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1 Costing 2 Accounting Prof. Clive Vlieland-Boddy Academic Year 2009-2010.

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Presentation on theme: "1 Costing 2 Accounting Prof. Clive Vlieland-Boddy Academic Year 2009-2010."— Presentation transcript:

1 1 Costing 2 Accounting Prof. Clive Vlieland-Boddy Academic Year

2 2 Activity Based Costing

3 3 Costs per service or activity. Costs are allocated to a service or activity Examples: Cost per sales enquiry Costs per warranty claim Costs per credit check

4 4 Cost Drivers There are two main types of cost driver: A resource driver, which refers to the contribution of the quantity of resources used to the cost of an activity. An activity driver, which refers to the costs incurred by the activities required to complete a particular task or project.

5 5 Activity-Based Costing A way to allocate as many costs as possible to a product Focuses on activities and cost of activities Each activity has its own cost driver Uses a separate allocation rate for each activity

6 6 Other Costing Issues

7 7 Job Costing Measures individual costs of production or service to each sales unit. Example: A builder will charge to a job all the materials and labour so as to identify the results of that particular job.

8 8 Processing Costing Traces all direct an indirect costs of manufacturing often on a batch process. They eventually divide these costs up to calculate a per unit cost.

9 9 Conversion Costs

10 10 Equivalent Units When valuing ending inventories of WIP, there may well be many partly completed units. These have to be equated into completed units. Example: At the month end a cycle manufacture has 500 half completed cycles. That would equate to 250 equivalent units.

11 11 Cost Volume Profit Analysis (CVP) & Break Even

12 12 The principles of variable/marginal costing 1.For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the relevant range). Therefore, selling an extra item of product or service: Revenue will increase by the sales volume of the item sold Costs will increase by the variable cost per unit Profit will increase by the amount of contribution earned from the extra item

13 13 Cost-volume-profit analysis Systematic method of examining the relationship between changes in activity and changes in total sales revenue, expenses and net profit CVP analysis is subject to a number of underlying assumptions and limitations The objective of CVP analysis is to establish what will happen to the financial results if a specified level of activity or volume fluctuates

14 14 CVP analysis assumptions All other variables remain constant A single product or constant sales mix Total costs and total revenue are linear functions of output The analysis applies to the relevant range only Costs can be accurately divided into their fixed and variable elements The analysis applies only to a short-time horizon Complexity-related fixed costs do not change

15 15 Break Even

16 16 CVP diagram

17 17 Margin of safety The extent that the revenue exceeds total costs, is called the margin of safety. Indicates by how much sales may decrease before a loss occurs

18 18 Break Even Analysis Remember: A higher price or lower price does not mean that break even will never be reached! The break even point depends on the number of sales needed to generate revenue to cover costs – the break even chart is NOT time related!

19 19 Activity Use the matrix on web site to do this

20 20 Budgets

21 21 Budgets

22 22 Budgets Estimates of the income and expenditure of a business or a part of a business over a time period Used extensively in planning Helps establish efficient use of resources Help monitor cash flow and identify departures from plans Maintains a focus and discipline for those involved

23 23 Budgets Flexible Budgets – budgets that take account of changing business conditions Static Budget – Based on pre determined level of activity

24 24 © John Wiley & Sons, 2005 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcotts Cost Management, 1eSlide # 24 Flexible Budgets A budget prepared for a multiple levels of sales volume is called a flexible budget. Flexible budgets are prepared at the beginning of the year for planning purposes and at the end of the year for performance evaluation. Differences between actual results and the flexible budget are called flexible budget variances.

25 25 Flexible Budget This is the budget we would have prepared HAD WE ONLY KNOWN the number of units that would be sold or produced

26 26 What is needed to do a flexible budget To do a flexible budget we need to know the assumptions used to create the original budget – Units expected to be sold – Expected selling price per unit – Variable cost per unit – Fixed costs (in total)

27 27 © John Wiley & Sons, 2005 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcotts Cost Management, 1eSlide # 27 Static Budgets A budget prepared for a single level of sales volume is called a static budget. Static budgets are prepared at the beginning of the year. Differences between actual results and the static budget are called static budget variances.

28 28 © John Wiley & Sons, 2005 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcotts Cost Management, 1eSlide # 28 Performance Evaluation A static budget variance includes effects from output volume. A flexible budget variance removes these output volume effects. Other adjustments to the year-end flexible budget may be made for a fair performance evaluation, such as Input price changes outside the control of the manager under evaluation Fixed cost increases outside the control of the manager under evaluation

29 29 Comparing Actual Results to Planned Results Budget comparisons and variances

30 30 © John Wiley & Sons, 2005 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcotts Cost Management, 1eSlide # 30 Budget Variances Managers compare actual results to budgeted results in order to monitor operations, and motivate appropriate performance. Differences between budgeted and actual results are called budget variances. Variances are stated in absolute value terms, and labeled as Favorable or Unfavorable.

31 31 Actual Vs Budget Actual Budget Variance Sales540, ,000 20,000 F Purchases350, ,000 10,000 U Because it is a positive variance the it is marked with a F. Unfavourable is marked with a U

32 32 Budgets Variance – the difference between planned values and actual values – Positive or Favourable variance – actual figures less than planned – Negative Unfavourable variance – actual figures above planned

33 33 © John Wiley & Sons, 2005 Chapter 10: Static and Flexible Budgets Eldenburg & Wolcotts Cost Management, 1eSlide # 33 Budget Variances Budget variances are investigated. The investigation may find: Inefficiencies in actual operations that can be corrected. Efficiencies in actual operations that can be replicated in other areas of the organization. Uncontrollable outside factors that require changes to the budgeting process.

34 34 Quantity variancePrice variance The difference between the actual price and the standard price The difference between the actual quantity and the standard quantity Standard variances Revenue or Cost Variance Analysis

35 35 Easier than formulas? Sales volume variance – (actual units – planned units) * planned selling price per unit Sales price variance – (actual unit price – budgeted unit price) * units sold Note: Some companies use contribution margin per unit instead of selling price to compute these variances.

36 36 Drilling down further... Sales volume variance can be further analyzed – Are sales more or less than expected because we sold a different mix of products than we planned? – The selling price for each product might also be different than we planned

37 37 Production Variances Direct materials – Price variance – Quantity variance The computations are similar to what we illustrated for sales. You change one element at a time and, from the difference, determine the impact on costs (instead of sales)

38 38 Direct labor – Rate variance – Efficiency variance

39 39 Maybe I can attribute the labour and materials variances to personnel for hiring the wrong people and training them poorly. Responsibility for Labour Variances

40 40 Variable overhead – Spending variance – Efficiency variance

41 41 Fixed overhead – Budget variance – Volume variance

42 42 Performance Reports

43 43 Report financial performance of responsibility centers Cost center Difference between actual results and budget Changes in labour dollars or hours Changes in purchased price vs. quantity discount Revenue center Variance due to selling more or less units than expected Variance due to price changes Profit center – Focus on both revenue and cost variances Copyright (c) 2009 Prentice Hall. All rights reserved.43

44 44 Management by exception – Only material variances are investigated Should focus on information, not blame Some variances are uncontrollable – Examples: increase in costs due to a natural disaster or macro economic issues Copyright (c) 2009 Prentice Hall. All rights reserved.44

45 45 Question 1 Activity Based Costing requires: a.Costs to be allocated to an activity b.Enables management to evaluate its services to customers c.Enables variances to be created on customer focused tasks. d.All of the above Answer: d. All of the above

46 46 Question 2 Job Costing is where: a.Costs are assigned to a particular job b.Often used by Accountants & Lawyers to charge their clients c.Enables accurate control of each job. d.All the above are correct Answer: d.

47 47 Question 3 Process costing is: a.Suitable for controlling costs in a manufacturing environment b.Usually allocates costs by batch then divides them up to get a per unit cost c.Both a and b are correct Answer: c.

48 48 Question 4 Equivalent Units: a.Are a method of assessing ending inventories b.Are calculated by establishing the extent that WIP is completed in terms of finished goods. c.A and B are correct Answer: c.

49 49 Question 5 CVP enables evaluation of: a.The number of units to be sold to break even b.The relationship that total costs have to total revenues c.Both a and b are correct Answer: c

50 50 Question 6 Margin of Safety is: a.The extent that revenues exceed total costs b.Is the extent that profits are above Break Even c.Represent the level of activity that can be lost before losses are sustained d.All above are correct Answer: d.

51 51 Question 7 A flexible budget is: a.A static budget adjusted for volume activity b.Is prepared for several levels of expected activity. c.Both A and B are correct Answer: c.

52 52 Question 8 A variance is: a.The extent that actual has departed from forecast b.Is either Favourable or Unfavourable c.Enables management by exception d.All above are correct Answer: d.

53 53 Question 9 A Sales variance can be: a.Both because of price and quantity b.Can only be a price variance c.Can only be a quantity variance Answer: a. recastrecast


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