MANAGEMENT ACCOUNTING 2

Week 1 Day 2:
Contemporary Costing Methods Contd.
Targeting Costing
Life – Cycle Costing
Environmental Accounting
 Classroom Rules

Always
Keep your mobile
preview/review Ask only relevant
phone switched off
relevant materials questions during
or in a silence
on Moodle teaching time
model
before/after class

Do not interrupt the Always take a

lecturer or session laptop with you for
when you arrive Dress Appropriately
all lectures and
late tutorials
 Module Learning Outcome
1. Explain and evaluate techniques employed by management accounting
practitioners aimed at facilitating decision making.

2. Select and appropriately apply decision-making techniques to facilitate

business decisions and promote efficient and effective use of scarce business
resources, appreciating the risks and uncertainty inherent in business and
controlling those risks

3. Apply the technique of budgeting as a tool for planning and control.

4. Undertake a comparative analysis between actual and planned performance

in order to calculate, analyse, explain, evaluate and provide remedy for
related variances.

5. Demonstrate appropriate academic writing skills, referencing and academic

practice. Engage effectively and confidently with assessment under
supervised examination conditions
 Module Assessment

The Module Assessments:

50% Case Study

50% Written Examination

 Module Aims
1. TO PROVIDE STUDENTS WITH THE KNOWLEDGE AND ABILITY TO
APPLY THE SKILLS AND COMPETENCES REQUIRED OF MANAGEMENT
ACCOUNTANTS AND DEMONSTRATE REQUIRED EMPLOYABILITY AND
TECHNOLOGY SKILLS.

2. TO BE ABLE TO IDENTIFY AND DISCUSS THE INFORMATION,

SYSTEMS AND DEVELOPMENTS IN TECHNOLOGY REQUIRED FOR
ORGANISATIONS TO MANAGE AND MEASURE PERFORMANCE.

3. TO BE ABLE TO IDENTIFY AND APPLY APPROPRIATE BUDGETING

TECHNIQUES AND METHODS FOR PLANNING AND CONTROL AND USE
STANDARD COSTING SYSTEMS TO MEASURE AND CONTROL
BUSINESS PERFORMANCE AND TO IDENTIFY REMEDIAL ACTION.

4. TO ASSESS THE PERFORMANCE OF AN ORGANISATION FROM BOTH A

FINANCIAL AND NON-FINANCIAL VIEWPOINT, APPRECIATING THE
PROBLEMS OF CONTROLLING DIVISIONALISED BUSINESSES AND THE
IMPORTANCE OF ALLOWING FOR EXTERNAL ASPECTS.
 Week 1 Day 2: Learning Outcome

i). Definition/derivation of target cost, steps, identify cost gap & gap close
& Challenges.

ii). Definition/derivation of life-cycle costs, benefits and challenges.

iii). Definition/derivation of environmental costs, and types.

iv). Challenges of environmental costing processes by businesses.

 Session Career Outcomes: cont..
v). You will be able to use your ability to derive a life cycle cost or profit in
manufacturing and service industry to calculate cost and revenue and determine
the profit of the business.

vi) Ability to identify the benefits of life cycle costing, will enable you to exploit
them for the benefit of the business

vii). Understanding the issues business face in the management of environmental

costs, will help you to control environmental costs

ii). By understanding the different methods, a business may use to account for
its environmental costs, you will be able to identify and apply the best method
for the business.
GBS GRADUATE ACHIEVEMENT
Committed to succeed You demonstrate dedication and persistence in pursuing your academic,
personal and professional goals and objectives.

Effective team member You demonstrate the skills, attitudes and behaviours necessary to inspire,
guide and lead others towards an identified goal.

Confident Leader You demonstrate the skills, attitudes and behaviours necessary to inspire,
guide and lead others towards an identified goal.

Professionally Oriented You demonstrate a professional mindset and readiness to apply your
knowledge, skills and competencies in a workplace and study context.
Enterprising mindset You demonstrate an innovative and proactive approach to identifying new
opportunities, adding value and solving problems in a variety of contexts.
Globally and socially aware You demonstrate global and social awareness through the ability to look
beyond yourself and your own cultural perspective and by being committed
to making a positive difference.

Digitally competent You demonstrate competence in a range of digital technologies and can
apply these skills effectively, safely and responsibly in a variety of contexts.
TARGET COSTING
Target Costing

What is target costing?

Target costing involves setting a target cost for a product, having identified a
target selling price and a required profit margin. The target cost is the target
sales price minus the required profit.

Target cost is the cost at which a product must be produced and sold in order to
achieve the required amount of profit at the target selling price. Planned,
estimated cost will be higher than its target cost. The aim of target costing is to
find ways of closing this target cost gap, and producing and selling the product
at the target cost.
7 Steps in implementing target costing
Determine a product specification of which an adequate sales
Step 1 volume is estimated.

Decide a target selling price at which the organisation will be

Step 2 able to sell the product successfully and achieve a desired
market share.

Estimate the required profit, based on required profit margin

Step 3 or return on investment.

Step 4 Calculate: Target cost = Target selling price – Target profit

Steps in implementing target costing-con.

Prepare an estimated cost for the product, based on the initial

Step 5 design specification and current cost levels.

Step 6 Calculate: Target cost gap = Estimated cost – Target cost.

Make efforts to close the gap. This is more likely to be

successful if efforts are made to 'design out' costs prior to
Step 7 production, rather than to 'control out' costs after 'live'
production has started.
 The markup percentage calculation is cost X markup
percentage, and then add that to the original unit cost
to arrive at the sales price.
For example, if a product costs $100, the selling price
with a 25% markup would be $125:

Mark-up and Gross Profit Margin = Sales Price – Unit Cost = $125
– $100 = $25.

Margin Markup Percentage = Gross Profit Margin/Unit Cost

= $25/$100 = 25%.
Sales Price = Cost X Markup Percentage + Cost =
$100 X 25% + $100 = $125.
 Mark-up and Margin-Cont
• Gross margin defined is Gross Profit/Sales Price. In this example, the
gross margin is $25. This results in a 20% gross margin percentage:
• Gross Margin Percentage = Gross Profit/Sales Price = $25/$125 = 20%.

How do we determine the selling price given a desired gross

margin?
• It is the inverse of the gross margin formula, that is, by simply dividing
the cost of the product or service by the inverse of the gross margin
equation.
• For example, if a 25% gross margin percentage is desired, the selling
price would be $133.33 and the markup rate would be 33.3%:
• Sales Price = Unit Cost/(1 – Gross Margin Percentage) = $100/(1 – .25) =
$133.33
• Markup Percentage = (Sales Price – Unit Cost)/Unit Cost = ($133.33 –
$100)/$100 = 33.3%
Deriving a Target Cost

•The target cost is calculated by starting with a market-

based target selling price and subtracting a desired
profit margin. The target cost is simply the target price
minus the required profit.
•Example 1
•A manufacturer wants to calculate a target cost for a
new product P, the price of which will be set at £1000.
The company requires a 30% profit margin on sales to
satisfy the company investors.
•Required:
•What is the target cost?
Deriving a Target Cost

•Solution
•Sales price-profit = cost
•Selling price of £1000 was established
•Profit required = 30% x $1000
• =£300
•Target cost =£1000-$300
• =£700
•This represents the highest acceptable cost to the
company.
Target costing & the target cost gap

Example 2
Knowledge Base Ltd has undertaken market research to find
out about views on the value of the product and also to obtain
a comparison with competitors' products. The results of this
research have been used to establish a target selling price of
£75. This is the price that the company thinks it will have to
sell the product at to achieve the required sales volume.
Below are cost estimates that have been prepared based on the
proposed product specification.
Target costing & the target cost gap
Manufacturing cost £
•Direct material 5.50
•Direct labour 25.00
•Direct machinery costs 1.10
•Ordering and receiving 0.50
•Quality assurance 5.90
Non-manufacturing costs
•Marketing 10.00
•Distribution 6.00
•After-sales service 3.00
•The target profit margin for the game is 30% of the target selling
price.
Target costing & the target cost gap

Required: Calculate the target cost of the new game and the target cost
gap.

Solution £
Target selling price 75.00
Target profit margin (30% of selling price) 22.50
Target cost (75.00 – 22.50) 52.50

Projected cost (Total manufacturing costs) 57.00

Target cost gap (57-52.50) 4.50
Target costing & the target cost gap

Comment
The projected cost exceeds the target cost by $4.50.
This is the target cost gap.

KB Ltd will therefore have to investigate ways to

reduce the cost from the current estimated amount
down to the target cost.
 Closing a target cost gap
The target cost gap is the estimated cost less the target cost.

NB: Increasing the selling price will not close the cost gap.

• In a system of target costing, the total target cost is split

into broad cost categories, such as development, marketing
and manufacturing.
• Then the manufacturing target cost per unit is split up
across the different functional areas of the product.
• The product is designed so that each functional product
area can be made within the target cost.
 Management can set benchmarks for improvement
towards the target cost, by improving production
technologies and processes.
Techniques that can be employed to reduce target
Closing a gap (these can only be used if they do not reduce
target cost quality).
gap- 1. Reducing the number of components
Techniques 2. Using cheaper staff
3. Using standard components wherever possible
4. Acquiring new, more efficient technology
5. Training staff in more efficient techniques
6. Cutting out non-value-added activities
7. Using different materials (identified using activity
analysis etc)
 Problems with target
costing for services

Services are much more difficult to specify

exactly, due to some of the characteristics of a
service.
Intangibility. Some of the features of a
service cannot be properly specified because
they are intangible.
Variability/homogeneity. A service can
differ every time it is provided, and a
standard service may not exist.
LIFE CYCLE
COSTING
What is Life Cycle Costing?
Life cycle Costing:-Is the estimation estimates
the costs and revenues attributable to a product
over its entire expected life cycle.
Life cycle costs of a product:-are all the costs
attributable to the product over its entire life,
from product concept and design to eventual
withdrawal from the market.
Product life cycle:-is essentially a process that
documents a product's journey from
development to withdrawal from the market.
Component 1. Research and development costs
elements of a •– Design costs – Cost of making a prototype
product's •– Testing costs
cost over its •– Production process and equipment: development
life cycle: and investment
2. The cost of purchasing any technical data
required (for example purchasing the right from
another organisation to use a patent)
3. Training costs (including initial operator training
and skills updating)

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 4. Production costs, when the
Component product is eventually launched in the
elements of a market
product's cost
5. Distribution costs (including
over its life transportation and handling costs)
cycle-con
6. Marketing and advertising costs
•– Customer service
•– Field maintenance
• – Brand promotion FAST FORWARD
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 7. Inventory costs (holding spare
Component
elements of a
parts, warehousing, and so on)
product's cost 8. Retirement and disposal costs,
over its life ie costs occurring at the end of a
cycle - cont… product's life, which may
include the costs of cleaning up
a contaminated site

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Why calculate life cycle
costs?
1. To assess the total costs of a
product over its entire life.
2. To assess the expected profitability
from the product over its full life.
3. To eliminate the products that are
not expected to be profitable to be
considered for commercial
development.

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The benefits of life cycle costing

It helps management to assess profitability over the

full life of a product, which in turn helps
management to decide whether to develop the
product, or to continue making the product.
It can be very useful for organisations that
continually develop products with a relatively short
life, where it may be possible to estimate sales
volumes and prices with reasonable accuracy .

The life cycle concept results in earlier actions to

generate more revenue or to lower costs than
otherwise might be considered .

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The benefits of life cycle
costing
Better decisions should follow from a
more accurate and realistic assessment
of revenues and costs, at least within a
particular life cycle stage.

It encourages longer-term thinking and

forward planning, and may provide
more useful information than traditional
reports of historical costs and profits in
each accounting period .

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ENVIRONMENTAL ACCOUNTING
 Environmental management accounting (EMA) is the generation
and analysis of both financial and nonfinancial information in order
Environmental to support internal environmental management processes.
Accounting

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Environmental concern and performance

(a) Short-term savings through waste minimisation and energy

efficiency schemes can be substantial.
(b) Companies with poor environmental performance may
face increased cost of capital because investors and lenders
demand a higher risk premium
(c) There are a number of energy and environmental taxes,
such as the UK's landfill tax on waste disposal.
(d) Pressure group campaigns can cause damage to reputation
and/or additional costs.
(e) Environmental legislation may cause the 'sunsetting' of
products and opportunities for 'sunrise' replacements.
(f) The cost of processing input which becomes waste is
equivalent to 5-10% of some organisations' revenue. .
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 Achieving business and
environmental benefits
(a) Integrating the environment into capital
expenditure decisions
(b) (b) Understanding and managing
environmental costs.
(c) Introducing waste minimisation schemes.
(d) (d) Understanding and managing life cycle
costs
(e) Measuring environmental performance.
(f) Involving management accountants in a
strategic approach to environment-related
management accounting and performance
evaluation.
4 Types of environmental costs
Conventional costs, such as raw materials and energy costs, have an
impact on the environment.

Potentially hidden costs are relevant costs that are captured within
accounting systems but may be 'hidden' within 'general overheads’.

Contingent costs are costs that will be incurred at a future date as a

result of discharging waste into the environment, such as clean-up
costs.

Image and relationship costs are costs incurred to preserve the

reputation of the business; for example, the costs of preparing
environmental reports to ensure compliance with regulatory standards.
Achieving business and
environmental benefits
External environmental costs are costs
that an organisation causes, but which are
suffered by others –eg the general public.
Internal environmental costs include,
the costs of preventing environmental
damage (such as air filters and water
treatment equipment), the costs of
detecting environmental damage or
emissions, the costs of correcting
environmental damage that is caused, and
the costs of disposal of any waste
Identifying
environmental costs

Typical environmental costs are

listed below.
1. Consumables and raw materials
2. Transport and travel
3. Waste
4. Waste and effluent disposal
5. Water consumption
6. Energy
Controlling environmental costs

Once a business has defined, identified and

allocated environmental costs, it can begin the
task of trying to control them through
environmental management systems.
ISO 14001 prescribes that an environmental
management system must comprise:
1. An environmental policy statement
2. An assessment of environmental aspects and
legal and voluntary obligations
3. A management system
4. Internal audits and reports to senior
management
5. A public declaration that ISO 14001 is being
complied with
 Input/output analysis

Input/output analysis operates on the principle that what

comes in must go out.
Input/output analysis measures the input to a production
process or system, and the output from the system
Any difference between the amount input and the amount
input is 'residual', which is called 'waste’.
Input and output quantities are measured first, and these
can then be given a cost.
By accounting for process outputs in this way both in
physical quantities and in monetary terms, businesses are
forced to focus on environmental costs.
 The focus of management attention with
Accounting for flow cost accounting should be to reduce
the proportion of negative products in
environmental costs total output and increasing the proportion
of positive products.
 Under this technique, material flows through an
organisation are divided into three categories, and the
Accounting for cost of each category is measured separately.
1. Material
environmental 2. System: this is the in-house handling that is required
costs (including labour) and its cost
3. Delivery and disposal: this is the cost of transport and
the cost of disposal of waste
Challenge with Environmental
activity-based costing
Challenge with environmental activity-based costing.
(a) Identify the hidden environmental costs and link them
to 'environmental activities’
(b) Charge the costs of each environmental activity to
individual product costs according to the amount that
each product is responsible for the environmental activity
Environmental activities and environment-driven may
include activities and costs relating to:
(b) Prevention work
(c) Detection
(d) Corrective action
(e) Disposal of waste
Environmental life cycle costing
Environmental costs for a product are considered from the
design stage of the product right up to the end of life costs,
such as decommissioning and removal.
This approach makes an assessment of expected
environmental costs over the entire life of a product.
These costs will include 'internal' costs that the organisation
will incur
This enable management to make a decision about whether
the environmental costs are acceptable, or they can consider
ways of reducing the costs to a more acceptable level.
REFERENCES

Kaplan (2021), Performance Management, Kaplan Publishing

Drury, C. (2020) Management and Cost Accounting, London, Cengage Learning
BPP (2021), Performance Management, BPP Publishing
BPP (2015), Advanced Management Accounting, BPP Publishing
Recommended Textbooks/Magazines
Student Accountant, Association of Chartered Certified Accountants
BPP (2021), Performance Management, BPP Publishing
Journals
Accounting and Business Research – ICA
Accountancy - ICAEW
 References Contd…..
•Management Accounting Research – CIMA
•Journal of Management Accounting Research
•Journal of International Financial Management and Accounting
•Websites
•www.accaglobal.com
•www.accountancyage.com
•https://www.cimaglobal.com/
•www.icaew.com
•www.bized.co.uk/learn/accountancy
•Avoiding Plagiarism - http://sja.ucdavis.edu/avoid.htm
•BBC News Business - http://news.bbc.co.uk/1/hi/business /
•The Best Search Engines -
www.lib.berkeley.edu/TeachingLib/Guides/Internet/SearchEngines.html
•Business and economic resources - www.bized.ac.uk
•The Financial Times – www.ft.com
Any Questions?