ACCT 2019 Lecture Notes

Week 1: Introduction to Management Accounting

Accounting Discipline Overview:
- Management accounting measures, analyses, and reports financial and nonfinancial
information that helps managers make decisions to fulfill organisational goals.
- Management accounting need not be GAAP compliant.
- Managers use management accounting information to:
o Develop, communicate and implement strategies
o Coordinate, product design, production, and marketing decisions and evaluate a
company’s performance
Distinguish financial accounting from management accounting:
- Financial accounting: prepares reports most frequently used by decision makers external to
the organisation
- Management accounting: prepares reports must frequently used by decision makers internal
to the organisation
- Cost accounting: is a “method for measuring the cost of a project, process or thing”. It
includes both financial and nonfinancial information and is used for both financial and
management accounting.
Strategic Decisions and the Management Accountant:
- Strategy specifies how an organisation matches its own capabilities with the opportunities in
the marketplace.
- There are two broad strategies: cost leadership and product differentiation
- Strategic cost management describes cost management that specifically focuses on strategic
issues
Questions answered by Management Accounting:
- Who are our most important customers, and what critical capability do we have to be
competitive and deliver value to our customers?
- What is the bargaining power of our customers?
- What is the bargaining power of our suppliers?
- What substitute products exist in the marketplace, and how do they differ from our product in
terms of features, price, cost and quality?
- Will adequate cash be available to fund the strategy, or will additional funds need to be
raised?
Value-chain and Supply-chain Analysis and Key success Factors:
- Creating value is an important part of planning and implementing strategy.
- Value is the usefulness a customer gains from a company’s product or service. The entire
customer experience determines the value a customer derives from a product.
Value-chain:
- The value chain is the sequence of business functions by which a product is made
progressively more useful to customers. The value chain consists of the following:
o Research and development
o Design of products and processes
o Production
o Marketing (including sales)
o Distribution
o Customer service
 - All of the above combined constitutes customer service
Decision-making, Planning, and Control: The Five Step Decision-making process:
- Identify the problem/uncertainties
- Obtain information
- Make predictions about the future
- Make decisions by choosing among alternatives
- Implement the decision, evaluate performance, and learn
Planning and Control Systems:
- Planning consists of:
1. Selecting an organisation’s goals and strategies,
2. Predicting results under various alternative ways of achieving those gaols,
3. Deciding how to attain the desired goals, and
4. Communicating the goals and how to achieve them to the entire organisation
- Management accountants serve as business partners in these planning activities because they
understand the key success factors and what creates value
- Control comprises:
1. Taking actions that implement the planning decisions,
2. Evaluating past performance, and
3. Providing feedback and learning to help future decision making
- The most important planning tool when implementing strategy is a budget. A budget is the
quantitative expression of a proposed plan of action by management and is an aid to
coordinating what needs to be done to execute that plan.
Line and Staff Relationships:
- Organisations distinguish between line management and staff management
o Line management is directly responsible for achieving the goals of the organisation
o Staff management provides advice, support, and assistance to line management
Organisational structure and the management accountant:
Management accounting beyond the numbers:
- The successful management accountant possesses several skills and characteristics that reach
well beyond basic analytical abilities. For example, management accountants must do the
following:
o Work well in cross-functional teams and as a business partner
o Promote fact-based analysis and make tough-minded, critical judgement without
being adversarial
o Lead and motivate people top change and be innovative
o Communicate clearly, openly, and candidly
o Have high integrity
Basic Cost Terminology:
- Cost: a sacrificed or forgone resource to achieve a specific objective
- Actual cost: a cost that has occurred
- Budgeted cost: a predicted cost
- Cost object: anything for which a cost measurement is desired
- Cost accumulation: the collection of cost data in an organised way by means of an
accounting system
- Cost driver: a variable, such as the level of activity or volume, that casually affects costs
over a given term
- Cost assignment: a general term that encompasses the gathering of accumulated costs to a
cost object in two ways:
o Tracing costs with a direct relationship to the cost object
o Allocating accumulated costs with an indirect relationship to a cost object
Direct and Indirect Costs:
- Direct costs can be conveniently and economically traced to a cost object
- Indirect costs cannot be conveniently and economically traced to a cost object
- Instead of being traced, these costs are allocated to a cost object in a rational and systematic
manner
- Direct costs: Have a cause-and-effect relationship with cost object
- Indirect costs: Are used for many cost objects. Cannot be easily traced to any specific cost
object.
Types of inventory in Manufacturing:
- Direct materials: resources in-stock and available to use
- Work-in-progress (WIP): goods partially worked on but not yet completed
- Finished goods: goods completed but not yet sold
- NOTE: Merchandising-sector companies hold only one type of inventory: Merchandise
inventory
Commonly Used Classifications of Manufacturing Costs:
- Also known as inventoriable costs/product costs
- Direct materials: acquisition costs of all material that will become part of the cost object
- Direct labour: compensation of all manufacturing labour that can be traced to the cost object
- Indirect manufacturing: all manufacturing costs that are related to the cost object but cannot
be traced to that cost object in an economically feasible way
Cost behaviour:
- Cost behaviour is the variation in costs relative to the variation in an organisation’s activities
- Ability to analyse cost behaviour requires knowledge of an organisation’s economic
environment and operations.
 - Costs can be categorised by how they are used in decision making
- Costs can also be distinguished by the way they change as activity or volume levels change.
Variable, fixed and mixed costs:
- Variable costs
o Increase (in total) as activity levels increase
o Remain constant (on a per unit basis)
- Fixed costs:
o Decreases (on a per unit basis) as activity levels increase
o Remain constant (in total) for a ‘relevant’ range
- Mixed costs:
o Part fixed/part variable

Week 2:
Basic Costing Terminology – Review:
- Cost objects: are anything for which a cost measurement is desired
- Direct costs: are costs than can be traced to that object in an economically feasible way
- Indirect costs: care costs that cannot be traced in an economically feasible way
- Cost pool: a grouping of individual indirect cost items. Cost pools simplify the allocation of
indirect costs because the costing system does not have to allocate each cost individually.
- Cost-allocation base: a systematic way to link an indirect cost or group of indirect costs to
cost objects
Cost Assignment:

Costing Approaches:
- Actual costing: allocates indirect costs based on the actual indirect cost rates times the actual
quantities of the cost allocation base
- Normal costing: allocates indirect costs based on the budgeted indirect cost rates times the
actual quantities of the cost allocation base
- Both methods allocate direct costs to a cost object the same way – by using actual direct cost
rates times actual consumption
Actual Costing Normal Costing
Direct Costs Actual direct-cost rates x Actual direct-cost rates x
actual quantities of direct- actual quantities of direct-
cost inputs cost inputs
Indirect Costs Actual indirect-cost rates x Budgeted indirect-cost rates
actual quantities of cost- x actual quantities of cost-
allocation basis allocation bases
 7 Step Approach to Job Costing using Normal Costing:
- Identify the job that is the chosen cost object (e.g. events)
- Identify the direct costs of the job (salary of events manager, rent/depreciation of event hall,
electricity for the hall)
- Select the cost-allocation base(s) to use for allocating indirect costs to the job. (No. clients
attending the event)
- Identify the indirect costs associated with each cost-allocation base. (Determine the
appropriate cost pools that are necessary e.g., Drinks, Food, Waitstaff)
- Compute the Rate per Unit of each cost-allocation base used to allocate indirect costs to the
job (normal costing uses budgeted values): Budgeted Manufacturing Overhead Costs /
Budgeted Total quantity of Cost allocation Base
- Compute the indirect costs allocated to the job: Budgeted Manufacturing Overhead Rate x
Actual Base Activity for the Job
- Compute total job costs by adding all direct and indirect costs together
Flow of Costs in Job costing:

Accounting For Overhead:

- Actual costs will almost never equal budgeted costs. Accordingly, an imbalance situation
exists between the two overhead accounts.
o If Overhead Control > Overhead Allocated, this is called UNDERALLOCATED
overhead.
o If Overhead Control < Overhead Allocated, this is called OVERALLOCATED
overhead.
- The difference between the overhead accounts will be adjusted in the end-of-period adjusting
entry process, using one of three following methods:
o Adjusted allocating rate approach
 All allocations are recalculated with the actual, exact allocation date
o Proration approach
 The difference is allocated between cost of goods sold, work-in-process,
and finished goods based on their relative amounts
o Write-off approach
 The difference is simply written off to cost of goods sold
Choosing Among Approaches:
- When management is deciding between approaches, they should consider the following:
o Purpose of the adjustment
o Total amount of underallocation or overallocation
 o Whether variance was over- or underallocated
- The choice of method should also consider materiality, consistency and industry
practice.
Single-Rate and Dual-Rate Methods:
- The single rate cost allocation method pools together all costs in a cost pool.
- The dual rate cost allocation method classifies costs in each cost pool into two cost pools – a
variable-cost cost pool and a fixed-cost cost pool
Budgeted versus Actual Rates:
- Budgeted rates let the user department know in advance the cost rates they will be charged
- During the budget period, the supplier department, not the user departments, bears the risk of
any unfavourable cost variances. Why?
o Because the user departments do not pay for any costs that exceed the budgeted rates
o When actual rates are used for cost allocation, managers do not know the rates to be
used until the end of the budget period.
Budgeted versus Actual Usage Allocation Bases:
- Organisations commit to infrastructure costs on the basis of a long-run planning horizon
- The use of budgeted usage to allocate these fixed costs is consistent with the long-run horizon
The Costing Framework:
- A way in which to determine full cost of a cost object:

Allocate multiple support department costs:

Allocation methods:
- Three methods are commonly used to allocate support department costs to operating
departments:
o Direct method
o Step-down method
o Reciprocal method
Direct Method:
- Cost of services between service departments are ignored and all costs are allocated directly
to production departments
Step-down Method:
- Allocates support costs to other support departments and to operating departments that
partially recognises the mutual services provide among all support departments
- One-way Interaction between Support Departments prior to allocation
- Info systems will have a new total to allocate to production departments; its own costs plus
those costs allocated from PI maintenance
- Service department costs are allocated to other service departments and to production
departments, usually starting with the department that serves the largest number of other
service departments.
- Once a service department’s costs are allocated, other service departments’ costs are not
allocated back to it.
Reciprocal Services Method:
- Info systems will have a new total to allocate to production departments; its own costs plus
those costs allocated from PI maintenance
- Calculate simultaneous equation
Choosing between methods:
- Reciprocal is the most precise
- Direct and step-down are simple to compute and understand
- Direct method is widely used
Allocating Common Costs:
- Common costs – the cost of overeating a facility, activity, or cost object that is shared
between two or more users at a lower cost than the individual cost of the activity to each user
Methods of Allocating Common Costs:
- Stand-alone cost-allocation method: uses information pertaining to each user of a cost object
as a separate entity to determine the cost-allocation weights
- Individual costs are added together, and allocation percentages are calculated from the
whole, and applied to the common cost
- Incremental cost-allocation method ranks the individual users of a cost object in the order
of users most responsible for a common cost and then uses this ranking to allocate the cost
among users
o The first ranked user is the primary user and is allocated costs up the cost as a stand-
alone user (typically gets the highest allocation of the common costs)
o The second ranked user is the first incremental user and is allocated the additional
cost that arises from two users rather than one
o Subsequent users handled in the same manner as the second ranked user
Revenues and Bundled Products:
- A bundled product is a package of two or more products (or services) sold for a single price
- Bundled product sales are also referred to as “suite sales”
- The individual components of the bundle also may be sold as separate items at their own
“stand-alone” prices
- What businesses provide bundled products?

Revenue Allocation and Bundled Products:

- Revenue allocation occurs when revenues are allocated to a particular revenue object but
cannot be traced to it in an economically feasible manner
- Revenue object – anything for which a separate measurement of revenue is desired
- Bundled product – a package of two or more products or services that are sold for a single
price, but individual components of the bundle also may be sold as separate items at their own
‘stand-alone’ prices
Methods to allocate revenue to Bundled Products:
- Stand-alone (separate) revenue allocation method uses product-specific information on the
product in the bundle as weights for allocating the bundled revenues to the individual
products. Three types of weights may be used:
o Selling Prices
o Unit Costs
o Physical units
- Incremental revenue-allocation method ranks individual products in a bundle according to
criteria determined by management and then uses this ranking to allocate bundled revenues to
individual products (similar to earlier discussed incremental cost-allocation method)
o The first-ranked product is the primary product
o The second-ranked product is the first incremental product
o The third-ranked product is the second incremental product, etc.

Week 3: Cost-Volume-Profit Analysis: Inventory Costing

Inventory costing choices: overview
- Variable costing is a method of inventory costing in which all variable manufacturing costs
(direct and indirect) are included as inventoriable costs
- Absorption costing is a method of inventory costing in which all variable and fixed
manufacturing costs are included as inventoriable costs. Inventory “absorbs” all
manufacturing costs.
- Throughput costing is a method of inventory costing in which only direct materials are
included as inventoriable costs. All other costs are expensed.
Inventory costing: Differences in Income
- Operating income will differ between absorption and variable costing if inventory levels
change because of the difference in accounting for fixed manufacturing costs
- The amount of the difference represents the amount of fixed manufacturing costs capitalised
as inventory under absorption costing and expensed as a period cost under variable costing.
Absorption costing Income statement: (For external reporting)

Variable costing Income statement: (For internal reporting)

Absorption Costing:
- Under absorption costing because of the treatment of fixed overhead, both manufacturing and
sales volume affect the timing of when fixed overhead is recognised as an expense.
o If units are produced and sold in this period, overhead cost incurred to produce these
units are expensed in this period.
o If units from the last period are sold, some overhead cost from the last period are
expensed in this period.
o If units produced in this period are not yet sold, the overhead allocated to those units
will not be expensed until a future date when the units are sold
Absorption & Variable Costing profits compared:
- Short cut method to find the difference in Net Profit between both methods:
o Fixed manufacturing OH rate x Difference in inventory
- If more are produced than sold, absorption costing will have a higher figure, if more are sold
than produced then absorption costing will have a smaller figure than variable costing.
Comparing absorption and variable costing:
Absorption Variable
Consistent with accounting standards Not consistent with accounting standards
Useful for external reporting purposes Useful for performance evaluation and internal
decision making
Fixed AND variable OH allocated to inventory Only variable OH allocated to inventory
Admin & selling costs expensed as period costs Admin & selling costs expensed as period costs,
but with variable separated and included in
contribution margin
Inventory costs (including per-unit fixed and Inventory costs (only manufacturing variable
variable manufacturing costs) not expensed until costs) not expensed until the units are sold
units sold
Incentives to build up inventories:
- Under absorption costing: as inventory increases, the amount of fixed costs included in
inventory increases
- As a result, managers have incentives to inappropriately build up inventory quantities
because:
o Managers’ reputations often increase as result of increases in reported income
o Managers often receive bonus payments based on their ability to meet/exceed
targeted operating income levels
o Managers may be biased in their sales forecasts, preventing them from promptly
recognising a decline in sales
Disincentives to build up inventories:
- Managers could be unwilling to use inventory build-up that, while strengthening short-term
earnings, would negatively affect future earnings when those units are either sold or written
off
- Managers are not rewarded for inventory build-ups if bonus are based in variable costing
income
- Excessive inventory levels often viewed as evidence of poor management or deteriorating
sales
- Some entities use just-in-time inventory management
Cost-Volume-Profit Analysis:
- A technique that allows you to answer questions relating to the effects of sales volume, costs
and pricing on profit
- For example
o Which products/services do I want to prioritise (because they are more profitable)?
o What is the volume of sales I need to achieve a targeted level of profit?
o What is the minimum revenue I need to bring to avoid losses?
o Am I selling enough units to cover my fixed costs? Could I even increase fixed costs,
or would I be exposing my organisation to unnecessary risks by doing so?
Calculating profit and contribution margin:
- Determines how much revenue from each unit sold can be applied towards fixed costs
- Contribution Margin: CM = Total Revenue – Total Variable Cost
- Contribution Margin per unit: CM (per unit) = SP (per unit) – VC (per unit)
- Contribution Margin ratio: CMR = (TR – TVC) / TR or CM / TR or CM (per unit) / SP (per
unit)
- Profit: P = [(SP – VC) x Q] – FC or (CM(PU) x Q) – FC
Calculating breakeven point
- Breakeven point: where total revenue equals total costs, giving a profit of zero
- Breakeven point:
o Units/Revenues that need to be earned to achieve breakeven:
 BEP (in units) = FC / Unit CM
o Units/Revenue that need to be sold to achieve breakeven:
 BEP ($) = FC / CMR
CVP analysis for a single product:
- Target profit: revenues that need to be earned to achieve target profit
o TP ($) = (FC + TP) / CMR
 - Units that need to be sold to achieve target profit:
o TP (in units) = (FC + TP) / CM (per unit)
- Tax effects:
o Sometimes you are only given after tax profit. Hence, you first need to calculate
before-tax profit:
 P (before tax) = P (after tax) / (1 – tax rate)
o Revenues that need to be earned to achieve after tax profit:
 After tax profit = (FC + P (before tax) / CMR)
o Units that need to be sold to achieve after tax profit:
 After tax profit (units) = (FC + P (before tax) / CM (per unit))
CVP analysis graph:

Using CVP Analysis for Decision Making:

- Strategic decision such as lowering sale price entails risk
- CVP used to evaluate how the Operating income will change, but cannot be certain that our
estimates of increased sales will occur
- Managers use electronic spreadsheets to systematically and efficiently conduct CVP-based
sensitivity analysis to test how sensitive their conclusions are to different assumptions.
CVP Analysis for multiple products:
- Organisations often sell different products or services
- The sales mix is the proportion of different products and services
- For CVP, a constant sales mix is assumed
- The weighted average contribution margin (CM) per unit is the average CM per unit for
multiple products weighted by the sales mix. It is used to determine the breakeven point or
targeted profit in units
- WACM (per unit) = CM per unit x Sales Mix
o Combined weighted average contribution margin per unit
Total WACM (per unit) = WACM (Product 1) + WACM (Product 2) + WACM
(Product 3)
- Sales Mix = x%, y% and z%
o Total WACM = (CM per unit x x%) + (CM per unit x y%) + (CM per unit x z%)
- Discretionary expenditure decision:
o CVP analysis assists business decisions about discretionary expenditures i.e. deciding
to advertise one product heavily
Assumptions and limitations of CVP analysis:
- CVP analysis relies on forecasts of expected revenues and costs
 - Assumptions rule out fluctuations in revenues and costs, which means many uncertainties
arise:
o Is desired operating volume achievable?
o Will selling prices go up or down?
o Will sales mix remain constant?
o Will fixed or variable costs change in new relevant range?
o Will costs change due to unforeseen events?
o Are revenue and cost estimates biased?
Sensitivity Analysis:
- CVP provides structure to answer a variety of “what-if” scenarios.
- “what” happens to profit “IF”:
o Selling price changes
o Volume changes
o Cost structure changes
 Variable cost per unit changes
 Fixed costs change
Margin of safety and degree of operating leverage:
- CVP analysis can be used to help manage operational risk
- Operational risk
o …Risk of loss resulting from inadequate or failed internal processes, people and
systems, or external events
- Margin of safety
o …is the excess of a firm’s expected future sales above the breakdown point
 MoS = Budgeted sales = Breakeven sales
- Margin of safety percentage
o …Indicate the extent to which sales can decline before profits become zero
 MoS% = MoS (in units or revenue) / Budgeted sales (in units or revenue)
Margin of Safety – An indicator of Risk
- The margin of safety (MOS) calculation answers a very important question:
o If budgeted revenues are above the breakeven point, how far can they fall before the
breakeven point is reached?
o In other words, how far can they fall before the company will begin to lose money?
Cost structure:
- The cost structure is simply the relationship of fixed costs and variable costs to total costs
- Managers make strategic decisions that affect the cost structure of the company
- Can use CVP-based sensitivity analysis to highlight the risks and returns as fixed costs are
substituted for variable costs in a company’s cost structure.
- The risk-return trade-off alternative cost structures can be measured as operating leverage
Degree of operating leverage:
- …measures the extent to which the cost function is comprised of fixed costs
- A high degree of operating leverage indicates a high proportion of fixed costs
- Firms operating at a high degree of operating leverage:
o Face higher risk of loss when sales increase
o Enjoy profits that rise more quickly when sales increase
- DOL formula can be written in terms of either:
o Contribution Margin
 DOL = CM / Profit
 o Fixed Costs
 DOL (in terms of Fixed Costs) = (FC / Profit) + 1
- The degree of operating leverage can be used to:
o Gauge the risk of associated with cost function (high DOL = high FC)
o Calculate the sensitivity of profits to changes in sales (units or revenues)
 % change in profit = % change in sales x DOL
Degree of operating leverage and margin of safety percentage are reciprocals:
- Margin of safe percentage = 1 / Degree of operating leverage
- Degree of operating leverage = 1 / Margin of Safety percentage
- If the MoS is small, then DOL is large
- As the level of operating activity increases above break-even, MoS increases, and DOL
decreases
Week 4:
Strategic plans and operating plans:
- Budgeting is most useful when integrated with a company’s strategy
- To develop successful strategies, managers must consider questions such as:
o What are our objectives?
o What set of integrated choices can we make along the value chain, for example in
product or service design, operations, and marketing, to create value for our
customers while distinguishing ourselves from our competitors?
o What organisational and financial structures serve us best?
o What are the risks and opportunities of alternative strategies, and what are our
contingency plans if our preferred plan fails?
Budgets and the budgeting cycle:

Budgeting cycle and the master budget:

- Well-managed companies usually cycle through the following annual budgeting tips:
o Before the start of the financial year, managers look at:
 Past performance
 Market feedback
 Anticipated future changes
o Managers and accountants then work together to develop plans
- At the beginning of the financial year, senior managers give middle managers a set of
financial and non-financial expectations (derived from the budget), against which actual
operations and results will later be compared.
- During the year, any variance against the expected financial and non-financial figures is
examined and, if necessary, corrective action is taken.
Definitions to learn:
- Strategy
 - Budgets
- Master budget
- Operating budget
- Financial budget

Advantages and challenges of implementing budgets:

- Budgets help to:
o Promote coordination and communication among subunits within the company
o Provide a framework for judging performance and facilitating learning
o Motivate managers and employees to achieve their goals
- However:
o Budgeting is also time-consuming, employing significant resources and time
Time coverage of budgets:
- The timeline for a budget depends on the motive for creating the budget
- The most frequently used budget period is one year
- Businesses may also use a rolling budget or continuous budget. This budget is always
available for a specified future period, by continually adding a month, quarter, or year to the
period just ended.
Steps in preparing an operating budget:
- To facilitate the budgeting process, a company will go through the five-step decision making
process
o Identify the problem and uncertainties
o Obtain information
o Make predictions about the future
o Make decisions by choosing among alternatives
o Implement the decision, evaluate performance, and learn
1: The Sales/Revenue Budget
- Budgeted sales

2. The production Budget

- KTW want ending inventory sales to be equal to 20% of following month’s budgeted sales

- Example:
3. The Direct Materials Budget
- DIRECT MATERIALS USAGE BUDGET:
o At KTW, Semillon is stored in French oak barrels
o KTW want materials on hand at the end of each month equal to 10% of the
following month’s production to ensure continuous process
o On Dec 31st 1.08 French oak barrels that each carry 500L wine are on hand, at a cost
of $1200 each

- DIRECT MATERIALS PURCHASE BUDGET:

o At KTW, Semillon is stored in French oak barrels
o KTW want materials on hand at the end of each month equal to 10% of the
following month’s production to ensure continuous process
o On Dec 31st 1.08 French oak barrels that each carry 500L wine are on hand, at a cost
of $1200 each

o Example:
4. The Direct Labour Budget
- At KTW, each bottle of Semillon requires 0.1 hours of direct labour during harvest
- The company has a “no layoff” policy so all contractors will be paid for 40 hours of
work/week
- in exchange for the “no layoff” policy, workers agreed to a wage rate of $22ph regardless of
the hours worked (no overtime pay)
- For the next three months, the direct labour workforce will be paid for a minimum of 500
hours / month