Management Accounting Techniques Flashcards
Introduction to Cost Accounting (CH1)
What is Costing?
Costing is a system of computing cost by allocating expenditure to various stages of production or to different operations of a firm.
- It enables business managers to know the cost of their firm’s output (i.e. product or a service) and the revenues from sales.
Introduction to Cost Accounting (CH1)
What is the Purpose of Management Accounting?
Once costing information is available, managers can use it to assist with:
- Decision making - when implementing changes (e.g. make or buy a product)
- Planning - when preparing forecasts and budgets
- Control - When checking results against what was planned. e.g. control of expenditure.
Introduction to Cost Accounting (CH1)
What three things does Management Accounting involve?
- Management
- Current and Future
- Estimates
Introduction to Cost Accounting (CH1)
What are Cost Units?
- Cost units are units of output to which costs can be charged.
A cost unit can be:
- A unit of production from a factory (e.g. a car, a television, an item of furniture).
- A unit of service, such as a passenger-mile on a bus, a transaction on a bank statement, an attendance at a swimming pool, a call unit on a telephone.
Introduction to Cost Accounting (CH1)
What are Composite Cost Units?
Composite cost units are units of output which combine two simple units. (e.g., per passenger-kilometre, per ton-kilometre, or per kilowatt-hour).
Common in service sector businesses.
Examples of composite cost units include:
- the cost of a bus passenger, per mile
- the cost of a hospital patient, per day
Introduction to Cost Accounting (CH1)
What are the Two Types of Unit?
Simple Unit: These use a single standard or unit of measurement of the goods manufactured (e.g. per piece, per kilogram, per ton, per gallon, or per meter).
Composite Unit or Complex Unit: These combine two simple units (e.g. per passenger-kilometre, per ton-kilometre, or per kilowatt-hour).
Introduction to Cost Accounting (CH1)
What are Responsibility Centres?
Responsibility centres are segments of a business for which a manager is accountable.
Introduction to Cost Accounting (CH1)
What are the Differences between Management (cost) Accounting and Financial Accounting?
Management Accounting:
- Internal (management for decision-making, planning & control)
- Costing
Financial Accounting:
- External - (Legal / Owners & Investors)
- Bookkeeping
Introduction to Cost Accounting (CH1)
What is a Cost Centre?
Costs centres are segments of an organisation to which costs can be charged. It can be based on functions or sub-divisions.
- Organisations decide which section/function becomes a cost centre depending on its usefulness.
- A manager or supervisor will be responsible for each cost centre.
- Information from the cost accounts system will enable them to plan for the future, make decisions and control costs.
- Primarily do not generate income.
Introduction to Cost Accounting (CH1)
What are the 4 types of Responsibility Centres?
1. Cost Centre - (Cost)
2. Revenue Centre - (Revenue)
3. Profit Centre - (Income, Cost)
4. Investment Centre - (Investments , Income, Cost)
Introduction to Cost Accounting (CH1)
What are Profit Centres?
Profit centres are segments of a business to which costs can be charged, revenue can be identified, and profit can be calculated.
Managers are responsible for both costs incurred, and income generated.
Introduction to Cost Accounting (CH1)
What are Investment Centres?
Investment centres are sections of the organisation where information on income, costs and investment can be gathered.
Performance is measured by comparing the profit with the amount of money invested.
An example of an investment centre could be an individual shop within a chain of shops operated by the same company.
Introduction to Cost Accounting (CH1)
What are the 4 Classifications of Costs?
1. Function - Production / Selling & Distribution/ Administration & Finance
2. Element - Materials, Labour & Expenses (Overheads)
3. Nature - Direct or Indirect
4. Behaviour - Fixed, variable, Semi-variable & Stepped
Introduction to Cost Accounting (CH1)
What is Cost Behaviour?
Cost behaviour is the way in which costs alter with changes in the level of output or activity.
Three main ways in which costs behave:
* Fixed Costs
* Variable Costs
* Semi Variable Costs
Introduction to Cost Accounting (CH1)
Explain the 3 ways in which costs behave with examples
Fixed Costs
Stay the same - are usually time based and are independent of production - Rent, Rates, Insurance etc
Variable
Are unit based and dependent on output - materials and labour used in production etc
Semi-Variable
Part Fixed and Part Variable - a mixture of time and unit based - Labour, electricity etc
Introduction to Cost Accounting (CH1)
What are the 3 reasons for Classifying Costs?
- Decision making - when implementing changes
- Planning - when preparing forecasts and budgets
- Control - When checking results against what was planned
Introduction to Cost Accounting (CH1)
Why are Spreadsheets Beneficial?
Using spreadsheets to do this will be beneficial for both accounts staff, as it makes the process of producing management information more efficient and flexible.
Business managers may then understand the information more easily due to a clear format or graphs that makes it much clearer.
Introduction to Cost Accounting (CH1)
How does a Total Cost Statement look?
Direct materials
add Direct labour
add Direct expenses
equals PRIME COST
add Production overheads
equals PRODUCTION COST
add Selling and distribution costs
add Administration costs
add Finance costs
equals TOTAL COST
Material Costs (CH2)
Three types of Material Inventory
Materials inventory is the cost of:
- Raw materials and components
- Goods for resale
- Consumable items
Material Costs (CH2)
What is the Just-in-Time (JIT) Method?
A method favoured by manufacturers where supples are delivered to the production line just as they are needed. In this way inventory levels are kept very low.
For this method suppliers who can deliver reliably on time are needed.
Material Costs (CH2)
What is the Two-bin System?
Two bins are kept for each item of inventory.
When the first bin runs out, supplies are re-ordered before the second bin runs out.
Material Costs (CH2)
What is the Perpetual Inventory Method?
This system records receipts and issue of inventory as items pass in and out of the business and re-orders are made accordingly. Many supermarkets and manufacturers work on this basis.
Material Costs (CH2)
How do Businesses use Formulas for Inventory Control?
Formulas are used to calculate when orders for inventory need to be made and how much to order.
Material Costs (CH2)
5 key factors effecting Inventory Control (Fixed Quantity Method of Re-ordering)
- The Maximum Inventory Level
- The Inventory Buffer
- The Lead Time
- The Re-order Level
- The Appropriate Re-order Quantity
Material Costs (CH2)
What is Maximum Inventory Level?
- The Maximum Inventory Level - the amount of storage space available.
Material Costs (CH2)
What is the Inventory Buffer Level?
- The Inventory Buffer - the minimum level that inventory should fall to before the new order from the supplier is delivered.
Material Costs (CH2)
What is the Re-order Level?
- The Re-order Level - the point at which a new order is to be placed.
Material Costs (CH2)
What is Lead Time?
- The Lead Time - how long it takes for new inventory to be delivered after being ordered.
Material Costs (CH2)
How is Inventory Buffer Calculated?
Inventory Buffer = Re-order level - (average usage x average lead time)
Material Costs (CH2)
How is the Re-order level calculated?
Re-Order Level = Inventory buffer + (average usage x average lead time)
Material Costs (CH2)
How is the Maximum Re-order Quantity Calculated?
Max Reorder Qty = Max Inventory level - Inventory buffer
Material Costs (CH2)
How is the Minimum Re-Order Quantity Calculated?
Min Reorder Qty = Re-order level - Inventory buffer
Material Costs (CH2)
How is the Maximum Inventory Level Calculated?
Maximum Inventory level = Inventory buffer + Max reorder qty
Material Costs (CH2)
Wider factors affecting Inventory Management
- Needs of the business - e.g, if an inventory item is being used less frequently than before, the calculations will need to be revised to suit current and future needs.
- Obsolescence of inventory .e.g. if spare parts are kept for a particular make and model of vehicle, inventory levels will need to be run down when the vehicles are being replaced by those of a different make and model.
- Seasonal variations affecting usage and inventory levels - e.g. a business using oil for heating may be offered a cheaper price when usage is low in the summer which may make it worthwhile to buy; by contrast, when usage is high in the winter, the supplier’s price and lead times may increase.
Introduction to Cost Accounting (CH1)
What is the Function Classification of Costs?
- Production
- Selling and Distribution
- Administration and Finance
Introduction to Cost Accounting (CH1)
What is the Element Classification of Costs?
- Materials
- Labour
- Expenses (Overheads)
Introduction to Cost Accounting (CH1)
What is the Nature Classification of Costs?
- Direct
- Indirect
Introduction to Cost Accounting (CH1)
What is the Behaviour Classification of Costs?
- Fixed
- Variable
- Semi-Variable
- Stepped
Material Costs (CH2)
Three types of Materials held by Manufacturing Business
- Raw materials and Components
- Work-in-progress goods
- Finished Goods
Material Costs (CH2)
What type of Material is usually held by Trading Businesses?
- Goods for sale
Material Costs (CH2)
What type of Material is usually held by Service Businesses?
Consumable Materials
Materials Costs (CH2)
What is the Maximum Inventory Level?
Determined by the amount of storage space available in the warehouse, shop or office stationery cupboard.
Materials Costs (CH2)
What is the Inventory Buffer?
The minimum level that inventory should fall to before the new order from the supplier is delivered.
Calculated as = Re-order level - (average usage x average lead time)
Materials Costs (CH2)
What is the Lead Time?
How long it takes for new inventory to be delivered after being ordered.
Materials Costs (CH2)
What is the Re-order Level?
The point at which a new order is to be placed - this is often the most critical factor to determine.
Re-order level = Inventory Buffer + (average usage x average lead time)
Materials Costs (CH2)
Why is the Re-order Quantity important?
- If re-order amounts are too large, too much inventory will be held, which will be an expense to the business
- if re-order amounts are too small, the expense of constantly re-ordering will outweigh any cost savings of lower inventory levels, and there will be the danger that the item might run out.
Materials Costs (CH2)
Factors affecting Economic Re-order Quantity.
The economic order quantity (EOQ) - can be calculated by a mathematical formula which involves a number of different costs and other figures:
- Ordering cost - the administration cost of placing each order.
- Inventory Holding Cost - expressed as the cost of holding one unit of inventory per year.
- Annual usage - the number of inventory units used per year.
Materials Costs (CH2)
What is the Formula for the Economic Reorder Quantity?
Square Root of:
2 x annual usage x ordering cost
————————————————
Inventory Cost
= Economic Reorder Quantity
Materials Costs (CH2)
Why is the Economic Order Quantity (EOQ) important?
- The EOQ, helps struck a balance between the cost of placing an order and the cost of holding inventory
- EOQ represents the most efficient level of order to place because it minimises the total cost of ordering and storage.
- Once the EOQ has been calculated, it is used as the quantity of inventory to be ordered each time an order is placed.
Materials Costs (CH2)
How is Inventory Valued?
The lower of Cost and Net Realizable Value.
Materials Costs (CH2)
What are the methods of Inventory Valuation?
-
IAS 2 allows inventories to be valued using only two main methods;
FIFO and AVCO. The third, LIFO is only use for cost accounting purposes but not permitted for financial accounting (Not examinable). - Once a method is adopted, it has to be consistently applied unless there is a good reason not to do so.
Materials Costs (CH2)
What is the FIFO method of Inventory Valuation?
1. FIFO (first in, first out)
- Inventory is issued in order that it was bought, thus valued at the oldest cost price.
- Meaning inventory held in stores is valued at the most recent cost price.
Materials Costs (CH2)
What is the LIFO method of Inventory Valuation?
2. LIFO (last in, first out)
- Valuation of inventory issued is based on the cost of the inventory most recently purchased.
- Hence inventory held in stores is valued at the older cost price.
Materials Costs (CH2)
What is the AVCO method of Inventory Valuation?
- AVCO (average cost)
Overall average cost (or average weighted cost) is calculated for the inventory held in stores or issued using the formula:
Average Cost = Total cost of goods in store / Number of goods in store
Meaning a new average cost must be calculated each time a new inventory is purchased.
Materials Costs (CH2)
Categorising of Inventory according to IAS 2
When calculating the lower of cost and net realisable value, note should be taken of:
- separate items of inventory, or
- groups of similar items
This means that the inventory valuation rule’ must be applied to each separate item of inventory, or each group or category of similar inventory.
Materials Costs (CH2)
What are the 3 methods of valuing raw materials?
For raw materials, the comparison is made between cost (which can be found using techniques such as FIFO, LIFO, or AVCO) and net realisable value.
Materials Costs (CH2)
What three things make up the cost of inventory?
By using the full production cost by including:
- Direct materials
- Direct labour
- Production overheads
Materials Costs (CH2)
What are the Principles of Double-Entry Bookkeeping?
• a debit entry records a gain in value, an asset or an expense
• a credit entry records the giving of value, a liability or an income item
Materials Costs (CH2)
What four Accounts are involved in Double-Entry Bookkeeping for Materials Costs?
- Inventory account
- Production account
- Payables ledger control account
- Bank account
Materials Costs (CH2)
What Bookkeeping Entry should be made when there is a Purchase of materials on credit from a supplier?
Dr Inventory (asset gained)
Cr Trade payables (creditors) control
Materials Costs (CH2)
What Bookkeeping Entry should be made when there is a Purchase of materials on cash terms (i.e. Immediate payment from bank)?
Dr Inventory
Cr Bank
Materials Costs (CH2)
What Bookkeeping Entry should be made when there is an Issue of materials to production?
Dr Production
Cr Inventory
Materials Costs (CH2)
What Bookkeeping Entry should be made when there is a Return of materials from production to inventory?
Dr Inventory
Cr Production
Labour Costs (CH3)
What is a Direct Labour Cost?
Direct labour cost is the wages paid to those who work on a production line, are involved in assembly, or are involved in the output of a service business.
Labour Costs (CH3)
What are the 4 Main Methods of Direct Labour Cost?
The three main methods for direct labour are:
- Time rate (Basic pay) - based on normal time worked
- Overtime - based on extra time worked
- Piecework - based on amount of work carried out
- Bonus - ‘add on’ pay to normal time rate and overtime
Labour Costs (CH3)
Methods of Calculating Labour Output
Time Sheets - record employees’ hours
Clock Cards - employees ‘clock in’ at the start of work, and ‘clock out’ at the end
Piecework Tickets - completed by employees who work on a batch of output
Job Cards - where each employee records the amount of time spent on each job
Route Cards — which are used to follow a product through the production process — on which employees record the amount of time they spend working on the product
Computer Cards — ‘swipe’ cards which link direct into the computerised payroll are increasingly being used by employers to record attendance
Labour Costs (CH3)
When is Time Rate used?
Time rate is often used where it is difficult to measure output, and where quality is more important than quantity. Variations include a high time rate, used to motivate employees where a higher standard of work is required.
Labour Costs (CH3)
What are the Advantages of Time Rate?
- Easy to calculate
- No requirement to establish time allowances and piecework rates
- The employee receives a regular wage, unaffected by fluctuations in output
- The employer pays a regular amount, making planning for cash flows easier
- Can be used for all direct labour employees
- Quality does not suffer as a result of hurried work
Labour Costs (CH3)
What are the Disadvantages of Time Rate?
Both efficient and inefficient employees receive the same wage
No incentive is given to employees to work harder
Slower working will not affect basic wage, but may lead to overtime
More supervisors are needed to ensure that output is maintained.
Labour Costs (CH3)
When is Piecework used?
Piecework rate is used where the quantity of output is important, and there is less emphasis on quality.
Labour Costs (CH3)
Variations of Piecework?
Variations include:
- Piecework with guaranteed time rate
- Differential piecework system, where a higher rate is paid for all output beyond a certain level, e.g. 50p per unit for the first 100 units each day, then 60p per unit thereafter
- Attendance allowances, paid to encourage employees on piecework to attend each day, thus ensuring that the production-line can be staffed and operated every working day
Labour Costs (CH3)
Advantages of Piecework?
- Payment of wages is linked directly to output
- More efficient workers can earn more than those who are less efficient
- Work is done quicker and less time is wasted
Labour Costs (CH3)
Disadvantages of Piecework?
- Not suitable for all direct labour employees
- Pay is reduced if there are production problems, e.g. machine breakdown or shortage of materials
- Product quality is likely to decrease
- More inspections may be needed
- Control systems needed to check the amount produced by each worker more complex pay calculations
- May be difficulty in agreeing piecework rates with employees
- The employer cannot plan ahead for wages costs so easily, as they may be irregular amounts
Labour Costs (CH3)
When are Bonuses useful?
Bonus systems are used to encourage employees to be more efficient in an environment where the work is not so repetitive.
Variations include an accelerating premium bonus — which is an increased bonus paid for higher levels of output, and group bonuses paid to groups of employees who achieve increased output
Labour Costs (CH3)
Advantages of Bonuses
Wages linked to output, but minimum wage is guaranteed
Each week work is done quicker and less time is wasted more efficient workers can get more bonus
Bonus system can be applied to the entire workforce
Labour Costs (CH3)
Disadvantages of Bonuses
- A bonus is not paid if circumstances beyond employees control prevent work, e.g. machine breakdown or shortage of materials
- Quality of finished product may be low
- More inspections may be needed and additional control procedures
- Pay calculations may be more complex
Labour Costs (CH3)
Qualities of a Good Labour Payment Method
Reward should be related to effort and fair to all staff
The method should be easy to manage and administer, and cheap and efficient to run
It should be easy for employees to understand how pay is calculated
Payment should be made at regular intervals and soon after the event, e.g. employees on piecework should be paid in the week after the production has been achieved
The principles of the scheme should remain constant, but there should be flexibility to deal with changes in production techniques
Labour Costs (CH3)
Direct and Indirect Labour Costs
Direct costs:,
* labour costs of production-line employees
Indirect costs:,
* labour costs of other employees, such as supervisors, office staff, etc
Labour Costs (CH3)
How are Overtime Payment rates decided?
When production-line employees work overtime they are usually paid at a rate above the time rate.
However, where a customer requests overtime to be worked to get a rush job completed, then the full overtime rate is charged as direct labour, and passed on as a cost to the customer.
Labour Costs (CH3)
How are Idle Time Payments decided?
Idle time occurs when production is stopped through no fault of the production-line employees:
- for example, a machine breakdown, or a shortage of materials.
Employees paid under a piecework or a bonus system will receive time rate for the period of the stoppage. Such wages costs are normally charged to overheads as indirect labour.
Similarly, time spent by direct workers on non-productive work — e.g. attendance on a training course - would also usually be treated as an overhead.
Labour Costs (CH3)
When are Equivalent Units used?
- When production employees are paid on the basis of output, a calculation of equivalent units may need to be required.
- This happens when part of the production at the end of the accounting period is work-in-progress for the labour content.
Example:
- 10,000 units have been completed during the month and, at the month-end, 2,000 units are work-in-progress and are 50 per cent complete for the labour content.
The equivalent units completed for the month will be: 10000 units + (2000 units x 50%) 11,000 equivalent units
Labour Costs (CH3)
Bookkeeping for Labour Costs
A wages control account links to the payroll accounting system. It is used to charge labour costs to the various responsibility centres of a business.
- Direct labour costs are charged to production
- Indirect labour costs are charged to production overheads
- Administration labour costs are charged to non-production overheads
Labour Costs (CH3)
How would a Transfer of Direct Labour Costs to Production be shown in Double Entry Bookkeeping?
Dr Production
Cr Wages Control a/c
Labour Costs (CH3)
How would a Transfer of Indirect Labour Costs to Production Overheads be recorded in Double Entry Bookkeeping?
Dr Production Overheads
Cr Wages Control a/c
Labour Costs (CH3)
How would a Transfer of Administration Labour Costs to Non-Production Overheads be recorded in Double Entry Bookkeeping?
Dr Non-Production Overheads
Cr Wages Control a/c
Overheads and Expenses (CH4)
What are Direct Costs?
Direct Cost can be identified directly with each unit of output.
