ACCT 2013

Cost Management Systems

Topic 10

TUTORIAL QUESTIONS
Attempt the Self-Study problem starting from page 1075 in your textbook followed by: P22.33, P221.37 & P22.39.

4.

RANKING OF PROJECTS
Ranking means to order alternative capital projects in sequence from best to worst. The reasons for ranking capital projects include:  Having limited funds (money) or other resources.  Mutually exclusive projects, namely one project precluding the adoption of other alternative projects. For example, building or upgrading an airport or other form of infrastructure such as a hospital, freeway, university, bridge, sports or entertainment stadium etc. Your textbook introduces a Profitability Index as a means of ranking besides using NPV, IRR and Payback Period. Technically, NPV is superior to IRR, in that, it measures added wealth compared to the efficiency of the investment. However, in reality the ranking of projects with different lives is most difficult because you are trying to estimate, predict or guess what will happen after the shorter of the two projects concludes. Some organisations in order to resolve ranking problems use a maximum Payback Period of, for example, 3 or 5 years; any projects that recover funds over a longer period are automatically rejected. The downside to this approach is that some exceptional profit opportunities may be forgone if an organisation is totally inflexible in its application of this type of ranking policy. NPV, IRR and the Profitability Index may give us some insight and guidance but they quite likely will not give us a conclusive ranking and ultimately they may well need to be complemented by non quantifiable information or even just a “feeling”. See Section 5 on the next page.

TUTORIAL QUESTION
You should now attempt P22.43.

89

ACCT 2013

Cost Management Systems

Topic 10

5.

INVESTMENTS IN ADVANCED TECHNOLOGIES

One of the shortcomings in using capital budgeting techniques is that depending on the project(s) being considered there may be significant benefits and costs that simply are too difficult to quantify or cannot be quantified. Indeed there may be impacts from projects, which at the time of evaluation are either not seen or by any means properly understood in terms of their effects on profits. For example, how do you quantify improved customer service, which is the result of installing new database software? The recently emerged business channel of Electronic Commerce is an example of just how difficult capital projects can be to evaluate. Today, in many cases, if you do not offer online services then you will loose market share, that is, competitive advantage. The issue with E Commerce in some industry sectors is not about making a positive NPV or satisfactory IRR; it is about business survival. What do you think the future prospects would be for any of the following who do not offer online services: airlines, major hotel chains, financial institutions, stock brokers, real estate agents, universities etc? One of the benefits of Internet technologies is that the transaction, data storage and retrieval costs are extremely small relative to traditional commerce. In the medium and long terms, in some of the previously mentioned industries, as more clients and customers migrate to the Internet ultimately organisational cost structures will be considerably lowered. However, in the formative years of E Commerce, for each industry, there are usually no cost savings because for the first market entrant it is about “grabbing” a strategic advantage by capturing a greater market share. If the first entrant is successful, then, for its competitors, E Commerce becomes all about retrieving lost market share and survival. The difficulty for capital budgeting techniques is that the potential cost savings at the time of adopting E Commerce technologies are often far too vague to be confidently quantified for individual NPV, IRR and Payback analyses. Sometimes, to get an improved perspective of potential projects, it can help if we model NPV, IRR etc. for a range of scenarios (estimates). For example, best case, worst case etc. You should thoroughly read this section, in your textbook, as it is needed to place our accounting techniques in their proper perspective, namely, as useful tools for evaluating capital projects but with a number of limitations.

TUTORIAL QUESTION
You should now attempt 22.21.

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Naturally the cash flow statements will sometimes be used to find ways to adjust the project to bring it within the financial constraints of the firm. especially when DCF techniques are to be used. 91 . Cost management also becomes an issue when these detailed plans are used in the monitoring of the implementation and in the post implementation evaluation of projects.ACCT 2013 Cost Management Systems Topic 10 SUMMARY This topic has introduced you to some of the more intricate issues that impact on the preparation of cash flow statements for the evaluation of medium and long-term projects. In this way it is important in cost management.

 Measure social and environmental performance. The British Accounting Review June. 4th edition.  Recognise the role of social and environmental accounting in improved decision-making.  Know the benefits of recognising social and environmental impacts. H and Hilton. Sydney: McGraw Hill. Management Accounting: Information for managing and creating value.  Describe the difficulties in measuring and recognising social and environmental impacts. not included Norris. B (2004) "Motivating Socially Responsive Decision Making: The Operation of Management Controls in a Socially Responsive Organisation". Chapter 17 Supplementary Reading. Thorne.  Improve supply chain management through the application of social and environmental accounting.ACCT 2013 Cost Management Systems Topic 11 TOPIC 11 SOCIAL AND ENVIRONMENTAL ACCOUNTING OBJECTIVES By the end of this topic you should be able to:  Explain the term social and environmental accounting. pp.173-196 92 . R (2006). G and O'Dwyer.  Apply capital budgeting in social and environmental accounting. Resource: Text Reading Langfield-Smith.  Understand the concept of environmental management accounting. K.

social responsiveness and social accounting does not necessarily preclude environmental issues but could be written to implicitly include environmental issues. THE BENEFITS OF RECOGNISING ENVIRONMENTAL AND SOCIAL IMPACTS First we must clarify some conflict in the use of terms in the academic literature on social and environmental accounting. putting the category ‘environment’ together with categories such as society at large. employee morale. life cycle costing. waste management. local communities and employees. the balanced scorecard. EMA techniques can be broadly classified as:  Financially oriented techniques. One school of thought sees them as different but related. for example. energy practices.ACCT 2013 Cost Management Systems Topic 11 1. retention of staff. improved cost management. supply chain analysis…all provide management with techniques that can be adapted and applied to determining and evaluating social and environmental costs and benefits. potential liability… 2. management accounting also has a role to play in the determination of non quantifiable or intangible effects such as company image. we will adopt the clumsy reference to ‘Social and Environmental…’. the cost of recycling. Consequently. toxic chemicals. There is a view that organisations that seek to be socially and environmentally responsible improve their corporation’s long term prospects through establishing a “good” corporate image. the weight of solid waste produced. Consistent with the reading provided to you. improved long term competitiveness… 93 . capital budgeting. cost of quality reporting. EMA considers issues such as the costs of: pollution. The other school of thought regards environmental responsibility as a subset of social responsibility. if you refer to academic literature on this topic you should understand that the mention of social responsibility. ENVIRONMENTAL MANAGEMENT ACCOUNTING (EMA) Environmental and social management accounting looks at the role that management accounting can play in enabling managers to assess the impact on society and the environment from their decisions. Management accounting techniques such as activity based costing.  Physically oriented techniques. namely social responsibility and environmental responsibility. Additionally. noise etc. policies and practices. There are two schools of thought about the terms we are using. for example.

ENVIRONMENTAL ACCOUNTING AND IMPROVED DECISION MAKING Once we have collected data relevant to the costs of social and environmental impacts it can then be used for management decision-making. 5.  How to analyse social and environmental costs.  How to define environmental accounting. by the promotion of recycling with both suppliers and customers. IMPROVING SUPPLY CHAIN MANAGEMENT THROUGH ENVIRONMENTAL AND SOCIAL ACCOUNTING Supply chain management and the managing suppliers and the managing customers from topics 4 and 5 can both be applied to social and environmental accounting through establishing relationships that promote environmentally friendly practices. Please refer to the Cormack example on how the costs of environmental waste provided a new perspective on the company’s plastic moulding processes.) 4.ACCT 2013 Cost Management Systems Topic 11 3. 94 .  Quantifying the costs and benefits. For example. DIFFICULTIES IN MEASURING AND RECOGNISING ENVIRONMENTAL AND SOCIAL IMPACTS There are several difficulties in the field of social and environmental accounting including:  It is not possible to predict all of the future impacts of today’s decisions. (One suggested technique is to modify cost of quality analysis (topic 5) to society and the environment by using the four categories of prevention costs. internal failure costs and external failure costs.  How to define social accounting. appraisal costs.

MEASURING ENVIRONMENTAL AND SOCIAL PERFORMANCE Performance evaluation techniques such as the balanced scorecard can be modified to include social and environmental evaluation. please attempt Self-Study problems 1 and 2.14. and reduced material purchases due to recycling… TUTORIAL QUESTIONS From the textbook. KPIs and KPDs. improved waste management.2. 95 . SUMMARY In this topic you have been exposed to some ways in which the management accountant can assist with decisions that relate to environmental management and also others that are in some other way socially responsible.30.ACCT 2013 Cost Management Systems Topic 11 6. E17. 7. then attempt: Q17. whether that is through the addition of a social and environmental perspective or through the incorporation into existing perspectives of social and environmental objectives. ENVIRONMENTAL ACCOUNTING AND CAPITAL BUDGETING Comprehensive capital budgeting as covered in topic 10 should endeavour to measure cost savings from activities such as improved energy practices. Q17.

96 . to the use of product costs in decisions about pricing and product mix. in environmental and social management decisions. We hope you have enjoyed studying this course and wish you well in any future management position. the management of costs through improved quality decisions and quality cost analysis was considered and was seen to be linked to the move toward JIT principles in organisations. in which we hope you will benefit from the discussion of cost management and other issues covered here. The natural progression from suppliers to inventory and quality management was pursued. Control issues suggest monitoring and the comparison with plans so we completed our study of financial planning by covering capital budgeting. The mix of products has a direct impact on revenues but also on costs and cost management. reward etc) prompted consideration of traditional and contemporary performance monitoring and evaluation. In the second half of this course we moved away from product cost and operation cost issues toward managerial control and some planning issues. Managerial control through performance evaluation techniques (responsibility centres. We then proceeded to look closely at other cost management approaches such as management through the use of activity analysis (ABM). business process reengineering) but also the management of non-value adding costs cause by customers and suppliers. We considered the management of costs through the identification of the appropriate times to place orders and the most economic quantity to order or produce at one time. In this context we not only considered internal management issues (for example. Finally. and cost management in particular. Further. you were presented with material that considers the potential role of management accounting. moving us from ROI and RI toward the balanced scorecard and benchmarking.ACCT 2013 Cost Management Systems Overview COURSE OVERVIEW In this course we have taken you on a journey through refinements of the costing techniques you studied in prior studies. The more recent cost management technique of producing/ordering ‘Just in Time’ was also studied.