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F2- Management accounting

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F2 ACCA Phi Thanh Tu

Syllabus

F2 ACCA Phi Thanh Tu

Cost card- Cost statement of total cost of 1 unit of product


Direct labour Direct material Direct expense PRIME COST Variable production overheads MARGINAL PRODUCTION COST Fixed production overheads TOTAL PRODUCTION COST Non production overheads Admin cost Selling cost Distribution cost Finance cost TOTAL COST Profit (marked up 10%) Selling price Non-production cost 10 10 10 20 150 15 165 Production cost 30 20 10 60 10 70 30 100

F2 ACCA Phi Thanh Tu

Part B Cost accounting techniques


I. II. III.

IV.
V. VI.

VII.

Material cost Labor cost Overheads Marginal and absorption costing Job, batch and service costing Process costing Alternative costing techniques

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Part B-1- Material cost


Ordering and accounting for inventory Order quantities and reorder levels

I. II.

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I. Ordering and accounting for inventory


Inventory Accounting procedures for ordering and issuing inventory Recording of Inventory Physical inventory and book inventory

1. 2.

3.
4.

F2 ACCA Phi Thanh Tu

1. Inventory
Types of inventory: RM, FGs, WIP,

consumables/tools & supplies Control over inventory:


Ordering Purchasing Receipt Storage Issue Maintenance of Inventory at the most appropriate

level
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2. Accounting procedures for ordering and issuing inventory


Departments requires new material by sending Purchase request to Purchasing department Ordering < authorized purchase request>

Purchasing department send PO to: Suppliers Purchase Accounting department order Good receiving departments (stores) Suppliers receive Pos to prepare to deliver goods Suppliers deliver the Goods with Delivery Notes Goods receiving department will check the Goods received with Delivery notes and PO. Good receipt Notes are updated and then the copies are sent to Purchasing and accounting departments Purchasing department will monitor GRNs with PO to supervise the PO status

Goods delivery

Invoice sent from suppliers directly to accounting department for payment Invoice, GRN and PO are matched (3-way match) to ensure proper quantity and price Invoices F2 ACCA Phi Thanh Tu

2. Accounting procedures for ordering and issuing inventory


Inventory issuing:

Material requisition notes Authorize store keepers to release RM To update store records

Material returned notes Record unused RM returned to stores To update store records

Material transfer notes Transfer materials from one department to another To update store records

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3. Recording for inventory


Debit Inventory a/c: Purchase, Return to stores Credit Inventory a/c: Issuing, Return to suppliers Inventory valuation: FIFO, WAC, LIFO FIFO: assumes that materials are issued to out of stock in the order in which they were delivered into inventory WAC: values all items of inventory and issues at an average price. The average price is calculated after each receipt of goods. LIFO: assumes that materials are issued out of inventory in the reverse order to which they were delivered into inventory
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3. Recording for inventory


The following transactions occur during May 2008 related to item A: Opening balance + Purchasing = Issuing +Closing
Quantity units
Opening balance, 1 May Receipts, 7 May Issues, 11 May Receipts, 16 May Issues, 21 May Closing balance, 31 May Total F2 ACCA Phi Thanh Tu 100 400 200 300 400

unit cost
2.00 2.10

Total cost
200 840

2.12

636

200
1676

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3. Recording for inventory


FIFO method- the cost of issues and closing inventory value would be:
Quantity units unit cost $ 100 at $2 100 at $2.1 300 at $2.1 100 at $2.12 200 at $2.12 Total cost $

Issues, 11 May
Issues, 21 May Closing balance, 31 May

200
400 200

$410
$842 $424 1676

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3. Recording for inventory


LIFO method- the cost of issues and closing inventory value would be:
Quantity units unit cost Total cost

Issues, 11 May 200


Issues, 21 May 400 Closing balance, 31 May 200

200 at $2.1 300 at $2.12 100 at $2.1 100 at $2.1 100 at $2.0

$420
$846 $410 1676

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3. Recording for inventory


WAC method- the cost of issues and closing inventory value would be:
Quantity units Issues, 11 May Issues, 21 May Closing balance, 31 May 200 400 unit cost $ $1040/500= $2.08 $(624+636)/600= $2.1 Total cost $ 416 840 Inventory balance units 300 200 Inventory balance $ 624 420

200

$2.1

420

200

420

1676

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3. Recording for inventory


Exercise Exercise\FIFO WAC LIFO.docx

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4. Physical inventory and book inventory


4.1. Perpetual inventory vs. Periodic inventory
Perpetual inventory: Inventory is continuously updated. It is

the recording as they occur of receipts, issues and the resulting balances of individual items of inventory in ether quantity or quantity and value Inventory records are updated using stores ledger cards and bin cards, which show the records of receipts, issues and balances of the quantity (bin cards) and value (stored ledger cards).
Periodic inventory: Inventory is counted at the end of period

and then recorded accordingly. It records inventory purchase or sale in "Purchases/sales" account. Sales, Purchases" accounts are updated continuously
Inventory subsidiary ledger is not updated after each purchase

or sale of inventory. Inventory quantities are updated on a periodic basis.


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4. Physical inventory and book inventory


4.2. Stock taking
Definition: Stocktaking process involves: checking the physical

quantity of inventory held on a certain date and check this balance against the balances on the store ledger (record) cards or bin cards.
Method: Period stocktaking: count every item of inventory at the same

date (usually at the balance sheet date) Continuous stock taking: count selected items of inventory on a rotating basis. Each item is checked at least once a year with a valuable items being checked more frequently
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4. Physical inventory and book inventory


4.2. Stock taking
Physical count

Stock count is carried out It is the difference between book inventory vs. physical inventory <bin cards/ store ledger cards vs. inventory count> Investigate the inventory discrepancies Adjust store ledger cards/bin cards to reflect the true physical inventory count Identifying slow moving and obsolete item to bring attention to management Slow moving: items take long time to use up Obsolete: out of date, no longer required Management solutions on the slow moving and obsolete items

Inventory discrepancies

Adjust book inventory

Slow moving and obsolete items

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4. Physical inventory and book inventory


4.3. Control procedures to minimize discrepancies and loss of inventory
Problems Ordering goods at inflated prices(higher/unreasonable) control procedures use standard costs for Purchase quotation (for special items) Segregation of ordering and purchasing Physical controls over materials receipt, Fictitious purchase usage and inventory Check in all goods inwards at gates Shortage on receipts Delivery signature Regular stock taking Losses from inventory Physical security procedures Writing off obsolete or damaged inventory control of responsible officers over all which is good written-offs Losses after issue to production Record all issues department Standard usage allowance
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II. Order quantities and reorder level


1. 2. 3.

4.

Costs of holding inventory Economic order quantity Gradual replenishment of inventory Inventory control levels

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1. Cost of holding inventory


1.1. Reasons of holding inventory Sufficient goods available to meet expected demand Prevent hold-ups in the production process Meet future shortages Take advantage of bulk purchases discounts

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1. Cost of holding inventory


1.2. Holding costs Costs associated with holding inventory are known as holding costs Holding cost included: Interest on capital tied up in inventory Cost of storage space Cost of insurance Risk of obsolesce Deterioration: disposal cost for unusable inventory Holding cost can be distinguished between fixed holding costs and variable holding costs It is often stated as being valued at a certain percentage of the average inventory held

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1. Cost of holding inventory


1.3. Ordering/procurement costs
Ordering/procurement costs: are the costs associated with placing orders. They include: Administrative costs: are usually a fixed cost per order. The total admin costs of placing orders will increase in proportion to the number of orders placed. >>> Variable costs Delivery costs: are usually a fixed charge per delivery (order). The total delivery costs will also increase in direct proportion to the number of deliveries in the period. >>> Variable cost

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1. Cost of holding inventory


1.4. Stock out costs
Stock-out costs: are the costs associated with

running out of inventory and they include loss of sales, loss of customers and reduced profit

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1. Cost of holding inventory


1.5. Stock control and inventory holding cost

If inventory level is too low, there is a danger that

the number of stock-outs will increase, and there will increase in the number of order placed An increase in the number of order placed will cause a corresponding increase in ordering costs So, it should maintain inventory at a level (optimum level) where the total of holding costs, ordering costs and stock-out costs are at minimum. This is the main objective of stock control
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2. Economic order quantity


EOQ is the reorder quantity which minimizes

the total costs associated with holding and ordering stock = holding cost + ordering costs are at a minimum at the EOQ Graph:
Holding cost= ordering cost

EOQ= (2CoD/Ch) D= demand per annum Co= cost of placing one order Ch= cost of holding one unit for one year Q= Reorder quantity
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2. Economic order quantity

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2. Economic order quantity EOQ assumptions:


Average inventory= EOQ/2

The number of orders in a year= expected annual

demand/EOQ Total annual holding cost= EOQ/2*holding cost per unit of inventory Total annual ordering cost = number of orders*cost of placing an order TAC= CO * D/Q + ChQ/2

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2. Economic order quantity


EOQ with discount Discount for bulk orders Effect of quantity discount: The annual purchase price will decrease The annual holding cost will increase The annual ordering cost will decrease To establish whether the discount should be accepted or not: Calculate the TAC with the discount (including the purchase cost) Compare with the annual costs without the discount at EOQ point Steps: Calculate EOQ ignoring discount If EOQ< min purchase quantity to obtain bulk discount, calculate the

total cost for the EOQ (= the annual stockholding costs+ stock ordering costs + stock purchasing costs) Recalculate the total cost for a purchase order size that is only just large enough to qualify for the bulk discount = TAC of the bulk quantity Compare the total costs when the order quantity is the EOQ with the total costs when the order quantity is just large enough to obtain the discount. Select the min cost alternative
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3. Gradual replenishment of inventory


EOQ: inventory to be replenished immediately when organization

buy inventory from suppliers EBQ: inventory to be replenished gradually by manufacturing their own products internally Setup cost replaces ordering cost of EOQ Average inventory held in EOQ is greater than average held in EBQ for the same size of batch EBQ = (2CoD/[Ch(1-D/R)] Q= batch size D= Demand per annum Ch= cost of holding one unit for one year Co= cost of setting up a batch ready to be produced R= annual replenishment rate
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3. Gradual replenishment of inventory


Producing large batches at long interval will lead to low machine

setup costs (as fewer machines setups will be needed) and high holding costs (as more inventory)
Producing small batches at short interval will lead to high machine

setup costs (as more machine setups will be needed) and low holding costs (low average inventory levels as less inventory held)

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4. Inventory control level

Reorder level: when inventory reaches the reorder level, a replenishment order should be placed
RL= usage*lead-time (when demand in the lead time is constant)
RL= max usage* max lead time (when demand in the lead time is

not constant)
o Lead time= this is the time expected to elapse between placing

an order and receiving an order for inventory


o Reorder quantity: when the reorder level is reached, the quantity

of inventory to be ordered is known as the EOQ


o Demand: this is the rate at which the inventory is being used up

= inventory usage

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4. Inventory control level

Max inventory- this is a warning level when inventory are dangerously high.
Max inventory level = reorder level + reorder quantity min

usage*min lead time

Min inventory- this is a warning level when inventory are dangerously low and that stock-outs are potential threat. It is know as buffer inventory/safety inventory
Min inventory level = reorder level average usage*average lead-

time

Average inventory= Reorder quantity/2+ min inventory Free inventory= physical inventory + inventory on order- inventory requisitioned (not yet issued)
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Part B-2- Labor cost


Direct and indirect labor cost Recording, calculating and accounting for Labor cost Remuneration method Labor turnover and Measuring labor activity

1. 2.

3.
4.

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1. Direct and Indirect labor cost


Direct Make up part of the prime cost of a product Include basic pay of direct workers <Pay to employees who are directly involved in making a product> Indirect Make up part of overheads Include basic pay of indirect workers <Pay to employees who are not directly involved in making products> Bonus payment

Idle time: workers are paid but not making any products
Sick pay Pay for time spent by direct workers doing indirect jobs
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1. Direct and Indirect labor cost

Overtime and overtime premium of direct employees

Overtime paid = basic element + overtime premium

Direct cost Indirect cost Overtime premiums are treated as direct labor cost if it is at the specific request of a customer.
Shift allowance/premium >>>> similar to overtime premium

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2. Recording, calculating and accounting for Labor cost


2.1. Recording and calculating Labor cost Recording time spent doing jobs Time records: for payment, determining cost to be charged E.g.: Attendance record- show days absent or attend. E.g.: Time cards (gate or lock cards)- record time of arrival and departure. To be used in manufacturing industry Activity time record: Period related timesheets: commonly used in service industries, cover days/weeks/longer period Task related activity time records (job sheets, operation charts, piecework tickets)

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2. Recording, calculating and accounting for Labor cost


2.1. Recording and calculating Labor cost Organization for controlling and measuring labor cost: Personnel department Production planning department Time keeping department Wages department Cost accounting

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2. Recording, calculating and accounting for Labor cost


2.2. Accounting for labor cost Wages payment: Dr wage control account Cr Bank account Direct labor: Dr WIP account Cr Wages control account Indirect labor: Dr Production overhead account Cr Wages control account

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3. Remuneration method
Remuneration methods

(1) Time work

(2) Piecework scheme

(3) Bonus/incentive scheme

Wages = Hours worked x rate of pay per hour

Wages = Units produced x rate of pay per unit (a) High day rate system (e) Profit sharing schemes

(b) Individual/discretionary bonus schemes


(c) Time saved bonus scheme (d) Group bonus schemes 40 F2 ACCA Phi Thanh Tu

(f) Incentive schemes involving shares


(g) Value added incentive schemes

3. Remuneration method
(3) Bonus/ incentive schemes

(a) High day rate system is a system where employees are paid a high hourly rate in the expectation that they will work more efficiently than similar employees on a lower hourly rate in different company. (b) Individual bonus schemes Individual employees can qualify for a bonus on top of their basic wage, which each person's bonus being calculated separately. The bonus is unique to the individual. It is not a share of a group bonus The individual earns a bigger bonus with the greater his efficiency. quality safeguard.

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3. Remuneration method
(3) Bonus/ incentive schemes

(c) Time saved bonus schemes: Employees are paid for the time saved in completing the job The bonus encourage employees to do work at a faster rate.
(d) Group bonus schemes is an incentive plan which is related to the output performance of an entire group of workers, a department, or even the whole factory. (e) Profit sharing schemes is a scheme in which employees receive a certain proportion of their company year-end profits. Possible criteria of this scheme: position of employees and employment time.

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3. Remuneration
(3) Bonus/ incentive schemes (f) Incentive schemes involving shares A share option scheme is a scheme in which gives its members the right to buy shares in the company for which they work at a set date in the future and at a price usually determined when the scheme is set up. (g) Value added incentive scheme It is an alternative to profit as a business performance measure Value added = Sales - cost of brought-in materials and services Target value added should be set, some of any excess value added earned would be paid out as bonus.
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4. Labor turnover and measuring labor activity


4.1. Labor turnover To measure proportion of people leaving relatively to the average number of people employed Causes: Avoidable causes: poor remuneration/working conditions, lack of training opportunities/promotion prospect Unavoidable causes: retirement, illness, death, family reasons

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4. Labor turnover and measuring labor activity


4.1. Labor turnover Costs of labor turnover: Replacement costs: advertisement, selection, training costs, efficiency decreases Lower the performance of current employees Preventative costs: incurred to minimized Labor turnover, associated with escaping the avoidable causes: Increase wages Improve working conditions Increase training programs Promotion scheme Investigate high LT rate Labor turnover rate = Number of leavers who require replacement / average number of employees

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4. Labor turnover and measuring labor activity


4.2. Measuring labor activity Efficiency ratio (Productivity ratio)= (Expected hours to make output)/(Actual hour taken) x 100% If the ratio > 100%: productivity is greater than expectation If the ratio < 100%: less than expectation, inefficient labor Capacity ratio= (actual hours taken)/(budgeted hours) x 100% If the ratio >100%: work above capacity If the ratio <100%: work below capacity Production volume ratio/ Activity ratio = (Expected hours to make output)/(Budgeted hours) x 100% Production volume ratio = efficiency ratio x capacity ratio If the ratio >100%: produce more than budget If the ratio <100%: produce less than budget
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Part B-3- Overheads


1. 2. 3.

4.
5.

Overheads and cost categories review Absorption costing Under and over absorption of overheads Accounting entries Non-production overheads

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1. Overheads and cost categories review


Overheads is the cost incurred in the course of making product,

providing a service or running a department but cannot be traced directly and in full to the product/service/department Categories: Indirect Materials + Indirect labor + Indirect expense: Production OH: can be fixed or variable Administration OH Selling & distribution OH

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1. Overheads and cost categories review


Why should OH be included in the total cost of product?

Stock valuations Closing stock figure in the balance sheet Cost of sales figure in the P&L account Pricing decisions If companies follow full cost plus pricing strategy. Establishing the profitability of different products.

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2. Absorption costing
2.1. What is absorption costing? It is a method of sharing overheads between a number of different products an a fair basis. Objective: to include in the total cost of a product (unit or job) an appropriate share of the organizations total overhead By an appropriate share, an amount that reflects the amount of time and efforts has gone into producing a unit or completing a job Closing stock in the balance sheet and the COGS in the P&L a/c must be valued at full in PRODUCTION COST

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2. Absorption costing
2.2. Absorption costing procedures Stage 1: Allocation

Stage 2: Apportionment

Stage 3: Absorption

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2. Absorption costing
2.2. Absorption costing procedures STAGE 1: Allocation Allocation is the process by which whole cost items are charged direct to a cost unit or a cost centre. Indirect materials, Indirect labors, Security guard, Depreciation, Rent, etc.

Canteen

Maintenance

Machining

Assembly

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2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment Apportionment is a process whereby indirect costs are spread fairly between cost centers. 2 stages: Apportionment Re-apportionment

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2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment Basic of apportionment: apportion OH to Cost centers (production+service cost centers)
Overheads Rent, rates, heating and light, repairs and depreciation of buildings Depreciation, insurance of equipment Personnel office, canteen, welfare, wages and cost office Heating and cooling
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Basic of apportionment Floor area occupied by each cost center Cost of book value of equipment Number of employees or labor hours worked in each cost center Volume of space occupied by each cost center

2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment Basic of re-apportionment- apportioning service cost centers overheads to the production cost center using appropriate bases
Service departments Stores Maintenance Production planning Basic of apportionment Number of cost/value of material requisitions Hours of maintenance work done for each cost centers Direct labor hours worked in each production cost center

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2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment- reapportionment Service cost centre costs may be apportioned to production cost centers by using one of the following methods: Direct method Reciprocal method Step method

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2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment- Direct method Costs of each service costs centre are apportioned only to production cost centers
DIRECT METHOD

Interactions between service departments are ignored and all costs are apportioned directly to operating (Production) departments.

Service Department (Canteen)

Operating Department (Machining)

Service Department
(Maintenance)

Operating Department (Assembly)

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2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment- Step method Costs apportionment are performed in a step-down fashion, using predetermined ranking procedures (e.g., degree of support) STEP METHOD

Service Department Once a service departments costs are apportioned, other service department costs are not apportioned back to it.
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Operating Department

(Canteen)

(Machining)

Service Department (Maintenance)

Operating Department

(Assembly)

2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment- Reciprocal method Recognizes interactions of service costs centers prior to apportion to production cost centers Costs of each service costs centre are apportioned not only to production cost centers, but also to other service cost centers which make use of its services. The results of the reciprocal method may also be obtained using algebra and simultaneous equations.

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2. Absorption costing
2.2. Absorption costing procedures STAGE 2: Apportionment- Reciprocal method
RECIPROCAL METHOD

Service Department Interdepartmental services are given full recognition rather than partial recognition as with the step method. (Canteen)

Operating Department (Machining)

Service Department (Maintenance)

Operating Department

(Assembly)

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2. Absorption costing
2.2. Absorption costing procedures STAGE 3- Absorption
Overhead absorption is the process whereby overhead costs

allocated and apportioned to production cost centers are added to cost units, jobs or process costs using an appropriate basis
A product cost can now be determined:

Direct materials + + Direct labor Absorbed overhead Product cost

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2. Absorption costing
2.2. Absorption costing procedures STAGE 3- Absorption OH are usually added to cost units using a predetermined overhead absorption rate. Step 1: Estimate the OH likely to be incurred during the coming period. Step 2: Estimate the activity level for the period. This could be total hours, units, or direct costs of whatever it is upon which the OH absorption rates are to be based. Step 3: Divide the estimated OH by the budgeted activity level --> the OH absorption rate.
OH absorption rate
Step 4:

Total budgeted overhead costs


=

Total budgeted act. level

Absorb the OH into the cost unit by applying the calculated absorption rate. Overhead absorbed = predetermined OAR x Actual level of activity
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2. Absorption costing
2.2. Absorption costing procedures STAGE 3- Absorption Possible bases of absorption rate:
Rate per unit Rate per machine hour Rate per direct labor hour Percentage of direct material cost Percentage of direct labor cost Percentage of total direct cost Percentage of factor cost (for admin overhead) Percentage of sales or factory cost (for selling and distribution

overhead)

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2. Absorption costing
2.2. Absorption costing procedures STAGE 3- Absorption 3 methods of Absorbing Overhead Costs: Overhead can be absorbed into cost units in one of three ways:

Blanket absorption rate (Single plantwide rate)

Separate absorption rates (Departmental overhead rates)

Activity-based costing (later)

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2. Absorption costing
2.2. Absorption costing procedures STAGE 3- Absorption 3 methods of Absorbing Overhead Costs- Method 1- Blanket absorption rate Indirect Costs Cost Absorption Base Cost Objects
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Overhead Cost

Blanket absorption rate

Product 1

Product 2

Product 3

2. Absorption costing
2.2. Absorption costing procedures STAGE 3- Absorption 3 methods of Absorbing Overhead Costs- Method 2- Separate absorption rate Overhead Cost
Indirect
Costs

First
Stage Department A
Department A Overhead Rate Product 2

Department B
Department B Overhead Rate Product 3

Cost Objects
Absorption Base

Second
Stage
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Cost Objects

3. Under/Over absorption of overheads


Normal costing involves using the predetermined absorption rate in order to establish the actual cost of production.

Direct materials Direct labour Overheads


(based on the predetermined absorption rate)

xxx xxx xxx xxx

Actual cost of production

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3. Under/Over absorption of overheads


Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.

.
Overhead is over absorbed

Over absorption means that the OHs charged to the cost of sales are greater than the OH actually incurred. Actual OH Absorbed OH Over absorbed OH 1000 (1200) 200

Actual overhead costs incurred

Overhead absorbed to Work in Process

(OAR Activity)

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3. Under/Over absorption of overheads


Over and under absorption of OH occurs because the predetermined OH absorption rates are based on estimates.

.
Overhead is under absorbed

Overhead absorbed to Work in Process Actual overhead costs incurred (OAR Activity)

Under absorption means that inssufficient OHs have been included in the cost of sales. Actual OH Absorbed OH Under absorbed OH 1000 (900) 100

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3. Under/Over absorption of overheads


Adjusting of Over absorbed and Under absorbed Overhead:

--->Adjusting Cost of sales for under absorbed or over absorbed overhead


Overhead is:
Cost of sales Adjustment is: will:

Actual overhead > Underabsorbed overhead absorbed

Too low

Increase Cost of sales

Actual overhead < Overabsorbed overhead absorbed

Too high

Decrease Cost of sales

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4. Accounting entries
Occurrence of overhead

Dr Production overhead account Cr Inventory/ Wages control /Cash/Creditor accounts Absorption of overhead Dr WIP account Cr Production overhead account Over-absorption of overhead Dr Production overhead account Cr under/over absorbed overhead (P&L) Under-absorption of overhead Dr under/over absorbed overhead (P&L) Cr Production overhead account
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5. Non-production overheads
Method 1: Choose a basic for the overhead absorption rate
which most closely matches the non production overhead. E.g.: direct labor hours, direct machine hours and so on.
Method 2: Allocate non-production overheads on the ability of the

products to bear such cost. One possible approach is to use the production cost.

Estimated non production overheads

OAR=
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Estimated production costs

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5. Non-production overheads
Other bases for absorbing overheads
Types of overheads Selling and marketing Possible absorption rate Sales value

Research and development

Consumer cost (= pro.cost cost of direct materials)


Sales value Consumer cost

Distribution Administration

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Part B-4- Marginal and absorption costing


1. 2. 3.

4.

Recap of absorption costing Marginal costing definition and principles Absorption costing vs. Marginal costing Reconciling the profit figures given by 2 methods

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1. Recap of absorption costing


Absorption costing (Full costing): The cost of a unit of product consists of:
Direct materials Direct labor Manufacturing overheads

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2. Marginal costing definition and principles


Marginal cost is the variable cost of one unit of product or service >>>> would be avoided if that unit were not produced or provided The cost of a unit of product consists of only variable (marginal) manufacturing costs: Direct materials Direct labor Variable manufacturing overhead

Contribution = sales revenue variable costs of sales Fixed costs are treated as period costs and are charged in full to the PL account of the accounting period in which they are incurred

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2. Marginal costing definition and principles


No extra fixed cost incurred when output is increased By selling an extra item of product or service, the following will happen: Revenue will increase by the sale value of item sold Costs will increase by the variable cost per unit Profit will increase by the amount of contribution earned from the extra item

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3. Absorption costing vs. Marginal costing

Absorption Costing Direct Materials Product Costs Direct Labor Variable Manufacturing Overhead Fixed Manufacturing Overhead Period Costs
Variable Selling and Administrative Expenses

Variable Costing

Product Costs

Period Costs

Fixed Selling and Administrative Expenses

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3. Absorption costing vs. Marginal costing


Manufacturing Cost Flows
Balance Sheet

Costs Material Purchases Direct Labor

Inventories

Raw Materials

Income Statement Expenses

Variable Manufacturing Overhead


Fixed Manufacturing Overhead Selling and F2 Administrative ACCA Phi Thanh Tu

Work in Process Cost of Goods Sold Selling and Administrative

Finished Goods

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Period Costs

4. Reconciling the profit figures given by 2 methods


The difference is due to the difference stock valuation method used
Relation between production and sales Relation between marginal and absorption profit

Effect on inventory

Production > Sales

Inventory increases
Inventory decreases

Absorption > marginal


Absorption < Marginal Absorption = marginal

Production < Sales

Production = Sales
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No change

4. Reconciling the profit figures given by 2 methods


Income statements Sales Less COS + Opening inventory + Add production cost -Less Closing inventory Subtotal COS Add/less Under/Over absorbed O/H Less other variable costs Contribution Gross profit Less Fixed production O/H Fixed selling O/H Net profit
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Phi Thanh, Tu (EXTOther - VN/Hanoi): At variable production cost

Marginal costing $'000 $'000 X X X (X) (X) (X) X

Absorption costing $'000 $'000 X X X (X)

Phi Thanh, Tu (E Other - VN/Hano At full production c

(X) X

X (X) (X) X NIL (X) X

Part B-5- Job, batch and service costing


Job costing 2. Batch costing 3. Service costing
1.

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Costing system

Specific order costing


Work done by an organization consists of separately identifiable jobs or batches Job, batch costing

Continuous operation costing


Goods or services are produced as a direct result of a sequence of continuous operation or processes Process costing

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1. Job costing
Job Costing

Used for production of large, unique, or high-cost items. Built to order rather than mass produced. Many costs can be directly traced to each job.

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1. Job costing
Materials Indirect Direct

Factory Overhead

Apportion

Work in Progress

Finished Goods

Indirect Labor Direct Cost of Sales

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1. Job costing
Receive order from customers Schedule the job

Predict cost to complete job

Negotiate a sales price and decide whether to pursue the job.

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2. Batch costing
Batch Costing

Similar to Job costing Within each batch are number of identical units but each batch will Total production cost of batch be different Cost per unit in batch =
Number of units in batch

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2. Batch costing
JOB

&
BATCH

The units of a particular job/batch are easy to identify.

Individual goods Value of WIP at or Total production cost ofthe year end is services have batch very different the sum of the characteristics in batch incurred on costs Number of units and costs. incomplete job/batch.

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3. Pricing the Job/Batch


Pricing the Job Cost plus method

Mark-up Cost of job + Profit % 100 25 Cost of job + Profit

Margin % 100 25

= Selling price 125 Profit Mark-up: 25% on job cost


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= Selling price 125 Profit Margin: 20% on selling price

4. Service costing
Different characteristics of services: Simultaneity, Heterogeneity,

Intangibility, Perishability Difficulty in defining cost units. It is usually a composite cost unit E.g.: tones-miles for haulage companies patient days for hospital guest days for hotel services passenger miles for public transport companies Direct materials will be relatively small compared to labor & OH. However, service costing techniques are quite similar to job/batch costing: Cost per service unit
= -----------------------------------------

Total costs for period

Number of service units in the period

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Part B-6- Process costing


Process costing Losses in process costing Dealing with scrap value Losses with a disposal cost Valuing WIP Joint products & By-products

1. 2. 3.

4.
5. 6.

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1. Process costing
A form of continuous operation costing To be used in mass production of many identical products Output of process 1 forms the materials input of the next process Average cost per unit is calculated for each process

Average cost per unit

= -----------------------------------------

Costs of production

Expected or normal output

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1. Process costing
Differences Between Job-Order and Process Costing Job order costing Many jobs are worked during the period.

Process costing A single product is produced for a long period of time/ and/or going through different processes. Costs are accumulated by departments. Department production report is key document. Unit costs are computed by department (each process)
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Costs are accumulated by individual jobs. Job cost sheet is the key document. Unit costs are computed by job

1. Process costing
Direct labor and manu. OH are often combined into one product cost called conversion.
Direct Material s Overhead
Direct Labor Direct Material s Conversion

Dollar Amount

Dollar Amount

Type of Product Cost

Type of Product Cost

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2. Losses in process costing


Framework for dealing with process costing Step 1: Determine output & losses

Step 2: Calculate cost per unit of output, losses & WIP

Step 3: Calculate total cost of output, losses & WIP

Step 4: Complete accounts

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2. Losses in process costing


Step 1: Determine output & losses Normal loss: The loss is expected in a process Expressed as a % of material input to the process If Normal loss does not have a scrap value, It is valued in the process account as NIL If Normal loss has a scrap value, it is valued in the process account at this value. Revenue from scrap value is used to reduce the input cost of the process

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2. Losses in process costing


Step 1: Determine output & losses Abnormal loss and gains If the actual loss/gain in the process is different to what we are expecting, it is an abnormal loss or an abnormal gain Actual loss > normal loss = Abnormal loss Actual loss < normal loss = Abnormal gain Cost of abnormal loss and gain: not absorbed into the cost of good output Shown as loss and gain in the process account Value is the same as cost of unit of good output

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2. Losses in process costing


Step 1: Determine output & losses
Input: 1000 units Production Process Normal loss rate: 10% Output: 860 units

Actual Losses: 140 units

Normal loss: 100 units (10% x 1000 units)

Abnormal loss: 40 units (140 units - 100 units)

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2. Losses in process costing


Step 1: Determine output & losses
Input: 1000 units Production Process Normal loss rate: 10% Output: 960 units

Actual Losses: 40 units

Normal loss: 100 units (10% x 1000 units)

Abnormal gain: 60 units (100 units - 40 units)

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2. Losses in process costing


Step 2: Calculate cost per unit Rule: Unit cost of output is calculated based on expected output
Example:

For both case 1 & 2 above, if total costs of input is $4,500,

Cost per unit of output is:


$4,500/ 900 units = $5 per unit

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2. Losses in process costing


Step 3: Calculate total cost of output and losses Rule: Normal loss: No cost Abnormal loss: given a cost (equal to unit cost of out put) Abnormal gain: given a negative cost (equal to unit cost of out put)
Case 1 Normal loss: NIL Abnormal loss= 40units x $5 = $200 Output = 860units x $5 = $4300 Case 2 Normal loss: NIL Abnormal gain= 60units x $5 = $300 Output = 960units x $5 = $4800

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2. Losses in process costing


Step 4: Complete accounts
Case 1:

INPUT Cost incurred

PROCESS ACCOUNT Units $ OUPUT 1000 4500 Normal loss Output Abnormal loss

Units 100 860 40

$ 0 4300 200

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2. Losses in process costing


Step 4: Complete accounts
Case 1:

Process account

ABNORMAL LOSS ACCOUNT Units $ 40 200 Income statement

Units

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2. Losses in process costing


Step 4: Complete accounts
Case 2:

INPUT Cost incurred Abnormal gain

PROCESS ACCOUNT Units $ OUPUT 1000 4500 Normal loss 60 300 Output

Units 100 960

$ 0 4800

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2. Losses in process costing


Step 4: Complete accounts
Case 2:

Income statement

ABNORMAL GAIN ACCOUNT Units $ Abnormal gain

Units 60

$ 300

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3. Dealing with scrap value


Losses or spoilage may have scrap value. Basic rule: Revenue from scrap is not treated as an addition to sales

revenue, but as a reduction in costs. Scrap value

Normal loss/gain
LOSS

Abnormal loss/gain
GAIN

Deduct from cost of process Dr Scrap a/c


F2 ACCA a/c 106 Cr ProcessPhi Thanh Tu

Deduct from cost of abnormal loss


Dr Scrap a/c Cr Abnormal loss a/c

Deduct from value of abnormal gain


Dr Abnormal gain a/c Cr Scrap a/c

3. Dealing with scrap value

Example:

JJ has a factory which operates two production processes, cutting and pasting. Normal loss in each process is 10%. Scrapped units out of the cutting process sell for $3 per unit whereas scrapped units out of the pasting process sell for $5. Output from the cutting process is transferred to the pasting process: output from the pasting process is finished output ready for sale. Relevant information about costs for control period 7 are as follows: Pls prepare accounts for the cutting/pasting process, abnormal loss, abnormal gain and scrap. Cutting process Pasting process Units Input materials Transferred to pasting process Material from cutting process Added materials Labor and overheads
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$ 54,000

Units

18,000 16,000

16,000 14,000 32,400 28,000 70,000 135,000

Output Phi Thanh Tu F2 ACCA to FGs

4. Losses with a disposal cost


Disposal cost

Normal loss LOSS Add to cost of process Dr Process a/c Cr Disposal cost a/c

Abnormal loss/gain GAIN Add to value of abnormal gain


Dr Disposal cost a/c
Cr Abnormal gain a/c

Add to cost of abnormal loss Dr Abnormal loss a/c Cr Disposal cost a/c

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5. Valuing WIP
Equivalent units are partially complete and are part of work in

process inventory. Partially completed products are expressed in terms of a smaller number of fully completed units- as a proportion of completed units. Calculating and Using Equivalent Units of Production Cost per equivalent unit

Costs for the period Equivalent units of production for the period

Different degree of completion for each cost element: Materials Conversion costs = labor + overheads

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5. Valuing WIP
Example 1:

For process 1 in ABC Co, the following is relevant for the latest period: Period cost: $4440 Input: 800 units Output: 600 fully-worked units and 200 units only 70% complete. There were no process losses Prepare statement of Eus and Process 1 account.

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5. Valuing WIP
Example 1: Statements of EUs Output FGs 600 % 100% Eus 600

Closing WIP
Total Costs Cost per EU

200
800

70%

140
740 $4440 $6

Process 1 A/c Units Input 800 $ 4440 Transferred to next process WIP Total 800 4440 Units 600 200 800 $ 3600 (600*6) 840 (140*6) 4440

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5. Valuing WIP
How to value WIP if there is WIP at the beginning of the period? Valuing Opening WIP

FIFO method

Weighted Average method

Cost during period Work done during period


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Cost till date Work done till date

5. Valuing WIP
Assumption in FIFO Assumption in WAC WIP at the beginning of the period Makes no distinction between work must be completed, and transferred done in prior and current period out first. Closing WIP includes the most recently incurred costs Blends together units and costs from prior period and current period.

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5. Valuing WIP
Work in process, May 1: 200 units Materials: 55% complete. Conversion: 30% complete. Production started during May: Production completed during May: Costs added to production in May Materials cost Conversion cost Work in process, May 31: 400 units Materials 40% complete. Conversion 25% complete. $ 9,600 $ 5,575 5,000 units 4,800 units $ 368,600 $ 350,900

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5. Valuing WIP
Prepare the process account for May 2008- FIFO
Materials 5,000 Units Started

Beginning WIP 200 Units 55% Complete


200 x 45%

4,600 Units Started and Completed

Ending WIP 400 Units 40% Complete

90 Equivalent Units 4,600 Units Completed 160 Equivalent Units 4,850 Equivalent units of Materials
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400 40%

5. Valuing WIP
Prepare the process account for May 2008- FIFO
Conversion 5,000 Units Started

Beginning WIP 200 Units 30% Complete 200 x 70%

4,600 Units Started and Completed

Ending WIP 400 Units 25% Complete

140 Equivalent Units 4600 Units completed 100 Equivalent Units


4,840 Equivalent units of Conversion

400 25%

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5. Valuing WIP
Prepare the process account for May 2008- WAC
Materials 5,000 Units Started

Beginning WIP 200 Units 55% Complete

4,600 Units Started and Completed

Ending WIP 400 Units 40% Complete

4800 Units Completed 160 Equivalent Units 4,960 Equivalent units of Materials
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400 40%

5. Valuing WIP
Prepare the process account for May 2008- WAC
Conversion 5,000 Units Started

Beginning WIP 200 Units 30% Complete

4,600 Units Started and Completed

Ending WIP 400 Units 25% Complete

4800 Units completed 100 Equivalent Units


4,900 Equivalent units of Conversions

400 25%

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6. Joint and by products


6.1. Joint products
Joint products are two or more products produced

simultaneously by the same process up to a split-off point. Each is important and can have a significant sales value. Each should therefore be valued separately. e.g.., seafood processing, oil refining,... Cost incurred up to this point are called common costs or joint costs. The split-off point is the point at which the joint products become separate and identifiable. Should be treated as normal output from the process

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6. Joint and by products


6.1. Joint products
Joint Cost Apportionment Methods Physical units: production units Sales value at split-off point: the sales value of the total output

from the particular processes concerned.


Net realizable value: final sales value further processing cost

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6. Joint and by products


6.2. By products What are the differences between a joint and a by- product? The distinction between joint and by-products rests solely on the relative importance of their sales value. A by-product is a secondary product recovered in the course of manufacturing a primary product. Characteristics of By-products: Relatively low in sales value Small in quantity produced Sold in bulks

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6. Joint and by products


6.2. By products Accounting for by-products: Similar to Normal Loss Cost of By-product: Generally NO cost is apportioned to the by-products. Income of By-product: 4 methods added to sales of main products. treated as a separate, incidental source of income. deducted from the cost of production of the main product. Net realizable value (NRV) of the by-product is deducted from the cost of production in the period. ***** the most common method.

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Part B-7- Alternative costing


1. 2. 3.

4.
5. 6.

7.

Activity based costing Calculation of ABC Absorption costing vs. ABC Advantages and disadvantages of ABC Total Quality Management Life cycle costing Target costing

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1. Activity base costing (ABC)


Costs are firstly assigned to the activities which are the real

causes of the overhead Then costs of those activities are assigned to the products which are actually demanding those activities
Activity 1 Product 1 Overheads Activity 2 Product 2 Activity 3
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1. Activity base costing (ABC)


Activities cause costs: the special engineering, special testing,

machine setups, etc(they cause the company to consume resources). The reasons for the development of ABC: (1) manufacturing overhead costs have increased significantly, (2) the manufacturing overhead costs no longer correlate with the productive machine hours or direct labor hours, (3) the diversity of products and the diversity in customers' demands have grown, and (4) some products are produced in large batches, while others are produced in small batches.

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2. Calculation of ABC
Step1
Identify an organization's major activities

Step 2

Identify the cost drivers- factors which determine the size of the costs of an activity (cause the costs of an activity) Collect the costs of each activity into cost pools (equivalent to cost centers under the traditional costing methods) (each activity) Charge support overheads to products on the basis of their usage of the activity- number of the activitys cost driver it generates

Step 3

Step 4

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1. Activity base costing (ACB)

Activity Ordering Materials handling Production scheduling Dispatching

Cost drivers Number of orders Number of production runs Number of production runs Number of dispatches

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2. Calculation of ACB- Example


We will assume that a company has annual manufacturing overhead costs of $2,000,000of which $200,000 is directly involved in setting up the production machines. During the year the company expects to perform 400 machine setups. Lets also assume that the batch sizes vary considerably, but the setup efforts for each machine are similar. For simplicity, lets assume that the remaining $1,800,000 of manufacturing overhead is caused by the production activities that correlate with the companys 100,000 machine hours. Assume that a company manufactures a batch of 5,000 units and it produces 50 units per machine hour, calculate the cost assigned to the units with activity based costing and without activity based costing compares. If a company manufactures a batch of 50,000 units and produces 50 units per machine hour, show how the cost assigned to the units with ABC and without ABC compares.

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2. Calculation of ACB- Example


With ABC Mfg overhead costs assigned to setups Number of setups Mfg overhead cost per setup Without ABC

$200,000
400 $500

$0
Not applicable $0

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2. Calculation of ACB- Example


With ABC Total manufacturing overhead costs Less: Cost traced to machine setups Mfg O/H costs allocated on machine hours Machine hours (MH) Mfg overhead costs per MH Mfg Overhead Cost Allocations
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Without ABC $2,000,000 0 $2,000,000 100,000 $20

$2,000,000 200,000 $1,800,000 100,000 $18 $500 setup cost per batch + $18 per MH

$20 per MH

2. Calculation of ACB- Example


If the company manufactures a batch of 5,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:

With ABC Mfg overhead for setting up machine No. of units in batch Mfg O/H caused by Setup Per Unit

Without ABC

$500
5,000

$0
Not applicable

$0.10

Not applicable

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2. Calculation of ACB- Example


With ABC
Mfg overhead costs per machine hour No. of units produced per machine hour Mfg O/H caused by Production Per Unit Total Mfg O/H Allocated Per Unit
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Without ABC
$18 50 $20 50

$0.36

$0.40

$0.46

$0.40

2. Calculation of ACB- Example


If the company manufactures a batch of 50,000 units and it produces 50 units per machine hour, the costs assigned to the unit are:

With ABC Mfg overhead for setting up machine No. of units in batch Mfg O/H caused by Setup Per Unit $500 50,000

Without ABC $0 Not applicable

$0.01

Not applicable

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2. Calculation of ACB- Example


With ABC
Mfg overhead costs per machine hour No. of units produced per machine hour Mfg O/H caused by Production Per Unit Total Mfg O/H Allocated Per Unit
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Without ABC
$18 50 $20 50

$0.36

$0.40

$0.37

$0.40

2. Calculation of ACB- Example


As the tables above illustrate:

with activity based costing the cost per unit decreases from $0.46 to $0.37 because the cost of the setup activity is spread over 50,000 units instead of 5,000 units. Without ABC, the cost per unit is $0.40 regardless of the number of units in each batch. If companies base their selling prices on costs, a company not using an ABC approach might lose the large batch work to a competitor who bids a lower price based on the lower, more accurate overhead cost of $0.37. Its also possible that a company not using ABC may find itself being the low bidder for manufacturing small batches of product, since its $0.40 is lower than the ABC model of $0.46 for a batch size of 5,000 units. With its bid price based on manufacturing overhead of $0.40but a true cost of $0.46the company may end up doing lots of production for little or no profit.

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3. Absorption costing vs. ACB


ACB ABC ascertains the purpose of each activity or service and assigns the cost of such activity or service to the product or service unit that demands such activity. Absorption costing Cost of a product unit under absorption costing = cost of direct materials + direct labor + variable manufacturing overheads + (fixed manufacturing overhead costs/units produced).

Traces the costs of product units. Allocates costs to product units. (define activity >>> allocate COST) (allocate all production cost)

ABC presumes that products or It works under the simple approach services consume activities, and of assigning resources to products activities consume resources. It or services directly. thus, works to convert indirect costs F2 ACCA Phi Thanh Tu 136into direct costs.

3. Absorption costing vs. ABC


ABC Identifies the actual proportion of fixed overheads costs incurred by the product unit. Price fixation in ABC bases calculations to derive the actual overheads incurred on a unit, and does not vary with change in inventory levels. Absorption costing Divides equally the fixed overhead costs with the number of product units Price fixation in absorption costing depends on the inventory. The higher the inventory, the lower the product cost and lower the inventory; or the higher per-product cost Allowed by GAAP Remains more suitable for small firms and enterprises with homogeneous products or services.

Not allowed by GAAP.


Improves the quality of management accounting information, especially in large and multi-product operations
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4. Advantages and disadvantages of ABC


Advantages Estimate cost precisely Disadvantages The method is complex, time consuming and costly

Provide quantifiable figure for planning and estimates


Facilitate the determination of selling price

Not accept by GAAP


Difficult to identify/analyze/quantify cost in the activity

Help to identify inefficient/ nonprofitable products/activities


Help to allocate resources to profitable items Etc Etc

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5. Total quality management


TQM is a process of applying a zero defect philosophy to the

management of all resources and relationships within an organization as a means of developing and sustaining a culture of continuous improvement which focuses on meeting customer expectation. Quality combines the criteria:
How well made a product is/ how well performed if it is a service How well it serves its purpose How it measures up against its rival

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5. Total quality management


Basic principles of TQM:
Get it right, first time: basic principal of TQM- the cost of preventing

mistakes is less than the cost of correcting them. Continuous improvement: always possible to improve Performance measures for TQM must embrace every activity of the organization The requirement of quality: 8 requirements of quality according to Mark Lee Inman
Customer Preventing the cause of the defect in the 1st place Customer-supplier relationship Employees must be personally responsible for defect free production Emphasize cost of poor quality

Any level of defects is unacceptable All departments are involved Quality certification
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6. Life cycle costing

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5. Life Cycle costing


Market introduction Demand/sales -Demand needs to be created -Sales is slow to start Targeted price Growth Maturity Decline

- Public awareness increases - Sales volumes increase significantly Begin to decrease due to competition

Sales peaks

- Decline

Price

Tends to drop

Diminish

Cost

Very high

Reduced due to economics of scale


Begin to increase with a few players Begin to rise

Lower

Counter-optimal

Competition

Little or no

Increase

Increase/ Peaks

Profitability

Make no money

Go down

Diminish

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7. Target costing
Target cost is an estimate of a product cost which is determined

by subtracting a desired profit margin from a competitive market price. This target cost may be less than the planned initial product cost but it is expected to be achieved by the time the product reaches the maturity stage of the product life cycle

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7. Target costing
Step 1 Determine a product specification of which an adequate sales volume is estimated

Set a selling price at which the organization will be able to achieve a desired market share Step 2

Step 3

Estimate the required profit based on return on sales or return on investment


Calculate the target cost = target selling price- target profit

Step 4

Compile an estimated cost for the product based on the anticipated design specification an d current cost level Step 5

Step 6

Calculate cost gap = estimated cost - target cost


Make efforts to close the gap (at design phase)

Step 7

Negotiate with the customer before making the decision about whether to go ahead with the project Step 8
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