Decision and Control

Terminology
Profit and Loss Income Statement
Sales Revenue
Balance Sheet Statement of Finx Position
Fixed Assests Non current assets
Stock Inventory
Trade Debotors Trade creditors
Capital Equity
Profit a Retained earings

Ch 1: Standard costing

Standard cost: calculated from managements standards of effective operation and relevant, necessary
expenditure. Basis for; fixing selling prices, valuing Inv and WIP and to provide control over actual £
through variance analysis.

Provided cost data which can be used for: assisting in budget setting and evaluating performance, control
device – management by exception ny highlighting ‘out of control’ activities which require correcative
action. DM, forecasting and prediction of future costs, simplifies CI valuation as able to trace costs,
stretching target setting

Stnd costing: prep and use of stnd costs, their comparison with actuals and analysis of variances and
causes. Effective stnd costing system relies on standard cost reports, with variances identified.

Developing standards
Possible to set a standard cost for each operation. With identical operations should be able to ascertain
not just what they cost but also what they should cost. Takes into account:
1. Technical standard for quantities for material to be used and the working time required.
2. Cost standard for material prices and the hourly rates that should be paid.
Past data can be used to predict IF operating conditions are fairly constant. Therefore this method maynot
be suited to new ops. -ve past data may contain inefficiencies, which continue to be built into stnds.

Engineering stnds. Eng consider product and prdn process develop stnds considering material, DL and
VOH. Useful when evaluating new products. -ve eng stnds too tight & don’t consider human factors ie
behaviour of workers.
--
Basic approach to price stnds
1. Use current price when stnd is set. +ve standard is known fact. -ve Price likely to change, so limited
for planning purposes.
Stnds would need to be reviewed periodically to esure they are up to date otherwise variances wil
be due to invalid standards.
2. Use forecast of average prices. +ve need for revision -ve stnd may never correspond with acts so
variance on all transactions.

Standard Material: Input of raw materials > output product. Increased allowance for ‘normal wastage.’
Quantity required for 1 unit of measured output increased by normal work.

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Material Price Stnds: Same material, different supplier, 3 approaches. Price of incoming goods at total
delivered cost so should include cost of carriage inwards and other cost like non returnable packaging.
1. ID main supplier – use their £ as stnd – useful if other only used in emergency.
2. Lowest £ - target for buyer to be motivated to negotiate reduced £ from suppliers.
3. **Forecast proportion to be purchased from each – most satisfactory for control purposes as
forecast can be prepped with accuracy.

Standard Time: Expressed as standard hours. Realistic estimate of productive time required to perform
operation. Allowances include; operator fatigue, personal need. Also periodic activities; machine set up,
clean up, regrinding tools, online rectification. Allowances also for spoilt work or defects appearing in
course of processing.

Standard Labour rate:

1. Basic pay if mngmt objective to reduce or eliminate OT
2. Basic plus OT premium if normal leve of OT can be identified and deemed as necessary.

Stnd cost card – uses appropriate stnds for one unit (Abs costing)

Types of standards:
1. Ideal – optimal efficiency. No stoppages, loss of mats or services. UNREALISTIC and results in large
adverse variances, if unrealistic target, variances calculated ar of little meaning. Mngmnt ‘give up’
when faces with these stnds. DEMOTIVATING particularly when linked to performance related pay.
2. Target – Gives consideration to current performance and state of efficiency, and what could be
achieved with existing facilities. STREATCHING targets and effort made to achieve. – no questiaed
that it is going beyond what is attainable ie REALISTIC. Mangmnt and staff usually motivated by this
method.
3. Normal - level of activity more recent than “Basic Stnds’ and usually based on what company
already achieves on a regular basis.
4. Basic – Fixed and then not reviewed with changing conditions and in force for a long period of time.
In circumstances where there are rapid technological or significant price changes basic standards
are of limitled value since they quickly become OOD.

+ve of SC
Planning - prep and budget simpler. If stnds to be used for these they must be as accurate as possible so
MUST be revised on a frequent basis.
Control - exercised through comparison of Stnd vs Act, and isolation of variances, which are broken into
components (Did vs Should for £ and efficiency). Highlights areas of inefficiency, ‘management by
exception’ and correcative action to inprove efficiency in the future and alter stnds if necessary.
Subsidiary +ves
- If stnds perceived as attainable = motivating
- SC bkking system fulfils requirements for both internal and external reporting.
- Recording of stock is simplified as done at stnd price
-ve od SC
Costly to set up and maintain, stnds must be revised on regular basis to maintain effectiveness. Therefore
best suited to well established and repetative processes to revisions of stnds can be kept to a minimum.

Ch 2: Collection of cost info

Cost accounting: SPL/Income statement provides scorekeeping statistical info rather than info that forms
the basis of D&C. The provision of the addidtional detail is a function of cost accounting: cost-finding
‘taking the transacrtions than make up the finx accounts and analysing them to turn the data into
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information that will be helpful to managers of the business. Objectine analysis, matching expences to the
purpose for which they were incurred, in the form or a memo or as part of the bkking system.

Cost accounting has 2 effects on busi docs:

1. Addidtional internal documents needed to identify which products/services affected by various
transacions
2. Additional data regarding transactions will be needed to assist accurate classification and analysis.
Historical data required for reports
1. Finx accounts: SFP and SPL with supporting notes and schedules, and SOcashflow.
2. Data from analysis Accs of Busi, identifying cost units with cost centres. Sources for some cost may
be:
M – Prior month invoices and quotes
L – HR and Payroll dept for salary and deductions so wage rates can be established for costing.
O – Suppliers of utilities, communication from landlord re rent (possibly %age)
3. Data from source documents without evaluation (stats of labour efficirency, sickness, material
usage or machine breakdown.
Most reports include comparison with budgets, stnds targerst or estimates. Explaination of variances based
on investigation and knowledge – used in budget prep.

Cost recording
1. Analyse production, administration and marketing cost to facilitate; cost and profit calculations,
inventory valuations, forecast and budget data and DM data.
2. Production of periodic performance statements, necessary for management control
3. Analysis of past (profit measurement and inv valuation) present (cost and control) and future costs
(forecast, targets and budgets).

Costa Accnt and other mngrs

CAcc interpret data into £ values. Ensures all acc reps are intergrated and consistant. Information provided
should assist other mngrs. Work together to emnsure no confilict of validity between reports prepared by
each.

Benefits of CAcc: Discolsur of profitable and non profitable fiunctions (location, item). Identification of
waste and inefficiency esp with materials and labour.Analysis of movement in profit. Determination of
selling price. Valuation of inv (audit and tax impliactaions). Development of planning and control info.
Evaluation of cost effect of policy decisions.

Cost Units “quantative unit of prdn or service in relation to which costs are ascertained.”
Average unit cost: Prdn cost divided by the no of units produced. when prdn is consistent and leads to a
uniform production price.
Job Costs: Special customer jobs “cost unit” is the job. Periodic summery income statement.
Batch costs: Manufactiuring of mechanical or electrical components in a specific batch quantity. Batch of
each cost = cost unit. Thereafter possible to determine the cost of each unit.

Non manufacturing unit costs: Service industries or non manufacturing industries. Sometimes composite
units, where cost is dependant on two main factors.
Activity Cost unit
Accounts Chargable hr
College Student enrolled
Hotel Bed-night
Hospital Patient-day
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 Transport Kg-mile
Credit control Customer-acc
Selling Calls made
Maintenace Man-hr

Cost centre: location, function or item(s) of equipment in respect of which costs may be accumulated and
related to cost units for control purposes.
Prdn Assembly line, packing machine
Service dept Stores, canteen, QC
Service Departments such as ARec, ward or faculty
Profit centre: loc, func, items of equipt, cost rev and invest may be ascertained for the purpose of control
of the resulting profit (generates both cost and revenue).
Investment centre: loc, func, items of equipt, cost and rev and investments ascertained to control the
resulting profit (generates both cost and revenue as has ability to make investments in assets(such as
buying fleet of sales vehicles, or photocopier).

Cost classification
Cost control Nature; MLO
Cost acc Relationship to cost units (direct/indirect)
Budg and Behaviour (fixed/variable)
contribution analysis
DM Relevant/non relevant costs
Responsibility acc Controllable/uncontrollable

DM, DL, DEx = Prime costs

Indirect = OH
For inv valuation a distinction require for production OH (e.g. factory costs including utilities) and non-
production. NP costs are involved with converting FG to revenue, comprising of; selling, marketing and
distribution; and administration, OH. NPOH are not included in inv valuation.

OH can always be identified with cost centres.

Prime = Total direct costs

Full Production Cost = Total cost of all direct and indirect cost incurred with prdn of unit i.e Prime plus
indirect production OH cost.
Marginal cost = All variable costs

Limitations of cost classification.

Cost not totally fixed or totally variable and act in more complex ways:
- Bulk discount, fragmented graph
- Labour cost with increased production = OT Premium so no longer a straingt forward variable cost
- Production of large quantity and economy of scale (so curved)
p30 add graphs

High/Low with stepped fixed costs

- Select two activity levels with unchanged FC. Calc VCPU and total FC using the high low method.
- (High £ - Low £)/(High Quan – Low Quan) = VCPU. Change in £/Change in Output
- Total FC above threshold = High £ - (High Quan x VCPU)
- FC below threshold (if 10% increase in cost has been applied) = 100/110 x TFCAT
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 - Cost for y units = y x VCPU plus FC for above or below threshold
- N.B. Adjustments to FC may be needed when calc the total cost for new activity level.
OR
- High £ - Low £ = xy, of which x is the step up cost therefore y is the Total VC
- Change in units output
- VCPU = y/change in output
High/Low with changes in VCPU i.e. for output above x volume the VCPU falls by 10%
- Choose activity levels where VCPU remain the same.
- VCPU = (High £ - Low £ “ab” )/(High Quan – Low Quan) = £
- Total variable cost = Low quan x VCPU = a
- FC = Low £ “ab” – a = b

+ve
Simple to operate
Easy to understand

-ve
Accuracy of results as only considering two data sets. As the extreme ends of the activity range, and
therefore more likely to be a typical and possibly unrepresentative of the rest of the data, with more
normal output. Possibly overcome by selecting ‘next highlest/lowest’ but this destroys the simplicity of the
model

Fixed budget = plan, not a useful comparison

Flexed budget = reporting tool

Accounting for OH (indirect costs)

Indirect non-production costs never in cost of product, or inventory or COS.
Apportionment and allocation (absorption costing)
- Arrives at full unit cost
Marginal costing
- Only direct costs to establish CPU
- Indirect costs = general OH, not relating to units of output.

Allocation apportionment and absorption

Absorption: technique of attributing a CC’s ID costs to the units it produces.
Primary apportionment, then secondary apportionment from service departments to production cost
centres, representing the benefit derived from the service centre.

Absorption: rate PU, per DL hr, per machine hr, %age of salaries, %age of total prime cost. N.B. whichever
method or combination is used the results are only an estimate of what the product actually costs.
Absorption rate calculated at beginning of period, causing issues when actual cost and volumes are not the
same, leading to under- or over-absorption. Under-recovery of OH is shown as a separate line on the
income statement.

-ve of abs costing

Historically reasonable to assume the the more time invested in producing a product, the more resources it
required in general. Nowadays more mechanised, with two impacts:
- Higher proportion of OH accounted for with machine related costs (maintenance, repairs, power,
dpn)
- Amount of labour required is less representative of the production resources required
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 - Under-allocates OH to low volume products.

ABC
If >1 product
Cost Drivers: activities that are significant detriments of cost eg Machine set ups. CD represent the bases
for charging costs in the ABC system, with separate cost code established for each cost driver. For LT VOH
CD = Vol of activity
Cost pool: several cost driven by same activity (ie engine oil, machine breakdown and repair), cost added
to cost pools nad then absorbed by machine hrs.
+ more accurate representation of real cost of products, therefore pricing, sales stratergy and performance
management and decision making improved
+ better insight in to causes (drives) of OH
+ recognises that not all OH relate to production and sales volume
+ OH are a significant proportion of costs and mngr need to understand the drivers to manage the business
effectively. OH cost can be controlled by managing the cost drivers.
+ Can be applied to calculate realistc costs in complex business environ.
+ can be applied to all OH, not just prdn OH
+ easily applied to service costing as in product costing.

- do benefits outweigh cost of implementing it.

- little benefit if cost primerialy volume relate of OH are a small proportion of overall costs.
- impossible to allocate all OH to specific activities
- choice of both activities and cost drivers maybe inappropriate
- More complex to explain to stakeholders

Implications of switching to ABC significant commercial implications

- Pricing based on more realistic cost data, therefore pricing decisions improved as based on more
accurate cost data.
- Sales strategy can be more soundly based, as more realistic product. Enables sales team to target
customers, or stop, as markets segmants may be profitable/not under ABC.
- DMk improve
- R&D, prdn and sales effort concentrated on products that offer highest sales margins.
- Performance management can be enhanced as focus on selling the most profitable products
through control of cost drivers.
- Can be used as the basis for budgeting and longer term forward planning of overhead costs, the
more realistic budgeted OH should improve the system of performance management.
-
Eg on p 70 and TYU p79

Abs costing and Marginal costing – should all costs eventually be attributed to cost units?
- Production and selling. In Manufac, CI FG never includes an element of selling costs, valued at prdn
costs only (inc OH). However for pricing and profitability purposes the unit cost may include an
element of selling costs
- Fixed/Variable. Whether all prdn cost are absorbed into CI valuation depends on:
o TAC = abs all prdn costs inc FC, therefore treated as part of the cost unit and shown as part
of the COS.
o MC only abs VPC (direct and indirect). FC are treated as “period costs” and deducted as a
lump sum from the profits of the period concerned.
Abs rate determined by budgeted figures for output and cost of FOH, differences = under- and over-
absorption  corrected with entry to SPL
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Opening Statement p 81
Abs Cos Marginal
Rev Rev
Less COS Less COS
M M
L L
VOH VOH
FOH -------
X X
Under/Over -------
X X
Fixed prod cost
Admin and selling Admin and selling
X X
Adv Adv
Meet IAS2 stnds FOH same regardless of output
Business need to cover FOH to be profitable, so FOH charged as period costs, avoids
when setting the selling price, the full COPrd must apportionment and un/over abs.
be known. Focus on VC and the concept of contribution –
useful for DM
CI is carried forward, under abs costing F MC also carried forward the prodn cost of the
production OH CF to next period, which inflates inventory but not the FC element.
profit.
All costs absorbed and incorporated into the Pricing considerations. Cheaper to implement.
pricing decision, which should ensure profit is Difficut to set appropriate margin or mark up as
made, providing the target profit is achieved. need to ensure FC are covered. Prives often set too
However, to calc a FCPU, assumption made re sales low.
volume, which depends of price, which depends on Useful in ST DM concerining excess capacity of one
CPU. off contracts.
Arbitory, so prices may not realisticly compare with
what a customer is willing to pay
ABC – similar benefits to Abs costing as all costs abs into pricing decision, so profit should be made. Prob
most accurate cost and therefore pricing, sales stratergy, performance management and DM should be
improved.
Issue = complexity and ability to accurately allocate all OH to specific activities.

Fixed costs = unavoidable = not a relevant cost as constant, regardless of the course taken.
Cal contribution, does not inc FC
P88 TYU

CONSIDER HOW CHOSEN METHOD CAN IMPACT SELLIN PRICE AND THEREFORE SV.

Ch 4 Breakeven analysis (CVP Cost Volume Profit Anaylsis)

- Cost assumed to be F or V or seperable into these elements.
- Economies/diseconomies ignored to ensure VCPU is constant
- Consider how change in volume effects contribution  profit
- ContPU = Sales £ PU – total VCPU

Breakeven = FC/Cont PU
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MOS in units = Bud Sales – BE Sales
MOS % = (Bud S – BES)/Bud S x 100
MOS as sales rev = MOS units x Sales Price
Target Profit = (TFC+ required profit)/ContPU
Can show as summerised income statement:
Rev
(VC)
(Total FC)
Profit
C/S ratio = Cont/Sales val
BEP in terms of Rev = FC/(C/S)

The proportion of costs that are fixed in relation to variable costs = “Operating gearing” ++ fixed costs =
high operating gearing.
High operating gearing = high BEP and high contribution margin, so any small changes in revenue have a
large impact on profit.

Sensitivity analysis (what if) – determining effects of changes to the constants in the CVP model e.g. price,
vcpu,sales mix ratios. Hypothesising various outcomes broadens perspective of management, begore
making cost commitments.