ACF311M1/M2 Module: B.Devlin
ACF311M1/M2 Module: B.Devlin
ACF311M1/M2 Module: B.Devlin
Lecture Notes
B.Devlin
INTRODUCTION
TO
MANA!M!NT ACCOUNTIN
2
Lesson 1 Introduction to M"n"#e$ent Accountin#
What is accounting?
Accountin# is "n in%or$"tion s&ste$. It e'ists to (rovide in%or$"tion %or t)e end*
user. It is (ossi+le to distin#uis) +et,een t,o +r"nc)es o% "ccountin#.
1 Financial accounting.
T)e (ur(ose o% %in"nci"l "ccountin# is to re(ort t)e %in"nci"l (er%or$"nce o% t)e
co$("n&. It-s $"in %ocus is on e'tern"l re(ortin# to " nu$+er o% #rou(s vi..
O,ners / s)"re)olders 0
Lo"n creditors / +"n1s 0
Tr"de creditors /su((liers 0
2undr& creditors / su((liers o% services 0
overn$ent "#encies / t"' "ut)orities 0
!$(lo&ees / tr"de unions 0
A set o% %in"nci"l st"te$ents * " (ro%it "nd loss "ccount3 " +"l"nce s)eet "nd "
c"s) %lo, st"te$ent "re (re("red "nd (u+lis)ed.
2 Management accounting
T)e $"in (ur(ose o% $"n"#e$ent "ccountin# is to (rovide in%or$"tion to t)e
$"n"#e$ent te"$ "t "ll levels ,it)in t)e or#"nis"tion %or t)e %ollo,in# (ur(oses4
/"0 %or$ul"tin# t)e (olicies * str"te#ic (l"nnin#
/+0 (l"nnin# t)e "ctivities o% t)e or#"nis"tion * cor(or"te (l"nnin#
/c0 controllin# t)e "ctivities o% t)e or#"nis"tion
/d0 decision*$"1in# * lon#*ter$ "nd t"ctic"l
/e0 (er%or$"nce "((r"is"l "t str"te#ic "nd o(er"tion"l level
De%inition4 M"n"#e$ent "ccountin# is t)e "((lic"tion o% (ro%ession"l 1no,led#e
"nd s1ill in t)e (re("r"tion "nd (resent"tion o% "ccountin# in%or$"tion in suc) "
,"& "s to "ssist $"n"#e$ent in t)e %or$ul"tion o% (olicies "nd in (l"nnin# "nd
controllin# t)e o(er"tions o% t)e or#"nis"tion.
Let us loo1 "t " si$(le %in"nci"l st"te$ent.
!'"$(le Fin"nci"l Accounts
5 5
3
2"les 363666
Cost o% s"les 273666
********
ross (ro%it 83666
********
Deduct
Ad$inistr"tion e'(enses 23666
2ellin# "nd distri+ution e'(enses 13666
******** 33666
********
Net (ro%it 33666
********
Fin"nci"l "ccounts indic"te t)e results o% " +usiness over " (eriod o% ti$e. T)e&
de"l ,it) )istoric or ("st costs "nd "re concerned ,it) ste,"rds)i( "ccountin#.
A $"n"#e$ent "ccountin#/ cost st"te$ent (rovides in%or$"tion to "llo,
$"n"#ers to (l"n3 control "nd or#"nise t)e "ctivities o% t)e +usiness. T)e (ur(ose
o% " costin#/$""#e$ent "ccountin# in%or$"tion s&ste$ is4
1 to (rovide in%or$"tion "+out (roduct costin# to +e used in %in"nci"l
st"te$ents.
2 to (rovide in%or$"tion %or (l"nnin#3 controllin# "nd or#"nisin#.
T)e in%or$"tion (rovided +& t)e costin# s&ste$ s)ould +e4
relev"nt
reli"+le
ti$el&
succinct
(resented in t)e desired %or$"t.
4
A cost s&ste$ s)ould +e
cost e%%ective
"((ro(ri"te %or t)e or#"nis"tion
encour"#e $"n"#eri"l "ction.
!'"$(le M"n"#e$ent Accounts
9roducts
A B C Tot"l
M"teri"ls 573:66 533;66 583<66 51<3666
="#es 13<66 23<66 33666 ;3666
9rod. over)e"d <66 866 >66 23666
******* ******* ******* *******
9rod. cost 83:66 83:66 163766 273666
Ad$in. costs ;66 :66 <66 23666
2ellin# costs 366 766 366 13666
******* ******* ******* *******
Tot"l cost ;3:66 :3666 13266 2;3666
2"les 163276 163:66 :3>86 363666
9ro%it 23276 23:66 **** 33666
/Loss0 **** **** /232760 ****
Net (ro%it $"r#in 27? 28? **** 16?
******* ******* ******* *******
T)is (er%or$"nce st"te$ent is o% t)e s"$e +usiness "s t)e (revious e'"$(le o%
%in"nci"l "ccounts. @o,ever3 it #ives $"n"#e$ent $uc) $ore in%or$"tion. It
"n"l&ses t)e cost ele$ents in res(ect to $"teri"ls3 l"+our "nd over)e"ds "llo,in#
$"n"#e$ent to %ocus on costs ,)ic) reAuire investi#"tion "nd control. It
%"cilit"tes decision*$"1in#. !.#. s)ould (roduct C +e discontinuedB
Co$("red to t)e %in"nci"l "ccounts t)e $"n"#e$ent "ccountin# in%or$"tion
,)ic) is $uc) $ore co$(re)ensive ,ill "llo, $"n"#e$ent to +etter c"rr& out
t)eir %unctions o% (l"nnin#3 controllin# or#"nisin# "nd decision*$"1in#.
Cost cl"ssi%ic"tion
T)e $"n"#e$ent "ccount"nt ,ill use cost in%or$"tion %or t,o $"in re"sons.
1 to "scert"in t)e cost o% " (roduct. T)is in%or$"tion is used to v"lue stoc1
,)ic) is reAuired %or e'tern"l re(ortin# .
2 to "ssist $"n"#e$ent in t)e decision*$"1in# (rocess.
5
De(endin# on t)e cost o+Cective t)e costs ,ill +e cl"ssi%ied into " nu$+er o%
c"te#ories.
/"0 B& n"ture o% resource
/i0 M"teri"ls
/ii0 L"+our
/iii0 Ot)er !'(enses
/+0 B& t&(e o% cost
/i0 Direct Costs
/ii0 Indirect Costs * Over)e"ds
/c0 B& %unction
9roduction3 Ad$inistr"tion3 2ellin# "nd Distri+ution
/d0 B& t)e +e)"viour o% costs
/i0 Fi'ed or 9eriodic Costs
/ii0 D"ri"+le Costs
/iii0 2e$i*%i'ed3 or 2e$i*v"ri"+le Costs
Cost O+Cectives
/"0 9roduct costin#
It is essenti"l %or "n or#"nis"tion to "scert"in t)e cost o% $"nu%"cturin# "
(roduct. T)e in%or$"tion is used %or t,o (ur(oses4
1 to deter$ine t)e v"lue o% closin# stoc1 ,)ic) is reAuired %or t)e
%in"nci"l st"te$ents vi.. t)e (ro%it "nd loss "ccount "nd t)e
+"l"nce s)eet.
Direct $"teri"ls 5E
Direct l"+our 5E
Direct e'(ense 5E
*****
9ri$e cost 5E
9roduction over)e"ds 5E
*****
9roduction cost 5E
*****
2 Also so$e +usinesses use " cost (lus (ricin# str"te#&. T)e (roduct
cost is c"lcul"ted "nd " $"r1 u( (ercent"#e is "dded to "rrive "t "
sellin# (rice ,)ic) #ives " re"son"+le #ross (ro%it ,)ic) in turn
c"n cover t)e non*(roduction over)e"ds "nd le"ve " s"tis%"ctor&
net (ro%it.
6
/+0 Decision $"1in# * Cost +e)"viour
T)e cl"ssi%ic"tion o% costs into v"ri"+le3 %i'ed "nd se$i*%i'ed is i$(ort"nt in
ter$s o% decision*$"1in# "nd cost control3 "ctivities t)"t co$(rise t)e
%und"$ent"ls o% t)e $"n"#e$ent "ccountin# %unction.
Variable costs "re t)ose costs ,)ic) incre"se/decre"se ,it) t)e level o% (roduction
"nd s"les. In " $"nu%"cturin# co$("n& t)e v"ri"+le (roduction costs c)"n#e
directl& ,it) t)e level o% (roduction.
Fixed costs c"n +e eit)er co$$itted %i'ed costs or discretion"r& %i'ed costs. Fi'ed
costs "re ter$ed %i'ed +ec"use t)e& do not c)"n#e in res(onse to c)"n#es in t)e
level o% "ctivit&. It s)ould +e noted t)"t t)e& "re not %i'ed +ec"use t)e& do not
c)"n#e +ec"use cost ite$s li1e rent is o%ten su+Cect to revision.
Semi-fixed/semi-variable costs "re costs ,)ic) $ove in t)e s"$e direction +ut
not "t t)e s"$e r"te "s t)e level o% "ctivit&. T)e se$i*%i'ed/se$i*v"ri"+le cost
cont"ins " %i'ed "nd " v"ri"+le ele$ent. For e'"$(le3 t)e electricit& +ill cont"ins
" %i'ed or st"ndin# c)"r#e "nd "nd t)e v"ri"+le "s(ect ,)ic) de(ends on us"#e.
Cost "scert"in$ent
It is i$(ort"nt t)"t t)e $"n"#e$ent "ccount"nt c"n deter$ine t)e v"ri"+le "nd
%i'ed costs "nd t)ere "re " nu$+er o% tec)niAues to "ssist in se("r"tin# t)e %i'ed
"nd v"ri"+le ele$ents o% se$i*%i'ed or se$i*v"ri"+le costs.
1 An"l&sin# costs +& direct o+serv"tion o% t)e resources reAuired to
convert $"teri"ls into " %inis)ed (roduct "nd "((l&in# costs to
t)ese "ctivities. Direct $"teri"ls3 direct l"+our "nd $"c)ine ti$e
c"n +e est"+lis)ed Auite e"sil&.
2 B& ins(ectin# t)e "ccounts t)e "ccount"nt c"n cl"ssi%& costs "s
+ein# v"ri"+le or %i'ed.
3 @i#)*lo, $et)od. T)is $et)od ent"ils selectin# t)e (eriod o%
)i#)est "nd lo,est levels o% "ctivit& "nd co$("rin# t)e c)"n#es in
costs t)"t result %ro$ t)e t,o levels.
!'"$(le
Out(ut 16666units 536666
1<666units 576666
576666 * 536666 F 516666/
1<666units * 16666F <666units F 52(er unit.
T)e %i'ed costs t)ere%ore "re 516666.
7 T)e sc"tter#r"() or re#ression c)"rt.
7
Costs
Out(ut
On t)e sc"tter#r"() tot"l costs "re (lotted "#"inst out(ut "t " nu$+er o%
di%%erent "ctivit& levels. T)en " Gline o% +est %it- is dr",n t)rou#) so$e o% t)e
coordin"tes. =)ere t)is line coincides ,it) t)e H "'is t)is re(resents t)e level o%
%i'ed costs. Once t)is is est"+lis)ed it is si$(le to c"lcul"te t)e ot)er costs ,)ic)
"re not %i'ed ie. t)e v"ri"+le costs. T)e "ssu$(tion is t)"t "t .ero out(ut t)e
+usiness still )"s to $eet t)e %i'ed costs* t)e (eriodic costs rel"ted to ti$e.
8
MARINAL CO2TIN
FOR
D!CI2ION MAIIN
9
Lesson 2
M"r#in"l Costin# * " tec)niAue %or s)ort*run decision*$"1in#
One o% t)e $"in %unctions o% $"n"#e$ent is decision*$"1in#. M"n& o% t)e
decisions "re o% " s)ort*ter$ n"ture. Onl& r"rel& is " $"n"#er %"ced ,it) "
decision ,)ic) )"s " lon# ter$ i$("ct e#. +u&in# " ne, $"c)ine3 e'("ndin# t)e
%"ctor&3 t"1e*over o% "not)er co$("n&. 2ince $ost o% t)e decisions )"ve " s)ort*
ter$ i$("ct it c"n +e "ssu$ed t)"t t)e c"("cit& o% t)e %"ctor& ,ill not c)"n#e.
T)ere%ore %i'ed or (eriodic costs "re not "%%ected +& t"ctic"l s)ort*run decisions.
T)e onl& costs ,)ic) "re "%%ected "re v"ri"+le costs ie. t)ose costs ,)ic) v"r&
directl& ,it) t)e level o% "ctivit& o% t)e %"ctor&. T)ese ,ould include direct
$"teri"ls3 direct l"+our "nd v"ri"+le over)e"ds.
Also "ll t)e decisions co$(rise " c)oice +et,een "ltern"tive courses o% "ction.
T)ere%ore3 ("st costs c"n )"ve no relev"nce %or %uture decisions. 9"st costs c"n
consist o% sun1 costs or co$$itted costs.
In $"r#in"l costin# "ll costs "re cl"ssi%ied "ccordin# to )o, t)e& +e)"ve. T)e&
"re eit)er variable or fixed. T)e %i'ed costs "re tre"ted "s periodic ie. t)e& "re
rel"ted to ti$e . !'"$(les o% %i'ed costs ,ould +e rent3 r"tes3 insur"nce3
de(reci"tion etc. T)ese costs st"& const"nt in t)e s)ort*ter$ re#"rdless o% t)e
decision t)"t $"n"#e$ent t"1es. T)ere%ore3 in $"1in# decisions3 in c)oosin#
+et,een di%%erent "ltern"tive courses o% "ction $"n"#e$ent identi%ies t)e
v"ri"+le costs "nd tre"ts t)e %i'ed costs "s irrelev"nt.
To su$$"ri.e t)e tec)niAue o% $"r#in"l costin#4
Costs "re cl"ssi%ied "s eit)er %i'ed or v"ri"+le.
In t)e s)ort*run "ll %i'ed costs re$"in unc)"n#ed "nd t)ere%ore tre"ted "s
irrelev"nt.
T)e onl& relev"nt costs "re v"ri"+le costs ie. t)ose costs ,)ic)
incre"se/decre"se "s out(ut incre"ses/decre"ses.
De%inition4 M"r#in"l costin# is " costin# (rinci(le ,)ere+& v"ri"+le costs "re
c)"r#ed to cost units "nd t)e %i'ed costs "ttri+ut"+le to t)e relev"nt (eriod "re
,ritten o%% in %ull "#"inst t)e contri+ution %or t)"t (eriod. /ICMA0
M"r#in"l cost F v"ri"+le cost F direct $"teri"ls
direct l"+our
direct e'(ense
v"ri"+le over)e"d
Contri+ution F s"les revenue * v"ri"+le/$"r#in"l0 costs
Contri+ution is t)e "$ount ,)ic) )el(s to ("& o%% t)e %i'ed costs "nd "n& e'cess
re(resents (ro%it. Contri+ution is not (ro%it.
10
!'"$(le For$"t o% " M"r#in"l Costin# Inco$e 2t"te$ent
9roducts A B C Tot"l
2"les revenue E E E E
Less D"ri"+le costs /E0 /E0 /E0 /E0
****** ****** ****** ******
Contri+ution E E E E
****** ****** ****** ******
Fi'ed costs /E0
******
E
******
M"r#in"l cost is t)e "$ount "t "n& #iven volu$e o% out(ut +& ,)ic) tot"l costs
"re c)"n#ed i% t)e volu$e o% out(ut is incre"sed or decre"sed. It is t)e cost o%
$"1in# one e'tr" unit o% out(ut. T)e de%inition stesses t)e $"nner in ,)ic)
costs +e)"ve in rel"tion to t)e volu$e o% "ctivit&. It concerns t)e identi%ic"tion
o% v"ri"+le "nd %i'ed costs ie. t)e costs t)"t incre"se or decre"se "s out(ut
incre"ses or decre"ses. Onl& t)e v"ri"+le costs +ot) (roduction "nd non*
(roduction c)"n#e "s t)e out(ut c)"n#es.
!'"$(le4
A co$("n& $"nu%"cture units ,it) "v"i"+le cost (er unit o% 52 "nd %i'ed costs o%
5<3666.
Dolu$e /costs0 6 1 13666 163666
5 5 5 5
D"ri"+le costs *** 2 23666 263666
Fi'ed costs <3666 <3666 <3666 <3666
******* ******* ******* *******
Tot"l cost <3666 <3662 ;3666 2<3666
******* ******* ******* *******
Note 52 is t)e $"r#in"l cost or v"ri"+le cost (er unit.
11
A((lic"tions o% $"r#in"l costin#
/"0 Acce(t"nce o% " s(eci"l order.
E Ltd. $"1es " (roduct ,)ic) sells %or 51.<6. T)e out(ut %or t)e (eriod is :63666
units o% (roduct ,)ic) re(resents :6? c"("cit& . Tot"l costs "re 5>63666 "nd o%
t)ese it is esti$"ted t)"t 528.666 "re %i'ed costs. A (otenti"l custo$er o%%ers to
+u& 263666 units "t 51.16 "nd t)is ,ill use u( t)e co$("n&-s s("re c"("cit&.
2)ould $"n"#e$ent "cce(t t)is s(eci"l orderB
2"les 51263666
M"r#in"l costs/ :6( (er unit0 873666
********
Contri+ution <83666
Fi'ed costs 283666
********
9ro%it 363666
********
2(eci"l order4
2"les/263666 units J 51.160 5223666
Less D"ri"+le costs/263666 J :6(0 183666
**********
!'tr" contri+ution 83666
**********
9ro%its c"n +e incre"sed +& "n "ddition"l 583666 since %i'ed costs "re "lre"d&
covered. @o,ever $"n"#e$ent $ust consider ot)er relev"nt %"ctors in "rrivin#
"t t)e %in"l decision.
@o, ,ill e'istin# custo$ers re"ctB T)e& $"& ,is) to +u& "t 51.16 (er unit.
Could t)e s("re c"("cit& +e used $ore (ro%it"+l& r"t)er t)"n "cce(tin# t)e
s(eci"l orderB
2 2)ut*do,n decisions
O%ten $"n"#e$ent ,is) to "n"l&se t)e (er%or$"nce o% t)eir (roducts3 +r"nc)es3
divisions.
12
Consider t)e %ollo,in# e'"$(le.
!'"$(le4
9roduct A B C Tot"l
5 5 5 5
2"les 263666 <63666 2<3666 ><3666
Less
Direct $"teri"ls 13666 1<3666 163666 283666
Direct l"+our 33666 183666 173666 333666
Fi'ed over)e"ds 23666 ;3666 >3666 1:3666
******** ******** ******** ********
83666 3:3666 333666 ;;3666
******** ******** ******** ********
9ro%it//Loss0 173666 123666 /:36660 1:3666
=it) (roduct C $"1in# " loss $"n"#e$ent $i#)t consider discontinuin# t)is
(roduct. @o,ever3 usin# $"r#in"l costin# (rinci(les3 ,it) %i'ed costs tre"ted "s
irrelev"nt %or s)ort*run decision*$"1in# t)e inco$e st"te$ent c"n +e
re%or$"tted.
9rtoduct A B C Tot"l
5 5 5 5
2"les 263666 <63666 2<3666 ><3666
Less
D"ri"+le costs 73666 313666 273666 <>3666
******** ******** ******** ********
Contri+ution 183666 2>3666 13666 383666
Fi'ed costs 1:3666
********
Net (ro%it 1:3666
********
2ince (roduct C $"1es " contri+ution it $"& +e in"dvis"+le to close it do,n. I%
9roduct C is closed do,n t)e co$("n& ,ill lose 513666 contri+ution "nd t)e
over"ll e%%ect ,ould +e to reduce (ro%its to 51;3666.
3 M"1e or Bu&
2o$eti$es $"n"#e$ent $"& )"ve to consider ,)et)er it is +est to $"nu%"cture
(roducts or co$(onents or to su+*contr"ct t)e$ out "nd (urc)"se t)e$
e'tern"ll&.
13
!'"$(le4
A co$("n& $"1es (roduct 9. A co$(onent K used in t)e $"nu%"cture o% 9 c"n
+e (urc)"sed %ro$ " su((lier %or 5:. T)e costs to $"1e t)e co$(onent "re "s
%ollo,s4
Direct $"teri"ls 52
Direct ,"#es 53
D"ri"+le over)e"ds 52
******
D"ri"+le cost o% (roduction 5;
******
Assu$e s("re c"("cit& "nd t)e %i'ed costs re$"in unc)"n#ed.
O+viousl& it is c)e"(er to $"1e t)"n to +u&.
@o,ever3 i% t)e %ir$ is ,or1in# "t %ull c"("cit& "nd to $"1e co$(onent K
involves $ovin# so$e o% t)e c"("cit& %ro$ (roduct 9 t)en t)e decision is " little
$ore involved.
T)e %ollo,in# d"t" "((lies to (roduct 9.
2ellin# (rice 518
Direct $"teri"ls 58
Direct l"+our 57
D"ri"+le over)e"d 52
******
Contri+ution 57
******
T)e (roduction r"te %or (roduct 9 is < units (er )our "nd %or co$(onent K is 16.
T)e e%%ective cost o% $"1in# " unit o% co$(onent K is4
M"r#in"l cost o% (roduction 5;
9lus O((ortunit& cost o% 52
*****
T)e e%%ective cost is 5>
*****
B& s,itc)in# c"("cit& %ro$ (roduct 9 to co$(onent K t)ere is 52 contri+ution
lost. T)is is "n o((ortunit& cost ie. it is t)e +ene%it %ore#one +& c)oosin# one
course o% "ction over t)e ot)er.
7 Li$itin# %"ctor decisions
O%ten " co$("n& %inds t)"t t)ere is " li$itin# %"ctor or constr"int ,)ic) in)i+its
its c"("cit& to $eet t)e desired (roduction level. T)e li$itin# %"ctor $"& +e "n&
resource e#. $"teri"ls3 l"+our or $"c)ine )ours. M"n"#e$ent )"s to decide ,)"t
is t)e +est ,"& to "lloc"te t)e sc"rce resource "$on# t)e (roduct r"n#e in t)e
$ost e%%ective ,"& so t)"t (ro%its "re $"'i$ised.
14
!'"$(le4
9roduct E H L
Desired (roduction /units0 13666 23666 <66
5 5 5
2ellin# (rice (er unit 3< 2< 1<
D"ri"+le cost (er unit 1< 16 <
***** ***** *****
Contri+ution (er unit 26 1< 16
A s(eci"l $"c)ine is used to $"nu%"cture t)e t)ree (roducts "nd t)ere "re onl&
1<3666 $"c)ine )ours "v"il"+le.
9roduct E uses 26 $"c)ine )ours (er unit.
9roduct H uses < $"c)ine )ours (er unit.
9roduct L uses 2 $"c)ine )ours (er unit.
E H L
Contri+ution (er unit 26 1< 16
No. o% $"c)ine )rs. 26 < 2
Contri+ution (er $"c)ine )r. 1 3 <
R"n1in# /30 /20 /10
Desired (roduction level
9roduct L <66 units ' 2 )rs. 13666 )rs
9roduct H 23666 ' < )rs 163666 )rs
9roduct E 266 ' 26 73666 )rs
9roduct L e"rns <66 units ' 516 F 5<3666 contri+ution
9roduct H e"rns 23666 units ' 51< F 5363666 contri+ution
9roduct E e"rns 266 units '526 F 573666 contri+ution
*********
53>3666 contri+ution
**********
< 9ro%it 9l"nnin# or cost (ro%it volu$e "n"l&sis
M"n"#e$ent %eels it )el(%ul to "scert"in t)e level o% (ro%its e"rned "t cert"in
levels o% out(ut "nd s"les.
!'"$(le4
A co$("n& $"1es (roduct E ,)ic) )"s " sellin# (rice o% 516 (er unit "nd
v"ri"+le costs o% 5< (er unit ,it) %i'ed costs o% 5263666.
15
2"les /units0 23666 73666 83666 :3666 163666
******* ****** ******* ******* ********
5 5 3 5 5
2"les revenue 263666 763666 863666 :63666 1663666
D"ri"+le costs 163666 263666 363666 763666 <63666
******** ******** ******** ******** ********
Contri+ution 163666 263666 363666 763666 <63666
Fi'ed costs 263666 263666 263666 263666 263666
******** ******** ******** ******** ********
Net (ro%it /loss0 /1636660 *** 163666 263666 363666
******** ******** ******* ******* ********
At s"les o% 7666 units t)e co$("n& is "t +re"1*even (oint ie. contri+ution is eAu"l
to t)e %i'ed costs.
CO2T DOLUM! 9ROFIT
ANALH2I2
16
Lesson 3
Cost Dolu$e 9ro%it An"l&sis
T)e CD9 $odel $"1es t)e "ssu$(tions t)"t costs c"n +e si$(l& divided into
%i'ed "nd v"ri"+le costs. It "ssu$es t)"t over " r"n#e o% out(ut levels * t)e
relev"nt r"n#e * %i'ed costs re$"in const"nt "nd v"ri"+le costs incre"se directl&
,it) out(ut. T)e v"ri"+le costs +e)"ve in " line"r %"s)ion. T)e %i'ed costs "re
(eriodic costs so t)"t cost ite$s suc) "s rent3 r"tes3 insur"nce3 de(reci"tion etc.
"re const"nt "t "ll levels o% out(ut. T)ere is "lso "n "ssu$(tion t)"t t)e s"les
revenue +e)"ve in " line"r %"s)ion ie. t)e sellin# (rice is const"nt (er unit o%
out(ut.
!cono$ists t"1e " $ore re"listic vie, o% cost +e)"viour. T)e& contend t)"t
v"ri"+le costs do not +e)"ve in " line"r %"s)ion +ut "re e%%ected +& econo$ies o%
sc"le. Co$("nies c"n +ene%it %ro$ discounts %or +ul1 (urc)"ses o% $"teri"ls "nd
t)e econo$ies %ro$ t)e division o% l"+our. T)e econo$ists- $odel re(resented in
" curviline"r #r"() s)o,s t)e tot"l cost line rises stee(l& "t lo, out(ut levels3
levels o%% ,it)in " r"n#e o% out(ut "nd %in"ll& rises stee(l& "#"in "s t)e +ene%its o%
econo$ies o% sc"le decline. T)e tot"l revenue line rises stee(l&3 levels o%% "nd t)en
declines. T)is curviline"r tot"l revenue line re%lects t)e %"ct t)"t to "c)ieve $ore
s"les t)e co$("n& $"& )"ve to reduce t)e sellin# (rice "nd does not incre"se
(ro(ortion"ll& ,it) out(ut.
As " co$(ro$ise it is (ossi+le to "cce(t t)e "ssu$(tions t)"t t)e CD9 $odel is
+"sed on ,it)in " cert"in r"n#e o% out(ut * t)e relev"nt r"n#e. T)ere%ore3 t)e
CD9 $odel c"n +e used "s " (l"nnin# tec)niAue to4
/"0 %ind t)e +re"1*even (oint
/+0 deter$ine t)e $"r#in o% s"%et&
/c0 deter$ine " t"r#et volu$e
/d0 est"+lis) t)e (ro%it volu$e r"tio or contri+ution volu$e r"tio
/e0 deter$ine t)e o(er"tin# #e"rin#
It is (ossi+le to "scert"in t)ese +& usin# " +re"1*even c)"rt or +& usin# %or$ul"e.
17
Let us loo1 "t " +"sic "ccountin# eAu"tion ie.
2"les * Tot"l costs F 9ro%it
or
2"les * / D"ri"+le costs * Fi'ed costs 0 F 9ro%it
t)en
2"les * D"ri"+le costs F Contri+ution
ontribution is t)e e'cess o% s"les over v"ri"+le costs "nd it re(resents t)e sur(lus
"v"il"+le to $eet t)e %i'ed costs. Once t)e %i'ed costs )"ve +een $et "n&
contri+ution le%t is (ro%it.
At t)e +re"1*even (oint t)e s"les revenue #ener"ted covers t)e tot"l costs "nd no
$ore.
At t)e +re"1*even (oint t)e contri+ution is su%%icient to $eet t)e %i'ed costs.
Contri+ution F Fi'ed costs
B!9 F Fi'ed Costs
Contri+ution (er Unit
9/D or C/2 r"tio F Contri+ution E 166
2"les
T)e 9/D r"tio indic"tes t)e ? o% contri+ution to s"les.
18
For$ul"e4
1 Bre"1*even (oint F Fi'ed costs/ Contri+ution (er unit
2 M"r#in o% s"%et& F Bre"1*even (oint/units0 * T)e !'(ected 2"les
3 2"les/units0 to "c)ieve " (ro%it Fi'ed costs M T"r#et (ro%it
***********************************
Contri+ution (er unit
7 9ro%it volu$e r"tio F Contri+ution ' 166
****************************
2"les revenue
< T)e O(er"tin# e"rin# F Contri+ution / 9ro%it
It is (ossi+le to (resent t)e (ro%it volu$e rel"tions)i( in " c)"rt3 a profit-volume
chart. T)is c)"rt dis(enses ,it) t)e need to dr", cost "nd revenue lines "nd
concentr"tes on t)e rel"tions)i( +et,een (ro%it "nd out(ut.
Revenues
"nd
Costs /50
Out(ut /units0
A +re"1*even c)"rt
9ro%it
Out(ut /units0
19
Loss
Li$it"tions o% cost volu$e (ro%it "n"l&sis.
CD9 "n"l&sis is +"sed on " nu$+er o% si$(listic "ssu$(tions "+out cost
+e)"viour ,)ic) under$ine t)e $odel-s e%%ectiveness.
1 Costs c"n +e divided into %i'ed "nd v"ri"+le costs +ut in re"lit& $"n&
costs )"ve " %i'ed "nd v"ri"+le ele$ent/se$i*v"ri"+le0 "nd $"& not +e
e"s& to divide.
2 T)ere is " line"r rel"tions)i( +et,een out(ut "nd costs "nd revenues.
T)e econo$ists vie, tends to dis(ute t)is "nd (resents " curviline"r
$odel.
3 T)e +usiness )"s onl& one (roduct or t)ere is " s(eci%ic const"nt (roduct
$i'.
7 T)e onl& %"ctor in%luencin# costs "nd revenues is out(ut. Ot)er %"ctors
suc) "s (roduction e%%icienc& "nd (roduction $et)ods $"& i$("ct on
out(ut.
!'"$(le4
A co$("n& )"s s"les o% 1263666 units ,)ic) sell %or 51 ,it) t)e v"ri"+le costs <6(
(er unit. T)e %i'ed costs "re 5763666. T)e $"n"#e$ent ,"nt to 1no, t)e B/9
(oint3 t)e $"r#in o% s"%et& "nd t)e (ro%it. 2olve #r"()ic"ll& "nd +& %or$ul".
20
BUD!TIN
T)e 9l"nnin# 9rocess
All or#"nis"tions )"ve t)eir o+Cectives. 2o$e o% t)e o+Cectives $"& not +e
e'(ressed in "ccountin# ter$s %or e'"$(le o+Cectives to i$(rove t)e ,el%"re o%
t)e st"%% or to i$(rove t)e i$("ct on t)e loc"l environ$ent. @o,ever3 in t)is
c)"(ter t)e e$()"sis is on o+Cectives usu"ll& e'(ressed in Au"ntit"tive ter$s e#.
incre"se in $"r1et s)"re3 (ro%it #ro,t)3 incre"se in t)e "sset v"lue etc ,)ic) t)e&
,is) to "c)ieve. T)ere "re t)ree levels o% (l"nnin# * cor(or"te lon# ter$
(l"nnin#3 $ediu$ ter$ (l"nnin# "nd "nnu"l (l"nnin# or +ud#etin#. T)e "nnu"l
+ud#ets "re ste(s "lon# t)e ,"& to "c)ieve t)e lon#*r"n#e (l"n o% t)e
or#"nis"tion.
To ensure t)"t t)e o+Cectives "re "c)ieved (l"ns or +ud#ets $ust +e (re("red.
De%inition4 A +ud#et is " %in"nci"l or Au"ntit"tive inter(ret"tion (rior to "
de%ined (eriod o% ti$e3 o% " (olic& to +e (ursued %or t)"t (eriod3 to "tt"in " #iven
o+Cective.
Bud#ets "re ("rt o% t)e (l"nnin# "nd control (rocess. T)e& )el( to de%ine t)e
o+Cectives o% t)e or#"nis"tion. Bud#etin# is (ro+"+l& t)e $ost i$(ort"nt
contri+ution t)"t t)e "ccountin# de("rt$ent $"1es to t)e role o% $"n"#e$ent.
T)e "ccount"nt dr",s u( " (l"n ,)ic) inte#r"tes t)e v"rious %unction"l "re"s o%
t)e +usiness. Control is e'ercised +& %irstl&3 dele#"tin# res(onsi+ilit& to
de("rt$ent"l $"n"#ers %or t)e "tt"in$ent o% t)e +ud#ets "nd t)en t)e re#ul"r
co$("rison o% t)e "ctu"l results ,it) t)e (l"nned outco$es.
Bud#ets "ssists "n or#"nis"tion
to (l"n "nd control (ro%it"+ilit&
to (l"n "nd control (roduction resources
to (l"n "nd control c"(it"l e'(enditure
to (l"n "nd control %in"nce
An or#"nis"tion ,)ic) en#"#es in +ud#etin# c"n o+t"in t)e +ene%its o%
+etter (l"nnin# "nd ","reness o% ,)"t )"s to +e "c)ieved
#re"ter coordin"tion o% t)e di%%erent %unction"l "re"s
+etter co$$unic"tion ,it) st"%% contri+utin# to t)e t"r#ets to t+e set
$otiv"tion o% t)e st"%% ,it) st"%% "ssi#ned t)eir res(onsi+ilities
e%%icient "nd e%%ective use o% sc"rce resources "nd "n ","reness o% cost*
consciousness
21
Ad$inistr"tion o% t)e +ud#et.
T)e "d$inistr"tion o% t)e +ud#et is t)e res(onsi+ilit& o% t)e +ud#et o%%icer ,)o is
usu"ll& t)e "ccount"nt . T)e "ccount"nt ,or1s in conCunction ,it) t)e +ud#et
co$$ittee co$(rised o% t)e de("rt$ent"l $"n"#e$ent. 2enior $"n"#e$ent
outline t)e +ro"d str"te#ic o+Cectives o% t)e or#"nis"tion "nd co$$unic"te t)ese
to t)e %unction"l $"n"#ers. T)e +ud#et co$$ittee identi%ies t)e 1e& +ud#et
%"ctor ,)ic) deter$ines ,)"t "cts "s " constr"int on t)e or#"nis"tion-s "ctivities.
T)is 1e& +ud#et %"ctor decides t)e 1e& +ud#et ie. t)e one ,)ic) sets t)e
o+Cectives %or t)e su+ordin"te +ud#et. T)e su+ordin"te +ud#ets "re constructed
+& "s1in# t)e Auestions * ,)en "re t)e #oods to +e sold3 ,)ere "re t)e #oods to
+e sold "nd )o, "re t)e #oods to +e (roduced.It $"& +e t)e s"les volu$e ,)ic)
drives t)e ot)er su+sidi"r& +ud#ets. For inst"nce3 i% t)e s"les de("rt$ent
%orec"sts t)e "nnu"l s"les "t 263666 units t)en t)e (roduction +ud#et $ust +e
inte#r"ted ,it) t)is %i#ure. Altern"tivel&3 (roductive c"("cit& $"& +e t)e 1e&
+ud#et %"ctor . T)e co$("n& $"& )"ve t)e c"("cit& to (roduce onl& 1:3666 units
" &e"r so t)is %i#ure sets t)e o+Cectives %or t)e ot)er +ud#ets.
T)e "ccount"nt )el(s t)e $"n"#ers to set t)e +ud#ets +& (rovidin# in%or$"tion
"s reAuired. 2"les %orec"stin# $"& (roceed +& $e"ns o% st"tistic"l $et)ods ,)ic)
"re +"sed on econo$ic indic"tors or +& c"rr&in# out "n intern"l %orec"st +&
c"nv"ssin# t)e s"les st"%%. T)e current s"les level3 ("st trends3 $"r1et rese"rc)
c"n (rovide use%ul in%or$"tion.
On recei(t o% t)e v"rious +ud#ets t)e "ccount"nt noti%ies $"n"#ers o% revisions
to t)eir +ud#et. Once t)e "ccount"nt "nd t)e co$$ittee "#ree t)e $"ster
+ud#et ,)ic) is " %orec"sted (ro%it "nd loss "ccount "nd +"l"nce s)eet c"n +e
dr",n u(.
In ter$s o% control t)e "ccount"nt is res(onsi+le %or t)e re#ul"r $onitorin# o%
t)e +ud#ets3 %or re(ortin# +"c1 to t)e +ud#et co$$ittee re#ul"rl&/ d"il&3,ee1l&
or $ont)l& +"sis0 t)rou#) v"ri"nce re(orts "nd %or revisin# t)e +ud#ets i%
necess"r&.
9re("rin# +ud#ets
!'"$(le
T)e +ud#eted s"les o% M"#ee !n#ineerin# Lt. %or 1>'6 is "s %ollo,s4
9roduct 2"les units Unit sellin# (rice
D"# 263666 52<
M"# 1:3666 526
9"# 1<3666 522
T)e o(enin# stoc1s "t t)e +e#innin# o% t)e &e"r 1>'6
9roduct 9roduct units Co$(onent 9"rt units
D"# 33666 A 763666
M"# 33666 B <63666
9"# 23666 C 863666
D 763666
! 163666
T)e $"r1etin# director intends to run " $"r1etin# c"$("i#n to,"rds t)e end o%
1>'6 "nd )"s reAuested t)"t (roduct unit stoc1s s)ould +e incre"sed "t t)e end
o% 1>'6 "+ove t)e co$$ence$ent stoc1s +& t)e %ollo,in#
22
D"# incre"sed +& 26?
M"# incre"sed +& <6?
9"# incre"sed +& 26?
T)e (urc)"sin# director )"s reAuested t)"t "ll co$(onents ("rt stoc1s +e
reduced +& 26? "t t)e end o% 1>'6 +ec"use o% i$(roved deliver& ti$es %ro$
su((liers.
T)e (roduct $"teri"l s(eci%ic"tion "nd co$(onent cost %or e"c) o% t)e (roducts
"re "s %ollo,s4
Co$(onent ("rt A B C D !
9"rt cost /e"c)0 <6( 3<( 86( <<( 51.6
9roduct Co$(onent ("rts
(er (roduct
D"# 3 7 8 2 1
M"# 2 3 7 2 1
9"# < 2 3 3 1
T)e ne,l& "((ointed $"n"#in# director "s1s &ou to (re("re t)e %ollo,in#
+ud#ets "nd to e'(l"in t)e lin1"#e +et,een t)e$.
1 2"les +ud#et in (roduct units "nd v"lue
2 9roduction +ud#et in (roduct units
3 M"teri"l us"#e +ud#et in co$(onent ("rts.
7 M"teri"ls (urc)"se +ud#et in co$(onent ("rts "nd v"lue.
1. 2"les Bud#et 1>'6
9roduct Units 9rice Tot"l s"les
D"# 263666 52< 5<663666
M"# 1:3666 526 3863666
9"# 1<3666 522 3363666
******** ************
<33666 5131>63666
******** ************
Co$$ent4 t)e s"les +ud#et is co$(uted %ro$ t)e s"les in%or$"tion st"ted3 t)e
+ud#et s)o,s t)e t)e individu"l (roduct s"les units3s"les v"lue "nd tot"l s"les
v"lue. T)e +ud#eted s"les %or 1>'6 "re <33666 units ,it) " tot"l s"les v"lue o%
5131>63666.
23
9roduction +ud#et 1>'6
D"# M"# 9"#
2"les units /%ro$ t)e s"les +ud#et0 263666 1:3666 1<3666
Add closin# stoc1 33866 73<66 23766
******** ******** ********
233666 223<66 1;3766
Less o(enin# stoc1 33666 33666 33666
******* ******** ********
Bud#eted out(ut 263866 1>3<66 1<3766
******** ******** ********
Co$$ent4 t)e (roduction +ud#et is t)e reAuired (roduction to $eet s"les +ud#et
reAuire$ents "nd c)"n#es in stoc1s3 t)us since closin# stoc1 reAuire$ents "re
#re"ter t)"n o(enin# stoc1s t)en (roduction $ust +e incre"sed to co(e ,it)
reAuired (roduction %or s"les "nd incre"sed closin# stoc1 reAuire$ents.
3. M"teri"ls Us"#e Bud#et 1>'6 /Co$(onent us"#e0
9roduct 9rod. units A B C D !
D"# 263866 813:66 :23766 1233866 713266 263866
M"# 1>3<66 3>3666 <:3<66 ;:3666 3>3666 1>3<66
9"# 1<3766 ;;3666 363:66 783266 783266 1<3766
******** ******** ******** ******** ******** ********
<<3<66 1;;3666 363:66 1;13;66 27;3:66 <<3<66
******** ********* ******** ********* ********* ********
Co$$ent4 t)e $"teri"l us"#e +ud#et is t)e co$(onent us"#e. T)is is si$(l& t)e
(roduction units %ro$ t)e (roduction +ud#et eAu"ted to t)e co$(onent
s(eci%ic"tion in e"c) (roduction unit e#. $"teri"l us"#e o% co$(ont A is t)e tot"l
us"#e o% co$(onent A in D"#3 M"# "nd 9"#.
7. T)e M"teri"l 9urc)"se Bud#et 1>'6
Co$(onent A B C D !
M"teri"l us"#e +ud#et 1;;3:66 1;13;66 27;3:66 1283766 <<3<66
Closin# stoc1 323666 763666 7:3666 323666 :3666
********** ********** ********* ********** **********
26>3:66 2113;66 2><3:66 1<:3766 833<66
O(enin# stoc1 763666 <63666 863666 763666 163666
********* ********* ********* ********* *********
18>3:66 1813;66 23<3:66 11:3766 <33<66
9rice (er co$(onent <6( 3<( 86( <<( 51.66
5:73>66 5<83<>< 517137:6 58<3126 5<33<66
Co$$ent4 T)e $"teri"l (urc)"se +ud#et #ives t)e cost "nd Au"ntit& o% e"c)
co$(onent t)"t is needed to +e (urc)"sed "nd t)e over"ll cost o% "ll %ive
co$(onents. T)is +ud#et is +"sed on t)e $"teri"l us"#e +ud#et "dCusted %or
o((enin# "nd closin# stoc1s.
24
C"s) Bud#ets
T)e c"s) +ud#et s)o,s t)e %orec"sted c"s) in%lo,s "nd out%lo,s o% " +usiness
"nd $e"sure t)e esti$"ted +"l"nce or de%icit o% c"s)%or " ("rticul"r (eriod.
T)e "dv"nt"#es o% (l"nnin# %or c"s) resources is essenti"l since " +usiness c"nnot
survive ,it)out c"s).
Adv"nt"#es4
T)e c"s) +ud#et ensures "deAu"te c"s) (l"nnin# "nd control
/"0 C"s) de%icits "re reve"led "nd $"n"#e$ent c"n res(ond +& t"1in#
"((ro(ri"te "ction. Re$edi"l "ction c"n +e t"1en +& inCectin# $ore
c"(it"l into t)e +usiness3 +& +orro,in#3 +& e'"$inin# t)eir credit (olic&
or +& de%errin# c"(it"l e'(enditure.
/+0 C"s) sur(luses "re indic"ted "nd once reco#nised need to +e $"n"#ed.
M"n"#e$ent c"n invest c"s) in t)e s)ort*ter$3 or "v"il o% tr"de discounts
+& +ul1 (urc)"sin# $"teri"ls or %in"nce c"(it"l (roCects.
!'"$(le
T)e London To& Co. Ltd. co$$enced o(er"tions in Dece$+er 1>'6 ,it) "
c"(it"l o% 58663666 ,)ic) ,"s r"ised t)rou#) "n issue o% 8663666 ordin"r& s)"res
o% 51 e"c). T)e (roceeds o% t)e s)"re issue ,ere ("id into t)e co$("n& +"n1
"ccount. Durin# t)e course o% Dece$+er " nu$+er o% tr"ns"ctions too1 (l"ce "nd
t)ese "re su$$"ri.ed +elo,.
C"s) su$$"r& Dece$+er 1>'6
5 5
9roceeds %ro$ s)"re issue 8663666
Less Le"se)old (re$ises /26 &e"rs0 3663666
9l"nt /est. li%e 16 &e"rs0 :63666
!Aui($ent /est. li%e 16 &e"rs0 1863666
Tools 263666
R", $"teri"ls 163666 <;63666
********** **********
C"s) +"l"nce "v"il"+le 363666
FFFFFF
Hou "re #iven t)e %ollo,in# "ddition"l in%or$"tion.
/"0 2"les "re +ud#eted "s %ollo,s4 5:63666 in N"nu"r&O 51863666 in Fe+ru"r&
"nd 52763666 in su+seAuent $ont)s. Fi%t& (er cent o% t)e s"les ,ill +e c"s)
s"les "nd t)e ot)er %i%t& (er cent credit s"les. T)e (eriod o% credit
e'tended to custo$es ,ill +e one $ont).
/+0 T)e cost o% r", $"teri"ls ,ill "$ount to 76? o% t)e s"les revenue. @"l%
t)e $"teri"ls cost %or "n& one $ont) ,ill +e ("id in c"s)O t)e ot)er )"l%
,ill +e ("id %or durin# t)e $ont) o% (urc)"se.
25
/c0 T)e co$("n& intends to 1ee( " stoc1 o% r", $"teri"ls o% 5163666
t)rou#)out t)e &e"r.
/d0 Direct ,"#es ,ill +e incurred "t t)e r"te o% 5<63666 (er $ont). No ti$e
l"# is e'(ected )ere.
Ot)er e'(enses* de(reci"tion on (re$ises3 (l"nt "nd eAui($ent ,ill +e
c"lcul"ted on " str"i#)t*line +"sis.T)e tools ,ill +e re*v"lued "nnu"ll& "nd it is
e'(ected t)"t "nnu"l losses ,ill "$ount to 26 (er cent. All ot)er e'(enses ,ill +e
incurred "t t)e r"te o% 5763666 (er $ont) * t)e ti$e l"# )ere ,ill +e one $ont).
Hou "re "s1ed to (re("re t)e co$("n&-s C"s) +ud#et3 " +ud#eted 9ro%it "nd
Loss "ccount %or t)e %irst si' $ont)s o% o(er"tions "nd " +ud#eted B"l"nce 2)eet
"s "t 36 Nune 1>'1.
N"n Fe+ M"r A(r M"& Nun Me$o
5666 5666 5666 5666 5666 5666 5666
O(enin# +"l"nce 36 7 /170 18 ;6 127
C"s) in%lo,
C"s) s"les 76 :6 126 126 126 126
Credit s"les 76 :6 126 126 126 126Dr
****** ****** ****** ****** ******* *******
Tot"l ;6 127 1:8 2<8 316 387
****** ****** ***** ***** ****** ******
C"s) out%lo,
R", $"ts. *c"s) 18 32 7: 7: 7: 7:
R", $"t. *credit 18 32 7: 7: 7: 7:Cr
Direct ,"#es <6 <6 <6 <6 <6 <6
Ot)er e'(enses 76 76 76 76 76 76Cr
****** ****** ****** ****** ****** ******
Tot"l 88 13: 1;6 1:8 1:8 1:8
****** ****** ****** ****** ****** ******
Closin# +"l"nce 7 /170 18 ;6 127 1;:
FFF FFF FFF FFF FFF FFF
2tudents s)ould note t)"t4
/"0 De(reci"tion never "((e"rs in " c"s) +ud#et "s it is " non*c"s) e'(ense.
/+0 In res(ect to credit tr"ns"ctions ti$e l"#s )"ve to +e +uilt into t)e c"s)
+ud#et
It is use%ul to )"ve " $e$o colu$n to record ite$s ,)ic) ,ill "((e"r in t)e
+"l"nce s)eet i% reAuired.
Bud#eted 9ro%it "nd Loss Account
%or si' $ont)s endin# 36 Nune 1>'1
5 5 5
Cost o% s"les 7:63666 2"les 132663666
Direct ,"#es 3663666 ;:63666
26
**********
O(er"tin# (ro%it 7263666
********** ***********
132663666 132663666
FFFFFFF FFFFFFF
De(reci"tion O(er"tin# (ro%it 7263666
9re$ises ;3<66
9l"nt 73666
!Aui($ent :3666
Tools 23666
******* 213<66
Ot)er e'(enses 2763666
Net (ro%it 1<:3<66
********** **********
7263666 7263666
FFFFFF FFFFFF
T)e (ro%it "nd loss "ccount is (re("red on "n "ccru"ls +"sis unli1e t)e c"s)
+ud#et ,)ic) is (re("red on " recei(ts "nd ("&$ents +"sis. Also3 de(reci"tion
"((e"rs "s "n e'(ense in t)e (ro%it "nd loss "ccount.
Bud#eted B"l"nce 2)eet
"s "t 36 Nune 1>'1
Aut)orised "nd Issued
C"(it"l
5 5 5 5
Fi'ed "ssets Cost De(. NBD
8663666 Ord. s)"res 51
e"c)
8663666 9re$ises 3663666 ;3<66 2>23<66
Reserves 9l"nt :63666 73666 ;83666
9ro%it "nd loss "ccount 1<:3<66 !Aui($ent 1863666 :3666 1<23666
Tools 263666 23666 1:3666
********* ******** *********
<863666 213<66 <3:3<66
********* *********
Current Li"+ilities Current
"ssets
Creditors 7:3666 M"teri"ls 163666
Accrued e'(enses 763666 De+tors 1263666
C"s) 1;:3666 36:3666
******** *********
*
**********
:783666 :783666
FFFFFF FFFFF
Bud#eted de+tors3 creditors "nd c"s) +"l"nce is o+t"ined %ro$ t)e c"s) +ud#et.
Det"ils o% %i'ed "ssets c"n +e o+t"ined %ro$ t)e c"(it"l e'(enditure +ud#et.
In%or$"tion "+out s)"re c"(it"l3 de+entures etc. c"n "lso +e o+t"ined %ro$ t)e
(revious +"l"nce s)eet.
Bud#etin# * t)e Control 9rocess
De%inition4
27
Bud#et"r& control is t)e est"+lis)$ent o% de("rt$ent"l +ud#ets rel"tin# t)e
res(onsi+ilities o% e'ecutives "nd t)e continuous co$("rison o% "ctu"l ,it)
+ud#eted results3 eit)er to secure +& individu"l "ction t)e o+Cective o% t)"t (olic&
or to (rovide " +"sis %or its revision. T)e +ud#et itsel% is $erel& " (l"n on ("(er
,)ic) o% itsel% ,ill not +e e%%ective unless t)ere is " s&ste$ o% control ,)ic) c"n
$onitor t)e or#"nis"tion-s (ro#ress to "c)ievin# t)e o+Cectives.
B& $e"ns o% co$("rin# "ctu"l results ,it) t)e +ud#ets "nd identi%&in# "n&
di%%erences /v"ri"nces0 ,)ic) occur $"n"#e$ent c"n t"1e re$edi"l "ction or
revise t)e +ud#et i% necess"r&. T)e "nnu"l +ud#ets "re +ro1en do,n into $ont)s
so t)e co$("rison is (er%or$ed re#ul"rl& "nd results in " +ud#et re(ort
i(resented to t)e de("rt$ent"l $"n"#ers. To ensure t)"t $"n"#e$ent "re not
over+urdened ,it) "ccountin# d"t" e'ce(tion re(orts $"& +e %urnis)ed. T)ese
re(orts identi%& onl& si#ni%ic"nt v"ri"nces t)"t reAuire $"n"#e$ent-s "ttention
"nd conseAuentl& "re $ore user %riendl& "nd s)ould encour"#e "n "((ro(ri"te
$"n"#eri"l res(onse.
9ersonnel De(t Mont)l& Bud#et Re(ort Fe+ru"r&
Cost
code
Descri(ti
on
Bud#et Actu"l D"ri"nce Bud#et Actu"l D"ri"nce
616 2u(erviso
rs- s"l"r&
5<:3666 58<3666 5;3666
/A0
5118366
6
512<36
66
5>3666
/A0
Fle'i+le Bud#etin#
U( to t)is (oint t)e +ud#et )"s +een %i'ed. T)is is Auite "((ro(ri"te %or (l"nnin#
(ur(oses +ut o% little use %or control (ur(oses. T)e %i'ed +ud#et does not res(ond
to t)e "ctu"l level o% "ctivit&. =)en or#"nis"tions co$(ile t)e $"ster +ud#et it is
+"sed on " cert"in level o% out(ut "nd s"les. In $ost inst"nces3 t)e co$("n& $"&
%ind t)"t t)is o(er"tin# level is not set "t t)e "ctu"l level o% "ctivit&. Indeed $ost
or#"nis"tions %ind it di%%icult to %orec"st t)e "ctu"l level o% "ctivit& e#. t)ere $"&
+e " se"son"l c)"r"cteristic to t)e co$("n&- tr"din#. In suc) c"ses t)e +usiness
$"& %ind it $ore use%ul to (re("re %le'i+le +ud#ets. A %le'i+le +ud#et is Gdesi#ned
to c)"n#e in "ccord"nce ,it) t)e level o% "ctivit& "tt"ined- /CIMA0
A %i'ed +ud#et is not desi#ned to c)"n#e ,it) di%%erent levels o% "ctivit&. It does
not "llo, %or t)e (re*deter$in"tion o% costs "nd revenues "t di%%erent levels o%
out(ut ,)ic) ,ould %"cilit"te co$("rison ,it) "ctu"l costs "nd t)e identi%ic"tion
o% v"ri"nces.
A %le'i+le +ud#et is desi#ned to reco#nise cost +e)"viour "t di%%erent levels o%
out(ut so "ctu"l results c"n +e co$("red ,it) t)e e'(ected results "nd t)e
co$(ut"tion o% v"ri"nces "nd v"ri"nce "n"l&sis is $"de (ossi+le.
!'"$(le4
A co$("n& (roduces #"rden %urniture ,)ic) e'(eriences %luctu"tions in
(roduction levels +ec"use o% its se"son"l n"ture. T)e %ollo,in# costs %or t)e
+ud#eted level o% "ctivit& o% 263666 units "nd t)e "ctu"l (roduction costs %(r t)e
(eriod "re #iven.
Bud#et Costs /263666
units0
Actu"l costs incurred
/1;3866 units0
5 5
M"teri"ls * v"ri"+le 213666 263666
L"+our * v"ri"+le 13666 >:6
M"inten"nce * v"ri"+le 33666 238:6
28
Fi'ed (roduction costs 163666 163666
2ellin# costs * %i'ed <3666 83666
******** ********
763666 3>866
******** ********
Durin# t)e relev"nt (eriod3 t)e "ctu"l nu$+er o% units (roduced ,"s 1;3866.
Hou "re reAuired to (re("re " +ud#et %le'ed "t t)e "ctu"l level o% "ctivit&. In
(re("rin# t)e %le'ed +ud#ets it is i$(ort"nt to identi%& %i'ed "nd v"ri"+le costs to
%orec"st costs "t di%%erent levels o% "ctivit&.
Actu"l costs Fle'ed +ud#et
/1;3866 units0
D"ri"nce
5 5 5
M"teri"ls 263666 1:37:6 13<26 /A0
L"+our >:6 ::6 166 /A0
M"inten"nce 238:6 23876 76 /A0
Fi'ed (roductioon
costs
163666 163666 *****
2ellin# costs 83666 <3666 13666 /A0
******* ******* ***********
3>3886 <3666 23886
******** ******* **********
T)e v"ri"nce re(ort )i#)li#)ts t)"t in res(ect to "ctu"l $"teri"ls3 l"+our3
$"inten"nce "nd sellin# costs3 t)ese "re )i#)er t)"n e'(ected. M"n"#e$ent c"n
e'"$ine "nd "n"l&se t)e v"ri"nces "nd t"1e "((ro(ri"te "ction.
M"n& +usinesses (re("re %i'ed +ud#ets %or de("rt$ents ,)ere e'(enditure $"&
+e $ore (redict"+le suc) "s t)e "d$inistr"tion de("rt$ent. Fle'i+le +ud#ets c"n
+e co$(iled %or t)ose de("rt$ents ,)ose e'(enditure is closel& lin1ed to t)e
level o% o(er"tions suc) "s t)e (roduction de("rt$ent.
T)e @u$"n !le$ent in Bud#etin#
2o %"r t)e e$()"sis )"s +een on t)e tec)nic"l "s(ects o% +ud#etin# vi.. t)e
(re("r"tion "nd "d$inistr"tion o% +ud#ets. @o,ever3 t)e +e)"viour"l conte't
deserves $ention. One o% t)e $"in co$(onents o% +ud#etin# is control ,)ic) is
"ll "+out "lterin# t)e +e)"viour o% t)e )u$"n resources in t)e or#"nis"tion.
ConseAuentl&3 t)ere $"& +e so$e st"%% ,)o re#"rd +ud#ets "s " constr"int on
t)eir %reedo$ "nd $"& tr& to su+vert t)e e%%ectiveness o% t)e +ud#et. @o, c"n
senior $"n"#e$ent ensure t)"t t)e +ud#etin# s&ste$ c"n +e $ost e%%ectiveB
Rese"rc) %indin#s "ssert t)"t $"n"#ers (re%er to ,or1 to,"rds "c)ievin#
o+Cectives ,)ic) $otiv"te t)e$. It "((e"rs t)"t $otiv"tion is t)e #lue ,)ic)
)olds t)e +ud#etin# "nd control s&ste$s to#et)er so cre"tin# t)is $otiv"tion is
t)e 1e&. T)ere "((e"r to +e " nu$+er o% %"ctors involved.
29
1 Bud#ets /t"r#ets0 s)ould +e set "t " level ,)ic) "re strin#ent "nd
c)"llen#in# +ut "tt"in"+le. I% set too )i#) to +e un"tt"in"+le t)e st"%% $"&
+e de$or"lised "nd $"& not tr& to "c)ieve t)e t"r#ets.
2 De("rt$ent"l $"n"#ers in consult"tion ,it) t)eir st"%% s)ould +e
(er$itted to ("rtici("te in t)e settin# o% t)eir +ud#ets +& so doin# t)e&
,ill )"ve o,ners)i( o% t)e$ "nd ,ill strive to "tt"in t)e$. 9"rtici("tion
cl"ri%ies res(onsi+ilities3 incre"ses co$$unic"tion t)rou#)out t)e
or#"nis"tion "nd c"n )el( to (ro$ote line*st"%% rel"tions. @o,ever3 it is
,ell to "c1no,led#e (ossi+le d&s%unction"l +e)"viour "s " conseAuence o%
("rtici("tion in +ud#et*settin# suc) "s G+ud#et"r& ("ddin#- or
G+ud#et"r& sl"c1-. It $"& serve t)e $"n"#er to +uild Gsl"c1 into t)e
+ud#et ie. to )"ve " G("d- +et,een t)e %or$"l (l"n "nd t)e e'(ected
"ctu"l results so t)"t t)e& )"ve " cus)ion in c"se un"ntici("ted events
c"use t)eir (er%or$"nce to decline.
3 2ince +ud#ets tend to +e used "s " $"n"#e$ent (er%or$"nce criteri"
t)ere s)ould +e " re,"rd s&ste$ in (l"ce. Too o%ten +ud#ets "re used "s "
$ec)"nis$ to %ocus on (oor (er%or$"nce so is it "n& ,onder t)"t t)e
st"%% )"ve ne#"tive %eelin# "+out t)e$.
7 Overe$()"sis on (er%or$"nce/v"ri"nce re(orts $"& encour"#e ne#"tive
"ttitudes to +ud#etin#. @o(,ood re%erred to t)e G+ud#et constr"ined-
st&le o% $"n"#e$ent ,it) (er%or$"nce in $eetin# t)e +ud#et "s t)e
$"in criteri".
T)e or#"nis"tion s)ould +e concerned ,it) ot)er $"n"#e$ent (er%or$"nce
criteri" suc) "s concern ,it) Au"lit&3 #ood industri"l rel"tions3 coo(er"tion ,it)
colle"#ues etc.
T)ere "re si#ni%ic"nt +ene%its %or or#"nis"tions ,)ic) en#"#e in +ud#etin#.
1 Bud#etin# %orces $"n"#e$ent to %ocus on t)e %uture3 to consider t)e
d&n"$ics o% t)e e'tern"l environ$ent "nd identi%& t)e (otenti"l
o((ortunities "nd t)re"ts.
2 In t)e (rocess o% (re("rin# t)e +ud#ets $"n"#ers "re co$(elled to co*
ordin"te t)e v"rious "ctivities o% t)e or#"nis"tion "nd to +e less
Gde("rt$ent"l $inded- "nd to +e $ore Gco$("n& $inded-.
3 It tends to encour"#e co$$unic"tion t)rou#)out t)e or#"nis"tion. 2t"%%
"re ","re o% ,)"t t)e& "re e'(ected to "c)ieve "nd re#ul"r +ud#et
re(orts "nd +ud#et $eetin#s 1ee( t)e$ in%or$ed.
7 B& "ssi#nin# $"n"#eri"l res(onsi+ilit& %or t)e "tt"in$ent o% t)e +ud#ets
"nd t)e re#ul"r co$("rison o% "ctu"l results "nd e'(ected outco$es
individu"l $"n"#eri"l (er%or$"nce c"n +e "scert"ined.
< Rese"rc) )"s indic"ted t)e role +ud#ets )"ve in $otiv"tin# $"n"#ers to
"c)ieve t)e co$("n&-s o+Cectives. ood (er%or$"nce c"n le"d to c"reer
"dv"nce$ent so t)e $"n"#ers desire to +e success%ul is lin1ed to t)e
success o% t)e co$("n&.
30
IND!2TM!NT A99RAI2AL
M!T@OD2
31
Lesson 7
Most o% t)e decisions $"n"#e$ent )"ve to de"l ,it) "re t"ctic"l "nd s)ort*run
+ut on occ"sion t)e& $"& )"ve to consider " decision t)"t rel"tes to " lon# (eriod
o% ti$e. Once t)e decision is t"1en t)e +usiness )"s to live ,it) it "nd $"& %ind it
di%%icult to disinvest or reverse so " #re"t de"l o% c"re )"s to +e t"1en in t)ese
decisions.. In t)e (l"nnin# (rocess t)e co$("n& $"& )"ve decided to (ersue "
#ro,t) str"te#& so t)ere $"& )"ve to +e invest$ent in c"(it"l (roCects to sust"in
t)e #ro,t) in s"les "nd (roductive c"("cit&. C"(it"l e'(enditure on ne,
+uildin#s3 (l"nt "nd $"c)iner& $"& +e needed %ro$ ti$e to ti$e. A#"in t)e
co$("n& $"& decide r"t)er t)"n #ro, or#"nic"ll& " str"te#& o% $er#er or
t"1eover is +est. =)"tever t)e st"te#& t)e v"rious invest$ent (roCects )"ve to +e
(ro(erl& "((r"ised. C"(it"l (roCects )"ve to c)osen "nd decisions "s to t)e
%in"ncin# o% t)e$ )"s to +e deter$ined.
De%inition4
C"(it"l invest$ent "((r"is"l is t)e (rocess o% ev"lu"tin# t)e cost "nd +ene%its o%
" (ro(osed invest$ent in o(er"tin# "ssets.
T)e "((r"is"l (rocess consists o% $e"surin# t)e in%lo,s o% c"s) "#"inst t)e
out%lo,s o% c"s) ,)ic) "rise "s " conseAuence o% t)e decision.
T)ere "re %ive $"in "((r"is"l tec)niAues4
1 9"&+"c1
T)is tec)niAue considers t)e len#t) o% ti$e it t"1es to recover t)e initi"l
inves$ent outl"& "nd t)e (roCect st"rts to ("& %or itsel%. I% " co$("n& invests
51663666 on " c"(it"l (roCect t)e Auestion is )o, lon# does it t"1e to #et +"c1
51663666 c"s) %ro$ t)e (roCect. C"s) %lo, does not include "n& non*c"s) ite$s
suc) "s de(reci"tion. T)ere%ore3 i% t)e invest$ent returns "re #iven in (ro%it "%ter
de(reci"tion ter$s t)e "nnu"l de(reci"tion is "dded +"c1. Net c"s) %lo, is t)e
di%%erence +et,een c"s) received "nd c"s) ("id durin# " de%ined (eriod o% ti$e.
!'"$(le4
A co$("n& is considerin# investin# in " ne, $"c)ine ,)ic) costs 51663666.
T)e %ollo,in# in%or$"tion is "v"il"+le4
5 5
Initi"l outl"& 1663666
Net c"s) %lo,
He"r 1 263666
He"r 2 363666
He"r 3 763666
He"r < 263666 1163666
******** ********
Net (ro%it"+ilit& 163666
*******
ReAuired4
=)"t is t)e (roCect-s ("&+"c1 (eriodB
T)e (roCect ("&s %or itsel% "%ter 71/2 &e"rs. At t)e end o% t)"t (eriod t)e (roCect
(roduces net c"s) %lo,s o% 51663666 eAu"l to t)e cost o% t)e ori#in"l invest$ent.
32
T)e ("&+"c1 $et)od )"s univers"l "((e"l +ec"use o% its si$(licit& "nd t)e %"ct
t)"t it tends to %"vour less ris1& c"(it"l (roCects. 9roCects t)"t t"1e too lon# to
("& %or t)e$selves "re ris1ier "nd t)is $et)od tends to reCect t)ese.
2 Accountin# r"te o% return
T)is $et)od est"+lis)es t)e rel"tions)i( +et,een t)e c"(it"l cost o% " (roCect "nd
t)e (ro%its "ccruin#. T)e "ccountin# r"te o% return is c"lcul"ted +& t)e %ollo,in#
%or$ul".
Aver"#e "nnu"l (ro%it
******************************* ' 166
Aver"#e cost o% invest$ent
An "ver"#e (ro%it is c"lcul"ted over t)e li%e o% t)e (roCect. T)e "ver"#e cost o%
invest$ent is c"lcul"ted +& "ddin# t)e initi"l cost o% t)e invest$ent "nd t)e v"lue
"t t)e end o% its use%ul li%e divided +& t,o.
!'"$(le4
A co$("n& )"s t,o "ltern"tive (roCects A "nd B3 e"c) involvin# "n outl"& o%
5<663666 "nd 58663666
!"c) (roCect )"s "n econo$ic li%e o% < &e"rs. 9roCect A )"s " residu"l v"lue o%
5<63666. Annu"l (ro%its +e%ore de(reci"tion is 52663666 +e%ore de(reci"tion.
9roCect A 9roCect B
5 5
Initi"l outl"& <663666 8663666
Annu"l (ro%its /Hr. 1*<0 136663666 136663666
Less de(reci"tion /Hr. 1*<0 <663666 <<63666
********** **********
9ro%its "%ter de(reci"tion <663666 7<63666
********* *********
Aver"#e net (ro%it 1663666 >63666
********** ********
Accountin# r"te o% return 76? 2:?
T)e ARR $et)od is e"s& to "d$inister "nd is understood +& +usiness in #ener"l
+ec"use o% is si$il"rit& ,it) t)e return on invest$ent /ROC!0 r"tio.
T)e $"in dis"dv"nt"#e ,it) ("&+"c1 "nd "ccountin# r"te o% return is +ot)
i#nore t)e ti$e v"lue o% $one&. Mone& )"s " v"lue in ti$e3 n"$el&3 " r"te o%
interest. I% 51 is invested %or 1 &e"r "t " r"te o% interest o% 16? t)e invest$ent
#ro,s to 51.16 "t t)e end o% &e"r 1. I% 51.16 is invested in &e"r 2 t)e invest$ent
33
#ro,s to 51.21 "t t)e end o% &e"r 2. T)is (rocess is c"lled compounding ,)ic) is
re(resented +& t)e %or$ul" 51/1 M r0n.
T)e o((osite o% co$(oundin# is discounting. T)is "ns,ers t)e Auestion G ,)"t is
51 receiv"+le in " &e"r-s ti$e ,ort) in tod"&-s v"lueB- In (resent v"lue ter$s 51
receiv"+le in " &e"rs ti$e /"ssu$in# t)e r"te o% interest is 16?0 is 56.>6>. T)e
%or$ul" %or discountin# is4 51
***********
/1 M r0n
Invest$ent "((r"is"l co$("res t)e c"s) out%lo,s ,it) t)e c"s) returns %ro$ t)e
(roCect "nd t)ese c"s) %lo,s t"1e (l"ce over " len#t)& (eriod o% ti$e.
Discountin# "llo,s "ll t)e c"s) %lo,s to +e converted to (resent d"& v"lues ,)ic)
(er$its $e"nin#%ul co$("rison. T)e %ollo,in# invest$ent "((r"is"l $et)ods
e$(lo& t)e discountin# o% c"s) %lo,s.
3 Net 9resent D"lue
A ("rticul"r r"te o% interest is used to discount %uture %lo,s o% c"s) to (resent
v"lues. T)e discount r"te used $i#)t re%lect t)e cost o% o+t"inin# c"(it"l3 or "
t"r#et r"te/cut*o%% r"te3or " ris1*"dCusted r"te. Once t)e %uture c"s) %lo,s "re
discounted to (resent*d"& v"lues t)e& "re tot"lled "nd co$("red ,it) t)e cost o%
t)e (roCect. I% t)e discounted c"s) %lo,s e'ceed t)e cost t)e di%%erence is t)e net
c"s) %lo,. In #ener"l3 i% t)e N9D is (ositive t)e (roCect is ,ort) considerin#.
!'"$(le4
A co$("n& ,is)es to ev"lu"te " c"(it"l (roCect +"sed on t)e %ollo,in#
in%or$"tion. T)e initi"l outl"& is 51663666 "nd t)e (roCect )"s "n econo$ic li%e o%
< &e"rs "nd re"lises 5<3666 ,)en it is sold "t t)e end o% &e"r <. T)e (ro%its "%ter
de(reci"tion )"ve +een esti$"ted "s &e"r 1*3 5163666 "nd 51<3666 in t)e %in"l
t,o &e"rs. T)e r"te o% interest is 16?.
He"r C"s) %lo, Discount %"ctor 9resent v"lue Cu$ul"tive 9D
5 5 5
6 /16636660 1 /16636660
1 2>3666 6.>6> 283381 283381
2 2>3666 6.:28 233><7 <6331<
3 2>3666 6.;<1 223>3> ;332<7
7 373666 6.8:3 233222 >737;8
< 373666 6.821 213117 11;3<>6
8 <3666 6.<87 23:26 1263716
*********
N9D F263716
********
2ince t)eN9D is M52637163 t)e (roCect is ,ort),)ile.
7 Discounted ("&+"c1
In t)e c"lcul"tion o% t)e N9D in t)e (revious e'"$(le " colu$n records t)e
cu$ul"tive (resent v"lue o% t)e c"s) %lo,s. 2ince t)e ("&+"c1 $et)od is
34
criticised %or i#norin# t)e ti$e v"lue o% $one& it is (ossi+le to re$ed& t)is
s)ortco$in# +& usin# t)e discounted c"s) %lo,s to "scert"in t)e ("&+"c1 (eriod.
In t)is e'"$(le3 t)e ("&+"c1 (eriod is Cust over 7&e"rs. T)ere is " s)ort%"ll o%
5<3<27 ,)ic) )"s to +e #ener"ted in &e"r <.
5<3<27 38< d"&s
********* ' F 1; d"&s
511;3<>6
T)e discounted ("&+"c1 (eriod is 7&rs. 1; d"&s.
< Intern"l R"te o% Return
2o$eti$es t)e co$("n& ,is)es to 1no, t)e intern"l r"te o% return /IRR0 ie. t)e
&ield o% " c"(it"l (roCect. T)e co$("n& $"& o(er"te " cut*o%% (oint in res(ect to
(roCects "nd s)ould " (roCect-s &ield +e +elo, t)is t"r#et or t)res)old it ,ill +e
reCected. T)e $et)od is to discount c"s) %lo,s usin# di%%erent discount r"tes until
t)e N9D F 6. At t)"t (oint t)e tot"l (resent v"lue o% t)e c"s) %lo,s is eAu"l to t)e
outl"& on t)e (roCect. T)e discount r"te ,)ic) (roduces " N9D F 6 is t)e intern"l
r"te o% return o% t)e (roCect. In e%%ect3 t)e co$("n& could +orro, $one& "t "
r"te o% interest eAu"l to t)e intern"l r"te o% return to %in"nce t)e (roCect "nd t)e
returns %ro$ t)e (roCect ,ould "llo, t)e co$("n& to +re"1 even. I% t)e
co$("n&-s t"r#et r"te o% return %or c"(it"l (roCects is less t)"n " (roCect-s &ield
/IRR0 t)e (roCect is ,ort) consider"tion.
!'"$(le4
Usin# t)e d"t" %ro$ t)e (revious N9D e'"$(le ,or1 out t)e (roCects IRR.
At " discount r"te o% 16? t)e N9D F M5263716. To (roduce " ne#"tive N9D "
)i#)er discount r"te needs to +e c)osen. T)e $et)od (roceeds on " tri"l "nd
error +"sis. =)"t is t)e result i% " discount r"te o% 26? is used.
He"r C"s) %lo, /50 Discount %"ctor 26? 9resent D"lue /50
6 /16636660 6 /16636660
1 2>3666 6.:33 2731<;
2 2>3666 6.8>7 263128
3 2>3666 6.<;> 183;>1
7 373666 6.7:2 1833::
< 373666 6.762 13388:
8 <3666 6.33< 18;<
********
N9DF * ;327<
*******
To deter$ine t)e discount r"te ,)ic) (roduces N9D F 6 " (rocess o%
inter(ol"tion is used. Altern"tivel&3 it $"& +e solved #r"()ic"ll&.
35
T)e %or$ul" %or inter(ol"tion is4
IRR F A M P " / " *+ Q ' / A * B 0
16? M 5263716
**************** E 26? * 16? F 1;?
/5263716 M 5;327<0
T)e &ield or IRR o% t)e (roCect is 1;?. I% t)is is )i#)er t)"n t)e co$("n&-s
t"r#et r"te %or (roCects it is ,ort) consider"tion.
8 9ro%it"+ilit& Inde'
In t)e c"se ,)ere " co$("n& )"s " nu$+er o% "ltern"tive (roCects "nd )"s
li$ited resources it is use%ul to %ind " ,"& o% r"n1in# t)ese in rel"tion to t)eir
(otenti"l (ro%it"+ilit&. T)e $et)od is to divide t)e discounted c"s) %lo,s +& t)e
initi"l cost o% t)e (roCect.
9ro%it"+ilit& inde' %or (roCect E F 5126716
*********** F 1.2
51663666
For ever& 51 invested 51.2 ,ort) o% c"s) %lo, is #ener"ted.
36
T@! CO2TIN
OF
OD!R@!AD2
37
Lesson < A+sor(tion Costin#
De%inition4 Over)e"ds "re e'(enses ot)er t)"n direct e'(enses. T)e& include
indirect $"teri"ls3 indirect l"+our "nd ot)er indirect e'(enses. T)e (ri$e costs *
direct ,"#es cost "nd t)e cost o% $"teri"ls consu$ed c"n +e e"sil& "scert"ined
"nd c)"r#ed to " Co+ or (rocess. @o,ever3 $"n& costs "re incurred so t)"t t)e
+usiness c"n o(er"te e#. rent3 r"tes3 de(reci"tion3 )e"t "nd li#)t etc. T)e
tec)niAue %or c)"r#in# over)e"ds to (roducts3 Co+s or (rocesses is c"lled
"+sor(tion costin#. A+sor(tion costin# is concerned ,it) t)e t&(e "nd n"ture o%
costs r"t)er t)"n cost +e)"viour.
T)ere "re t,o $"in (ur(oses o% "+sor(tion costin#4
/10 to "scert"in t)e cost o% " (roduct3 Co+ or (rocess.
/20 to "ssist +usiness ,it) t)eir (ricin# * " cost (lus "((ro"c).
Cost "n"l&sis consists o% t)e %ollo,in# co$(onents
Direct $"teri"ls E
M Direct l"+our E
M Direct e'(ense E
********
9ri$e cost E
M 9roduction over)e"ds E
*******
9roduction cost E
M 2ellin# R Distri+ution over)e"ds E
M Ad$inistr"tion over)e"ds E
********
Tot"l cost E
*********
It is rel"tivel& e"s& to "scert"in t)e (ri$e cost "s t)e& "re closel& identi%ied ,it)
t)e %in"l (roduct. @o,ever it is $ore di%%icult to rel"te t)e indirect costs * t)e
over)e"ds to t)e (roduct. A+sor(tion costin# is "n "tte$(t to "c)ieve t)is so t)"t
over)e"s c"n +e c)"r#ed to (roducts.
T)ere "re t)ree st"#es in t)e "+sor(tion costin# (rocess* "lloc"tion3
"((ortion$ent "nd "+sor(tion.
Alloc"tion is t)e (rocess o% loc"tin# over)e"ds ,)ic) c"n +e identi%ied ,it) "
("rticul"r cost centre in t)"t cost centre. Over)e"d ite$s ,)ic) c"nnot +e
identi%ied ,it) " cost centre +ut "re incurred %or t)e +ene%it o% t)e entire +usiness
$ust +e s)"red out or "((ortioned "cross " nu$+er o% cost centres. I% t)ere "re
over)e"ds loc"ted in non*(roduction or service cost centres t)e& $ust +e re*
"((ortioned to (roduction cost centres. Fin"ll&3 ,)en "ll t)e (roduction
over)e"ds "re loc"ted in (roduction cost centres t)e %in"l st"#e o% "+sor+in# or
recoverin# t)e over)e"ds "nd c)"r#in# t)e$ to " (roduct3 Co+ or (rocess.
!'"$(le4
38
T)e %ollo,in# cost ite$s )"ve +een identi%ied in " co$("n& ,it) t,o cost centres
De(ts. A R B. T)e %loor "re" o% De(t. A is 23666 sA. %t. "nd De(t. B is 13666 sA. %t.
T)e v"lue o% $"c)iner& used in De(t. A is 513666 "nd 57666 in De(t. B.
2"l"ries o% su(ervisors in De(t. A 5763666
Indirect $"teri"ls used in De(t. B 53<3666
Rent R R"tes 5363666
Li#)t R @e"t 51<3666
Insur"nce o% $"c)iner& 5<3666
***********
512<3666
***********
Over)e"d B"sis De(t. A De(t. B Tot"l
2"l"ries Alloc"te 5763666 5763666
Ind. $"teri"ls Alloc"te 53<3666 53<3666
Rent R R"tes Floor "re" 5263666 5163666 5363666
Li#)t R @e"t Floor "re" 5163666 5<3666 51<3666
Insur"nce D"lue o% M"c). 513666 573666 5<3666
********** ********** ***********
5;13666 5<73666 512<3666
********** ********** ***********
In "((ortionin# costs " suit"+le +"sis is used e#. %loor "re" is used to divide t)e
rent o% t)e %"ctor& +et,een t)e t,o cost centres. T)e %ollo,in# +"ses o%
"((ortion$ent is use%ul in de"lin# ,it) cert"in over)e"d cost ite$s.
Over)e"d cost ite$ B"sis
Rent R R"tes3 Li#)t R @e"tin# Floor "re" o% cost centre
De(reci"tion3 insur"nce o% $"c)iner& Ori#in"l cost or +oo1 v"lue
9o,er costs @orse (o,er o% $"c)iner&
C"nteen e'(enses Nu$+er o% e$(lo&ees in cost centre
M"inten"nce costs %or (re$ises Floor "re"
Once over)e"ds "re "lloc"ted "nd "((ortioned "$on# " nu$+er o% cost centre i% t)ere
"re "n& over)e"ds loc"ted in non*(roduction cost centres t)ese )"ve to +e re$oved "nd
re*"((ortioned to t)e (roduction de("rt$ents.
!'"$(le4
A co$("n& )"s t)e %ollo,in# distri+ution o% over)e"ds in t,o (roduction
de("rt$ents A "nd B "nd t,o service de("rt$ents3 " stores "nd " $"inten"nce
de("rt$ent. ReAuisitions %ro$ t)e stores +& De(ts. A "nd B "re 513666 "nd 5<66
res(ectivel&. T)e $"inten"nce (ersonnel s(end t)ree*Au"rters o% t)eir ti$e in
De(t. A "nd t)e re$"inder in De(t. B.
Over)e"d De(t. A De(t. B 2tores C"nteen
5 5 5 5
Alloc"ted R A((ortioned 163666 <3666 33666 73666
Re"((ortion 2tores costs 23666 1666 ***
39
Re"((ortion M"inten"nce costs 33666 13666 ***
********* ******** ******** *******
1<3666 ;3666 6 6
******** ******* ******* *******
In t)e "+sor(tion st"#e "n over)e"d recover& /"+sor(tion0 r"te /OAR0 is
c"lcul"ted. T)e %or$ul" used is4
Bud#eted 9roduction Over)e"ds
OAR F ********************************************
2uit"+le +"sis
A nu$+er o% +"ses c"n +e used to co$(ute "n over)e"d r"te e#. l"+our cost
(ercent"#e3 $"teri"l cost (ercent"#e3 (ri$e cost (ercent"#e "nd cost units.
ener"ll&3 +usinesses use "n "ctivit& r"te to recover over)e"ds. T)is r"te is
usu"ll& l"+our )ours or i% "((ro(ri"te $"c)ine )ours. 2ince $"n& o% t)e
over)e"ds "rise "s " conseAuence o% t)e e$(lo&$ent o% l"+our or t)e use o%
$ec)"nis"tion it "((e"rs re"son"+le to e$(lo& one or ot)er o% t)ese +"ses.
!'"$(le4
Lets "ssu$e De(t. A is " $ec)"nised o(er"tion "nd )"s 363666 $"c)ine )ours
,)ere"s De(t. B )"s onl& 73666 $"c)ine )ours. L"+our )ours in De(t. A is <3666
"nd is 3<3666 l"+our )ours. Over)e"ds in De(t. A is 51<3666 "nd 5;3666 in
De(t.B.
De(t. A 51<3666
OAR F ************ F 56.<6 (er $"c)ine
)r.
363666 $"c)ine )rs.
De(t. B 5;3666
OAR F ************* F 56.26 (er l"+our
)r.
3<3666 l"+our )rs.
40
!'"$(le4 T)e co$("n& $"1es t,o (roducts E "nd H. T)e %ollo,in# in%or$"tion
is "v"il"+le4
9roduct E 9roduct H
5 5
Direct $"teri"ls 16 12
Direct l"+our 12 17
/="#e r"te 52 (er )r.0
M"c)ine )ours in
De(t. A 7 8
ReAuired4 C"lcul"te t)e (roduction cost o% t)e t,o (roducts.
9roduct E 9roduct H
5 5
9ri$e cost 22.66 28.66
M 9roduction over)e"ds
De(t. A /7 )rs. ' 6.<60 2.66 /8 )rs. ' 6.<60 3.66
De(t. B /8 )rs. ' 6.260 1.26 /; )rs. ' 6.260 1.76
********* **********
23.26 36.76
********* *********
41
Lesson 8 Activit& B"sed Costin#
In recent &e"rs t)ere )"s +een criticis$ o% t)e tr"dition"l s&ste$ o% costin# %or
over)e"ds / I"(l"n R Coo(er 0. Tr"dition"l cost s&ste$s ,ere desi#ned ,)en4
direct costs ,ere t)e do$in"nt %"ctor& costsO
over)e"d costs ,ere rel"tivel& s$"llO
in%or$"tion (rocessin# costs ,ere )i#)O
t)ere ,"s " l"c1 o% intense #lo+"l co$(etitionO
" li$ited r"n#e o% (roducts ,"s (roduced.
Tr"dition"l (roduct costin# $e"sures "ccur"tel& volu$e*rel"ted resources e#.
direct costs +ut t)e& %"il to $e"sure t)e ,"& (roducts consu$e non*volu$e
rel"ted "ctivities e#. su((ort services li1e $"teri"l )"ndlin#3 set*u( costs3
ins(ection costs. Resources "re used u( ,)en t)ese "ctivities "re tri##ered +&
(roduction. It is t)e (roducts ,)ic) c"use t)ese "ctivities to "rise "nd ABC
"tte$(ts to tr"ce t)e consu$(tion o% t)ese "ctivities +& t)e v"rious (roducts.
9roducts ,)ic) de$"nd " lot o% "ctivities "nd resources "re "lloc"ted "n
"((ro(ri"te s)"re o% t)e over)e"ds. For e'"$(le3 " ne, (roduct ,ill (ro+"+l& +e
lo, volu$e initi"ll&3 reAuirin# " lot o% $"c)ine set*u(s3 Au"lit& testin# etc. so it
s)ould +e"r t)e over)e"ds it is c"usin# to +e cre"ted.
!'"$(le4 T,o (roducts A "nd B "re (roduced / <666 units o% A "nd 7<666 units
o% B0. !"c) (roduct reAuires t)e s"$e nu$+er o% $"c)ine/direct l"+our )ours.
Nu$+er o% set*u(s4 A F 16 B F <
T)e cost o% set*u(s is 51.2$.
A+sor(tion costin#4
9roduct A F 51263666 /16? o% 51.2$.0 / <666units F 527 (er unit
9roduct B F 51.6:$ />6? o% 51.2$.0 / 7<3666 units F 527 (er unit
ABC s&ste$4
9roduct A F 5:663666 /16/1< ' 51.2$0 / <3666 units F 5186 (er unit
9roduct B F 57663666 /</1< ' 51.2$0 / 7<3666 units F 5:.:> (er unit
2ince (roduct A3 t)e lo, volu$e (roduct is res(onsi+le %or t)e #re"ter s)"re o%
t)e set*u( costs it is onl& ri#)t t)"t it "ttr"cts $ost o% t)is over)e"d. It is t)e
nu$+er o% set*u(s t)"t is t)e cost driver. T)e tr"dition"l costin# s&ste$ tends to
overcost )i#) volu$e (roducts "nd undercost lo,*volu$e +ut co$(le' (roducts.
De%inition4 Activit& +"sed costin# /ABC0 is concerned ,it) Gcost "ttri+ution to
cost units on t)e +"sis o% +ene%it received %ro$ direct "ctivities e#. orderin#3 set*
u(3 "ssurin# Au"lit&-.
ABC st"tes t)"t "ctivities c"use costs "nd (roducts/cost units consu$e t)e
"ctivities. It is used +& $"n"#e$ent to deter$ine t)e $ost (ro%it"+le (roducts
"nd to "((reci"te t)e cost i$(lic"tions o% t)e o(er"tion"l "ctivities ,it)in t)e
+usiness. It #ets $"n"#e$ent to underst"nd ,)"t c"uses costs. T)e tec)niAue
uses cost drivers to "ttri+ute costs to "ctivities "nd cost o+Cects. T)us3 over)e"ds
c"n +e rel"ted to t)e "ctivities ,)ic) c"use t)e$.
ABC divides "ctivities into %our c"te#ories4
42
1 Unit level "ctivities ,)ic) "rise e"c) ti$e " (roduct is $"nu%"ctured e#.
$"c)ine (o,er3 de(reci"tion o% $"c)iner& etc.
2 Tr"ns"ction level "ctivities ,)ic) "rise e"c) ti$e " tr"ns"ction )"((ens
e#. Au"lit& control3 ins(ection costs3 set*u( costs etc.
3 9l"nt level "ctivities ,)ic) rel"te to costs "risin# %ro$ t)e $"inten"nce
"nd o(er"tion o% t)e +usiness %"cilities.
In "+sor(tion costin# over)e"ds "re "ssi#ned to cost centres "nd c)"r#ed to cost
units +& usu"ll& " volu$e*+"sed $e"sure suc) "s $"c)ine or l"+our )ours
,)ere"s ABC uses " t,o*%old "((ro"c) +& loc"tin# costs in cost (ools "nd
identi%&in# cost drivers to %"cilit"te "ssi#nin# costs to cost units.
In (roduct costin# it is rel"tivel& e"s& to c)"r#e direct costs to cost units +ut t)e
(ro+le$ "rises in rel"tion to indirect costs/over)e"ds0. Over)e"d costs/resource
costs0 suc) "s rent3 r"tes3 $"inten"nce costs3 cle"nin# $"teri"ls etc. ,)ic) c"n +e
identi%ied ,it) " ("rticul"r cost (ool "re loc"ted t)ere. Ot)er over)e"ds ,)ic)
c"nnot +e identi%ied ,it) " cost (ool "re "((ortioned to t)e cost (ools +& $e"ns
o% cost drivers ,)ic) "re t)e $"in deter$in"nts o% t)e cost o% "ctivities. T)ese
over)e"ds "re (re*deter$ined in t)"t t)e& "re ("rt o% t)e +ud#etin# (rocess.
T)ese cost drivers $i#)t include t)e nu$+er o% (roduction runs3 t)e nu$+er o%
custo$er orders received3 t)e nu$+er o% Au"lit& control tests3 etc.
Activit& cost (ool Activit& cost driver
Advertisin# T)e v"lue o% s"les in e"c) s"les "re"
Ku"lit& control T)e nu$+er o% Au"lit& tests
9urc)"sin# T)e nu$+er o% (urc)"se orders
2et*u( costs T)e nu$+er o% set*u(s/(roduction runs
2tores T)e nu$+er o% $"teri"l reAuisitions
Des("tc) T)e nu$+er o% des("tc) notes
=)en t)e over)e"ds "re loc"ted in t)e cost (ools "n "ver"#e cost (er tr"ns"ction
is c"lcul"ted +& dividin# t)e tot"l cost o% "n "ctivit& +& t)e nu$+er o%
tr"ns"ctions (er%or$ed. T)is "ver"#e cost is t)en used to to c)"r#e e"c) (roduct
,it) t)e "$ount o% service de$"nded %ro$ e"c) "ctivit& cost (ool. ConseAuentl&3
(roducts "re c)"r#ed ,it) " %"irer s)"re o% t)e over)e"ds t)e& )"ve )el(ed to
cre"te. T)e result is $ore "ccur"te (roduct costin#3 +etter decision*$"1in# in
res(ect to t)e (roduct out(ut $i' "nd (roduct (ricin#.
!'"$(le4
T)e ABC co$("n& (roduces t,o (roducts E "nd H "nd t)e %ollo,in#
in%or$"tion is #iven4
9roduct E 9roduct H Tot"l
9roduction "nd 2"les /units0 2<3666 <3666 363666
******** ******* ********
Unit cost /50
Direct l"+our 2< 26
Direct $"teri"ls 1< <
O(er"tin# d"t"
M"c)ine )ours 1 2
L"+our r"te (er )our /50 1 1
Nu$+er o% set*u(s 7 26
Nu$+er o% ins(ections 76 :6
43
Over)e"ds
9roduction (rocessin# 5;663666
2et*u( 51263666
Ins(ections 51:63666
ReAuiredO
C"lcul"te t)e (roduct costs usin# /"0 A+sor(tion costin# /+0 ABC.
/"0 Assu$in# t)e over)e"ds "re "+sor+ed on t)e +"sis o% direct l"+our )ours.
Bud#eted over)e"ds 5136663666
OAR F *************************** F ************* F 52.<6 (er )our
L"+our )ours 7663666
All (roduction over)e"ds "re loc"ted in one cost (ool. T)e unit costs o% (roducts
E "nd H "re4
5 5
E H
Direct l"+our 1<.66 <.66
Direct $"teri"ls 2<.66 26.66
Over)e"d /2.<6 (er d.l.).0 3;.<6 12.<6
******* ********
;;.<6 3;.<6
******* *******
/+0 In ABC t)ree cost (ools "re identi%ied vi.. (roduction (rocessin#3 set*u( "nd
ins(ection costs. T)e cost drivers "re "lso identi%ied e#.
Cost Driver B"sis
9roduction (rocessin# Nu$+er o% $"c)ine )ours
M"c)ine set*u(s Nu$+er o% $"c)ine set*u(s
Ins(ections Nu$+er o% ins(ections
T)e over)e"ds (er cost (ool "nd t)e r"te (er cost driver "re co$(uted.
9roduction (rocessin# costs4
9roduction over)e"d 5;663666
***************************** F ************ F 526 (er $"c).)r.
M"c)ine )ours 3<3666
2et*u( costs4
Cost (er set*u( 2et*u( cost 51263666
**************** F ************ F 5<3666 (er set*u(.
No. o% set*u(s 27
Ins(ection cost4
44
Cost (er ins(ection Ins(ection cost
******************* F 51:63666 F 513<66 (er
No. o% ins(ections
T)e %in"l st"#e o% t)e (rocess is to use t)e cost driver r"tes to "ssi#n over)e"d
cost to (roducts.
E H
5 5
Direct l"+our 1<.66 <.66
Direct $"teri"ls 2<.66 26.66
9roduction over)e"d /10 26.66 76.66
2et*u( costs /20 6.:6 26.66
Ins(ection /30 2.76 27.66
****** *******
83.26 16>.66
******* *******
1 E F526 ' 1 $"c)ine )r. F526O H F 526 ' 2 $"c)ine )ours F 576
2 E F /5<3666 ' 7 set*u(s0/23<66 units F :6(O H F /5<3666 ' 26 set*u(s0/<3666
units F 526
3 E F /513<66 ' 76 ins(ections0/ 2<3666 units F 52.76O H F /513<66 ' :6
ins(ections0/ <3666 units F 527
T)e co$("rison o% t)e t,o "((ro"c)es is #iven4
9roduct E 9roduct H
A+sor(tion costin# 5;;.<6 53;.<6
ABC 83.26 516>.66
Adv"nt"#es o% ABC
1
2 It reco#nises t)e re"lit& in "dv"nced $"nu%"cturin# environ$ents t)"t
over)e"ds "re not rel"ted to direct l"+our since t)e (ro(ortion o% direct
l"+our costs is s$"ll in t)e tot"l costs o% " (roduct. Inste"d "ctivities c"use
over)e"ds.
3 Tr"dition"l costin# s&ste$s tend to underst"te t)e over)e"d cost o% " lo,
volu$e co$(le' (roduct "nd overst"te t)e over)e"d cost o% " )i#) volu$e
(roduct. ABC tends to "lloc"te over)e"ds to (roducts ,)ic) consu$e
"ctivities ,)ic) in turn c"use t)e over)e"ds to "rise.
7 2ince ABC (roduces $ore "ccur"te (roduct costs3 decisions t"1en +&
$"n"#e$ent "re +etter in%or$ed e#. (ricin# decisions.
< More "ccur"te (roduct (ro%it"+ilit& "n"l&sis c"n +e (roduced.
8 It cre"tes "n ","reness o% t)e v"rious "ctivities t)"t t"1e (l"ce in "n
or#"nis"tion "nd %ocuses on non*v"lue "dded "ctivities to "scert"in
,)et)er t)e& "re needed or not.
45
2TANDARD CO2TIN
46
Lesson ; 2t"nd"rd Costin#
2t"nd"rd costin# is " $"n"#e$ent control s&ste$ ,)ic) is to +e %ound in
$"nu%"cturin# industr& in ("rticul"r. Nust li1e +ud#et"r& control3 st"nd"rd
costin# is "lso ("rt o% t)e control s&ste$. Bot) use v"ri"nce "n"l&sis. 2t"nd"rd
costin# is " unit"r& conce(t ie. it uses st"nd"rd $"teri"l cost or st"nd"rd l"+our
cost. Bud#etin#3 on t)e ot)er )"nd uses t)ese unit st"nd"rd costs to co$(ile tot"l
costs e#. $"teri"l costs or l"+our costs.
D"ri"nces re(resent t)e di%%erences +et,een st"nd"rd costs "nd "ctu"l costs. T)e
st"nd"rd cost is ,)"t t)e cost is esti$"ted to +e "nd t)is is co$("red to ,)"t t)e
cost is "ctu"ll&.
D"ri"nces "re cl"ssi%ied "s %"vour"+le i% t)e "ctu"l costs "re less t)"n t)e
st"nd"rd costs "nd (ro%it is incre"sed "s " conseAuence. Adverse v"ri"nces
decre"se (ro%its. 2o$e v"ri"nces $"& +e controll"+le i% t)e individu"l $"n"#er
c"n in%luence t)e "ctu"l costs.
2o$e or#"nis"tions o(er"te on t)e (rinci(le o% management b! exception. T)e
"ccount"nt (resents "n e'ce(tion re(ort ,)ic) )i#)li#)ts t)e si#ni%ic"nt
v"ri"nces. T)is $e"ns $"n"#e$ent need onl& investi#"te cert"in v"ri"nces ,)ic)
lie outside set toler"nce levels.
A 2t"nd"rd cost is de%ined "s G " (re*deter$ined cost c"lcul"ted in rel"tion to "
(rescri+ed set o% ,or1in# conditions3 correl"tin# tec)nic"l s(eci%ic"tions "nd
scienti%ic $e"sure$ents o% $"teri"ls "nd l"+our to t)e (rices "nd ,"#e r"tes
e'(ected to "((l& durin# t)e (eriod to ,)ic) t)e st"nd"rd cost is e'(ected to
rel"te3 ,it) "n "ddition o% "n "((ro(ri"te s)"re o% +ud#eted over)e"d-. It is "
cost ,or1ed out in "dv"nce o% (roduction o% t)e e'(ected cost o% " (roduct or
service.
Adv"nt"#es o% 2t"nd"rd costin#
1 It (rovides $"n"#e$ent ,it) " consistent $et)od o% co$("rin# "ctu"l
(er%or$"nce ,it) (l"nned (er%or$"nce.
2 It (rovides " $e"ns o% ensurin# t)"t (rodution resources "re (urc)"sed
"nd used e%%icientl&.
3 In est"+lis)in# st"nd"rds $"n"#e$ent c"n e'"$ine "nd "((r"ise e'istin#
(r"ctices "nd (rocedures to ensure cost*e%%ectiveness "nd e%%icienc&.
7 It c"n inculc"te cost*conciousness in t)e st"%%.
< It )el(s to $otiv"te st"%% +& settin# re"listic st"nd"rds.
8 Usin# v"ri"nce "n"l&sis (er%or$"nce c" +e $onitored "nd i$(rove$ents
in ,or1 $et)ods c"n result.
T&(es o% 2t"nd"rd
47
Ide"l st"nd"rd * "ssu$es (er%ect (roduction conditions ,it) no $ec)"nic"l
%"ilure3 no stoc1*outs3 no st"%% "+senteeis$ etc. It is un"tt"in"+le +ut is "n
indic"tion o% ,)"t to strive %or.
Att"in"+le st"nd"rd * is " re"listic t"r#et "nd is +"sed on e%%icient ,or1in#
conditions ,it) "llo,"nce $"de %or $"c)ine +re"1do,n 3 stoc1outs etc.
B"sic st"nd"rd * is " st"nd"rd set %or use over " lon# (eriod o% ti$e "nd is
used to co$("re ,it) current st"nd"rds to to see t)e e%%ect o% c)"n#es in
conditions over t)e &e"rs.
Current st"nd"rd * is set to re%lect current conditions so )"s li$ited use in
ti$e. In ti$es o% in%l"tion suc) st"nd"rds $"& +e set $ont)l&.
D"ri"nce An"l&sis
Direct M"teri"l D"ri"nce
T)e $"in re"son %or "ctu"l "nd esti$"ted costs +ein# di%%erent "re eit)er "
c)"n#e in t)e (rice o% $"teri"ls or " c)"n#e in t)e us"#e o% $"teri"l.
1 M"teri"ls (rice v"ri"nce is t)e di%%erence in cost t)"t results %ro$ t)e
(rice +ein# di%%erent to t)e st"nd"rd.
/ 2t"nd"rd (rice * Actu"l (rice 0 ' Actu"l $"teri"l us"#e
2 M"teri"ls us"#e v"ri"nce is t)e di%%erence +et,een t)e "ctu"l us"#e o%
$"teri"l "nd t)e st"nd"rd us"#e $ulti(lied +& t)e st"nd"rd (rice.
/ Actu"l us"#e * 2t"nd"rd us"#e 0 ' 2t"nd"rd (rice
3 Tot"l $"teri"l v"ri"nce F Actu"l M"teri"l cost * 2t"nd"rd M"teri"l cost
Direct L"+our D"ri"nces
1 L"+our r"te v"ri"nce is t)e di%%erence +et,een t)e "ctu"l ,"#e r"te "nd
t)e st"nd"rd r"te o% ("& ti$es t)e "ctu"l )ours ,or1ed.
/ Actu"l * 2t"nd"rd r"te o% ("& 0 ' Actu"l )ours ,or1ed
2 L"+our e%%icienc& v"ri"nce is t)e di%%erence +et,een t)e "ctu"l )ours
,or1ed "nd t)e st"nd"rd )ours ie. t)e )ours t)"t s)ould )"ve +een
,or1ed to (roduce t)e "ctu"l out(ut.
/ Actu"l )ours * 2t"nd"rd )ours 0 ' 2t"nd"rd r"te o% ("&
3 Tot"l l"+our v"ri"nce F Actu"l L"+our cost * 2t"nd"rd L "+our cost
48
D"ri"+le Over)e"d D"ri"nces
1 T)e v"ri"+le over)e"d v"ri"nce is t)e di%%erence +et,een t)e v"ri"+le
over)e"d cost "ctu"ll& incurred "nd t)e cost ,)ic) s)ould )"ve +een
incurred %or t)e "ctu"l )ours ,or1ed. T)is "ssu$es t)"t v"ri"+le
over)e"ds "re directl& "ttri+ut"+le to l"+our )ours.
2
Actu"l e'(enditure * / 2t"nd"rd )ours ,or1ed ' D"ri"+le Over)e"d r"te 0
2 T)e v"ri"+le over)e"d e%%icienc& v"ri"nce is t)e di%%erence +et,een t)e
"$ount o% over)e"ds recovered +"sed on t)e st"nd"rd )ours o%
(roduction "nd t)e "$ount ,)ic) s)ould )"ve +een recovered i% t)e
"ctu"l )ours ,or1ed )"d +een "t st"nd"rd e%%icience&.
/ Actu"l )rs. ,or1ed * 2t"nd"rd )rs. ,or1ed 0 ' D"ri"+le Over)e"d r"te
3 Tot"l D"ri"+le O-@ D"ri"nce F Actu"l D"ri"+le O-@ cost * 2t"nd"rd
D"ri"+le O-@ cost
Fi'ed Over)e"d D"ri"nces
1 T)e %i'ed over)e"d e'(enditure v"ri"nce is t)e di%%erence +et,een t)e
e'(enditure "ctu"ll& incurred "nd t)"t "ctu"ll& +ud#eted.
Actu"l e'(enditure * Bud#eted e'(enditure
2 T)e %i'ed over)e"d volu$e v"ri"nce $e"sure t)e "$ount o% "n& under or
over recover& o% over)e"ds due to "ctu"l out(ut / $e"sure in ter$s o%
st"nd"rd )ours o% "ctu"l (roduction 0 +ein# di%%erent to t)"t +ud#eted.
Tot"l Fi'ed Over)e"d D"ri"nce F Actu"l Cost * 2t"nd"rd Cost
2"les D"ri"nces
1 T)e s"les $"r#in (rice v"ri"nce #ives t)e e%%ect on (ro%its o% " c)"n#e in
sellin# (rice.
/ Actu"l (rice * 2t"nd"rd (rice 0 ' 2"les volu$e
2 T)e s"les $"r#in Au"ntit& v"ri"nce is t)e di%%erence in (ro%it ,)ic)
results %ro$ " c)"n#e in t)e s"les volu$e.
/ Actu"l s"les * Bud#eted s"les 0 ' 2t"nd"rd (ro%it $"r#in
3 Tot"l 2"les D"ri"nce F Actu"l 2"les * 2t"nd"rd 2"les
49
9ro+le$s ,it) 2t"nd"rd Costin#
1 2t"nd"rd settin# is " len#t)& "nd costl& (rocedure.
2 2t"nd"rds "re o%ten seen +& t)e st"%% "s restrictions on t)eir +e)"viour
,)ic) c"n le"d to d&s%unction"lis$.
3 Re(ortin# v"ri"nces $"& not +e ti$el&3 cost e%%ective "nd encour"#e
$"n"#eri"l res(onse.
7 2t"nd"rds inv"ri"+l& (roduce v"ri"nces so$e o% ,)ic) $"& not +e
controll"+le e#. $"teri"l (rices ,)ic) c"n result in unnecess"r& re(ortin#
"nd investi#"tion.
< 2t"nd"rd costin# $"& +e in"((ro(ri"te %or cert"in 1inds o%
$"nu%"cturin# e#. Nust*in* Ti$e.
!'"$(le
A co$("n& E Ltd. (roduces " sin#le (roduct. T)e st"nd"rd cost (er unit "nd t)e
"ctu"l results %or " 7 ,ee1 (eriod "re "s %ollo,s4
2t"nd"rd Costs Actu"l Costs
5 5
Direct M"teri"ls /1 1ilo0 16 2"les 31>3666
Direct L"+our /2 )ours0 16 Direct M"teri"ls
D"ri"+le Over)e"ds 2 113266 1ilos J 5>.: 16>3;86
Fi'ed Over)e"ds < Direct L"+our
213666 )ours J 5< 16<3666
2t"nd"rd Cost
**************
2;
D"ri"+le Over)e"ds 213<66
2t"nd"rd M"r#in 3
**************
*
Fi'ed Over)e"ds <23666
**************
2t"nd"rd 2ellin# 9rice 36
**************
*
Net 9ro%it 363;66
***************
Bud#et out(ut %or t)e $ont) 163666
units
Actu"l out(ut 113666 units
50
2olution
M"teri"ls 9rice D"ri"nce
/ 29 * A9 0 ' AK
/ 516 * 5>.:60 ' 113266 1ilos F 52276 /F0
M"teri"ls Us"#e D"ri"nce
/ 2K * AK 0 ' 29
/ 116661 * 112661 0 ' 516 F 52666 /A0
L"+our r"te v"ri"nce
/ 2R * AR 0 ' A@
/ 5< *5< 0 ' 21666)rs. F 6
L"+our e%%icienc& v"ri"nce
/ 2@ * A@ 0 ' 2R
/ 22666)rs. * 21666)rs. 0 ' 5< F 5<666 /F0
D"ri"+le Over)e"d D"ri"nce
/ Actu"l e'(enditure * / @rs. ,or1ed ' DOAR0
/ 521<66 * / 21666)rs. ' 51 0 F 5<66 /A0
D"ri"+le over)e"d e%%icienc& v"ri"nce
Over)e"d "ctu"ll& recovered * Over)e"d recovered "t st"nd"rd l"+our e%%icienc&
/22666 ' 51 * 21666' 510 F 51666 /F0
Fi'ed over)e"d e'(enditure v"ri"nce
/ Bud#eted e'(enditure * Actu"l e'(enditure 0
/ 5<6666 * 5<2666 0 F 5 2666 /A0
Fi'ed over)e"d volu$e v"ri"nce
/ Bud#eted out(ut * Actu"l out(ut 0 ' FOAR
/ 26666)rs. * 22666)rs. 0 ' 52.<6S F 5<666 /F0
Fi'ed over)e"d "+sor(tion r"te o% 5< is eAuiv"lent to 52.<6 (er )our.
2"les $"r#in (rice v"ri"nce
/ 2t"nd"rd sellin# (rice * Actu"l (rice 0 ' 2"les volu$e
/ 536 * 52> 0 ' 11666 F 511666 /A0
2"les $"r#in Au"ntit& v"ri"nce
/ Actu"l s"les * Bud#eted s"les 0 ' 2t"nd"rd $"r#in
/ 11666 units * 16666 units 0 ' 53 F 53666 /F0
51
R!29ON2IBILITH
ACCOUNTIN
Res(onsi+ilit& Accountin# descri+es t)e decentr"lis"tion o% "ut)orit& ,it) (er%or$"nce o% t)e
decentr"lised units $e"sured in ter$s o% "ccountin# results.
52
Res(onsi+ilit& Accountin# reco#nises v"rious decision centres t)rou#)out "n
or#"nis"tion "nd tr"ce costs3 revenues3 "ssets "nd li"+ilities to t)e individu"l
$"n"#ers ,)o "re res(onsi+le %or $"1in# decisions "+out t)e costs in Auestion.
It is " G s&ste$ o% "ccountin# t)"t se#re#"tes revenues "nd costs into "re"s o%
(erson"l res(onsi+ilit& in order to "ssess t)e (er%or$"nce "tt"ined +& (ersons to
,)o$ "ut)orit& )"s +een "ssi#ned-.
Accountin# re(orts "re (rovided so t)"t ever& $"n"#er is ","re o% "ll t)e ite$s
,)ic) "re ,it)in )is/)er "re" o% "ut)orit& so t)"t )e is in " (osition to e'(l"in
t)e$.
T)ere "re t)ree res(onsi+ilit& centres or units. A res(onsi+ilit& centre is- " unit
or %unction o% "n or#"nis"tion )e"ded +& " $"n"#er )"vin# direct res(onsi+ilit&
%or its (er%or$"nce-.
T&(e o% unit M"n"#er )"s control over 9er%or$"nce Me"sure$ent
Cost centre Controll"+le costs D"ri"nce An"l&sis3
!%%icienc& $e"sures
9ro%it centre Controll"+le costs 9ro%it
2"les volu$e/(rices
Invest$ent
centre
Controll"+le costs Return on Invest$ent
2"les Residu"l Inco$e
Invest$ent in %i'ed/ =C
"ssets
Ot)er %in"nci"l r"tios
Cost centre4 G" loc"tion %unction or ite$ o% eAui($ent in res(ect o% ,)ic) costs
$"& +e "scert"ined "nd rel"ted to cost units %or control (ur(oses-.
9ro%it centreO G" se#$ent o% t)e +usiness entit& +& ,)ic) +ot) revenues "re
received "nd e'(enditures "re c"used or controlled3 suc) revenues "nd
e'(enditure +ein# used to ev"lu"te se#$ent"l (er%or$"nceT-
T)e $"n"#er o% " (ro%it centre is $"de "ccount"+le "nd res(onsi+le %or t)e
(ro%its "c)ieved. T)e $"n"#er s)ould +e "+le to $"1e decisions ,)ic) $"&
i$(rove (ro%it"+ilit&. In or#"nis"tions ,)ere (o,er is centr"lised t)e individu"l
$"n"#er $"& not )"ve "utono$& to $"1e t)ese decisions.
Invest$ent centre4 G " (ro%it centre in ,)ic) in(uts "re $e"sured inter$s o%
e'(enses "nd out(uts "re $e"sured in ter$s o% revenues "nd in ,)ic) "ssets
e$(lo&ed "re $e"sured U t)e e'cess o% revenue over e'(enditure t)en +ein#
rel"ted to "ssets e$(lo&ed-.
T)e invest$ent centre or division"l $"n"#er is "llo,ed discretion "+out t)e
"$ount o% invest$ent undert"1en +& t)e division so (ro%it $e"sure$ent "lone is
not su%%icient to $e"sure (er%or$"nce. 9ro%it s)ould +e rel"ted to t)e c"(it"l
e$(lo&ed in t)e division.
53
Division"l M"n"#e$ent 9er%or$"nce
T)ere "re t,o $"in (er%or$"nce $e"sures %or divisions U Return on C"(it"l !$(lo&ed or
Risidu"l Inco$e.
ROC! or ROI is " rel"tive st"tistic it loo1s "t t)e rel"tions)i( +et,een (ro%it"+ilit& "nd c"(it"l
e$(lo&ed.
Net 9ro%it/ Net Invest$ent in Assets
ROI c"n +e used in t,o ,"&s.
/10 As " control tec)niAue to co$("re division"l (er%or$"nce ,it)in " co$("n&.
/20 As " (l"nnin# decision tec)niAue to decide to "cce(t or reCect (roCects
ROI c"n +e loo1ed "t in t,o ,"&s4
ROI F Net (ro%it / Net invest$ent in "ssets
OR
ROI F Net (ro%it ' 2"les
**************** ************
2"les Net "ssets
ROI is not onl& " %unction o% profitabilit! +ut is "lso " result o% asset utilisation
It is essenti"l t)"t ,)en t)e r"tio is used %or co$("rison (ur(oses t)"t t)e s"$e "ccountin# rules
"nd (rocedures "re used to "rrive "t (ro%it "nd c"(it"l e$(lo&ed.
M"n"#e$ent "ction !%%ect on ROI
Reduce level o% costs I$(rove$ent in
Incre"se (ro%it $"r1 u( on s"les 9ro%it ele$ent
Reduce net "ssets e$(lo&ed I$(rove$ent in
Incre"se level o% s"les Asset use ele$ent
Adv"nt"#es
/10 It is re#"rded "s one o% t)e (ri$e (er%or$"nce $e"sures
/20 It de"ls ,it) (ro%it "nd net "ssets ,)ic) "re conce(ts ,ell understood in +usiness.
/30 Use%ul %or co$("rison o% one +usiness unit ,it) "not)er (rovided t)e s"$e "ccountin#
rules "re used.
Li$it"tions
54
/10 C"n le"d to su+*o(ti$"l decision*$"1in#. A $"n"#er ,ill +e un,illin# to "cce(t
(roCects "nd invest$ent o((ortunities ,)ic) do not (roduce " ROC! eAu"l or +etter to t)e
current ROC! +ein# e"rned +& t)"t division. /2ee over)e"d0
/20 C"re )"s to +e e'ercised in ter$s o% )o, t)e ROC! is c"lcul"ted.
Net (ro%it/ C"(it"l e$(lo&ed
Net (ro%it3 Controll"+le contri+ution3 Contri+ution.
C"(it"l e$(lo&ed U net tot"l "ssets3 int"n#i+le "ssetsB3 le"sed or )ired "ssets
/70 T)ere c"n +e $"ni(ul"tion o% t)e r"tio. It c"n le"d to "n e$()"sis on
s)ort*ter$is$ in res(ect to t)e (ro%it %i#ure. T)e tot"l "sset %i#ure c"n +e
$"ni(ul"ted* " reluct"nce to invest in ne, "ssets3 le"se r"t)er t)"n +u&
"ssets.
/<0
Li$it"tions o% ROI
T)e $"in dr",+"c1 ,it) ROI is it c"n le"d to su+*o(ti$"l decision*$"1in#. I% "
division"l $"n"#er-s (er%or$"nce is to "((r"ised +& ROI )e/s)e ,ill +e
un,illin# to "cce(t (roCects ,)ic) do not re"lise " return "t le"st eAu"l to t)e
current ROI +ein# e"rned +& t)"t division.
!. A division"l $"n"#er )"s invest$ent in "ssets st"ndin# "t 57 $illion ,it) "
current return o% 5:663666 (ro%it. A ne, invest$ent o((ortunit& (resents itsel%.
T)e invest$ent ,ould involve 51.8 $illion ,it) "n esti$"ted 52763666. T)e
$"n"#er-s (er%or$"nce is deter$ined +& ROI.
=ould t)e $"n"#er "cce(t t)e (roCectB
Current
(osition
Ne, (roCect Ne, (osition
5-666 5-666 5-666
Invest$ent level 73666 1.866 <3866
Inco$e %ro$
invest$ent
:66 276 13676
ROI 26? 1<? 1:.8?
T)e $"n"#er ,ould +e inclined to reCect t)e (roCect since it ,ould dilute t)e
ROI. Let-s su((ose t)e co$("n&-s over"ll cost o% c"(it"l is 16?. An& (roCect
,)ic) delivers " return in e'cess o% 16? incre"ses t)e ,e"lt) o% t)e co$("n&.
T)is is su+*o(ti$"l (l"nnin# "nd decision*$"1in#.
Net Residu"l Inco$e
=)ere"s ROI is " rel"tive $e"sure RI is "n "+solute inco$e $e"sure$ent. T)e
decision rule is i% " ne, invest$ent (roCect #ener"tes " (ositive return in e'cess
o% t)e co$("n&-s cost o% c"(it"l s)ould +e "cce(ted +& divisions ,it)in t)e
or#"nis"tion.
55
T)e RI ,or1s +& c)"r#in# divisions ,it) "n i$(uted interest c)"r#e eAu"l to t)e
or#"nis"tion-s cost o% c"(it"l. An& ne, (roCects #ivin# " sur(lus o% inco$e "%ter
+ein# c)"r#ed interest or rent s)ould +e "cce(ted.
Usin# t)e s"$e in%or$"tion "s +e%ore4
Current (osition Ne, (roCect Ne, (osition
5-666 5-666 5-666
Invest$ent level 7.666 13866 <3866
Inco$e %ro$
invest$ent
:66 276 13676
Less interest
c)"r#e J 16?
/7660 /1860 /<860
********* ********* ********
NRI 766 :6 7:6
FFFFFF FFFFF FFFFF
T)e $"n"#er ,ould "cce(t t)e (roCect since )is division"l "nd t)e co$("n&-s
residu"l inco$e is incre"sed "%ter " notion"l rent or interest is c)"r#ed %or t)e
use o% "ssets.
56