Management Accounting Training

MANAGEMENT ACCOUNTING TRAINING FOR TRAINEES

2

Compiled by: Prof. Rashied Small, Prof. Jade Jansen,

Prof. Yaeesh Yasseen, Zuhayr Dollie & Lucinda Smidt

Management Accounting Training

Introduction

Management Accounting Training 3

Cost & Management Accounting

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Management Accounting

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Management or managerial accounting is the process of identifying,

analysing, recording and presenting financial information that is used

internally by management for planning, decision-making and control.

Cost Classification & Cost Behaviour

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Cost Classification - Content

▪ Overview of cost classification

▪ Defining the cost object

▪ Identifying direct and indirect costs

▪ Identifying variable and fixed costs

▪ Separate costs for mixed costs

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Cost Classification - Overview

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Cost Object

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Cost Object:

Any activity for which a separate measurement of cost is undertaken

Cost Centre:

A production or service location, function activity or item of equipment for

which a cost can be ascertained

Cost Unit:

A unit or product or service in relation to

which costs are ascertained

Cost & Expenses

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Cost & Expenses

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Direct & Indirect Costs

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Direct & Indirect Costs

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Direct & Indirect Costs

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Direct costs

Materials used in the manufacture of

products (bricks, sand & cement used in

construction)

Salaries & wages paid to the production

staff – actively involved in the

manufacturing process (construction

employees)

Indirect costs

Cost accountant who administers all the

products undertaken by the business

Salaries paid to the project manager

who supervisors a number of projects in

the construction industry

Cost Behaviour

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Cost Cost Behaviour

Material

cost

Material costs changes as the number

of units produce changes – direct

relation between materials used and

output

Factory

rent

Rental for the factory will not be

affected by the number of units

produced – floor space has not

relationship to output

Salaries

paid

Salaries is challenging when

determine cost behaviour as it is

affected by the basis of payment – if

the basis in not linked to output then it

does not change in relation to

changes in output

Variable Cost

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Testing for Variable Costs

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Fixed Costs

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Testing for Fixed Costs

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Profit Maximisation

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Profit Maximisation

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Profit Maximisation

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Mixed Cost

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Testing for Mixed Costs

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Units 5,000 10,000 20,000

Total cost 20,000 30,000 50,000

Average cost per unit 4.00 3.00 2.50

Based on the average cost per unit, the cost is not a variable cost as the

average cost per unit changes in relation to the level of output – variable

cost is fixed per unit

Change in output 100% 100%

Change in average cost 33% 20%

Based on the change in the output and change in average cost per unit, the

cost is not a fixed costs as there is not a direct relationship between the

change in output and change in cost – changes in fixed cost represent an

inverse proportionate change in output and cost

Mixed Cost – Separation of Costs

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Mixed Cost – High-Low Method

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Selecting information for the

higher & lowest periods

Determine the difference between

the outputs and costs

Calculating the average per unit

based on the differences

Highest Lowest Difference

Output 60,000 80,000 20,000

Total cost 580,000 640,000 60,000

Average cost per unit 3.00

Total variable cost 180,000 240,000

Total fixed cost 400,000 400,000

Total cost 580,000 640,000

Absorption & Marginal Costing

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Absorption & Marginal Costing -Content

▪ Job and process costing

▪ Allocation fixed costs

▪ Activity-based costing

▪ Absorption and marginal costing

▪ Under/over absorbed costs

▪ Reconciliation of profits

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Job and Process Costing

Job Costing

▪ One or more jobs/work in a

process account

▪ Costs are determine for each

job

▪ Job cost sheet is the primary

document

▪ Unit cost is computed by

accumulating the costs

incurred for the job

Process Costing

▪ Work-in-progress account for

each department

▪ Costs are determined by the

department

▪ Production cost report is the

primary document

▪ Unit cost is computed by

accumulating the department

costs

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Process Costing Systems

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Allocation of Production Costs

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Allocation of Production Costs

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Basis of Allocating Costs

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Basis of Allocating Costs

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Basis of Allocating Costs

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Labour Intensive Capital Intensive

Overhead costs 562,500 Overhead costs 562,500

Labour hours 90,000 Machine hours 100,000

Pre-determine overhead

rate 6.25

Pre-determine overhead

rate 5.62

Actual labour hours 50,000 Actual machine hours 50,000

Applied overhead costs 312,500 Applied overhead costs 281,250

Activity-based Costing (ABC)

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Traditional Costing & ABC

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Allocation of Service Department Costs

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Allocation of Costs –Direct Method

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Allocation of Costs –Step-Down Method

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Service 1 Service 2 Dept. A Dept. B

Total cost 120,000 200,000 250,000 390,000

Dept. A 30% 60%

Dept. B 50% 40%

Service 2 20%

Service 1 (120,000) 24,000 36,000 60,000

Subtotal 224,000

Service 2 (224,000) 134,400 89,600

Product cost nil nil 420,400 539,600

Product Costing

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Absorption & Marginal Costing

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Absorption & Marginal Costing

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Cost Absorption Marginal

Direct material costs 25.00 25.00

Direct labour costs 10.00 10.00

Variable overhead costs 3.00 3.00

Fixed overhead costs 5.00 -

Product cost 43.00 38.00

Absorption & Marginal Costing

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OAR – Using Normal Capacity

Basis of calculating the overhead absorption rate:

▪ OAR – represents the standard costing base of allocating

overhead costs for a specified period.

▪ Normal production capacity is used to reflect the rate that should

be allocated for the specified period – constant and consistent

rate must be applied.

▪ If the budgeted or actual capacity changes significantly from the

normal capacity then the normal capacity must be reviewed and

adjusted if necessary.

▪ However if the change is due to special circumstances, such as a

special order, then the normal capacity should not be adjusted.

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Under/Over Absorbed Costs

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Under/over absorbed costs

▪ Under absorption costing inventory is measured based on the

total cost – including the overhead absorption rate.

▪ Profit is calculated based on the actual overheads incurred for the

period.

▪ Variance between the applied costs (inventory valuation) and the

actual costs represents the under/over absorbed costs.

▪ Applied costs is calculated by applying the overhead absorption

rate to the actual output (flexible budget).

▪ Under/over absorbed costs can be treated as:

(a) set-off to the cost of goods sold

(b) Treated as an operating expense or income

Under/Over Absorbed Costs

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Under/Over Absorbed Costs

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Reasons of absorbed cost variances

▪ Errors in estimating the overhead

expenses

▪ Errors in estimating the normal

capacity/output

▪ Unforeseen changes in the production

capacity

▪ Seasonal fluctuation in the overhead

expenses

▪ Overhead rate may be applied to the

normal capacity which may be less

than the full operating capacity

Reconciliation of Profits

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Reconciliation of Profits

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The OAR was R5.00 and the variable production costs were R25.00. The actual

production was 100,000 units of which 20,000 were unsold; and the total fixed

production costs of R480,000.

Absorption Marginal

Sales (selling price of R 50,00) 4,000,000 4,000,000

Variable production costs 2,500,000 2,500,000

Fixed production costs (applied) 500,000 NIL

Inventory on hand (R30.00 & R25.00) (600,000) (500,000)

Gross profit 1,600,000 2,000,000

Manufacturing costs NIL 480,000

Over absorbed costs (500,000 – 480,000) 20,000 NIL

Profit 1,620,000 1,520,000

OAR including in inventory (20,000 x 5) 100,000

Reconciliation of Profits

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Production Wastages

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Production Wastages

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Operating Budgets

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Operating Budget - Content

▪ Introduction

▪ Using budgets to improve performance

▪ Risks and budget failures

▪ Budgeting methods

▪ Forecasting

▪ Operating budget

▪ Cash budget

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Introduction

▪ Budgeting is a planning tool used by management to quantify the

action plans of the organisation – financial plan.

▪ Budgeting is a is a tool used by management to allocate

resources to achieve the goals of the organisation in the most

effective and efficient manner.

▪ Reasons for Budgeting:

• Control – control the implementation of budget and activities

• Allocation of resource – facilitate the allocation of resources

as the budget is adjusted

• Monitoring – tracking the progress towards achieving goals

• Evaluation – evaluate performance of staff and departments

• Risk management – facilitate the mismanagement of

resources and wasteful expenses

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Introduction

▪ Purpose of Budgeting:

• Resource planning – allocation of resources to achieve goals

economically and efficiently.

• Financial planning – financial forecasting and activities.

• Financial control – control over the costs for the activities of

the business.

• Communication – facilitate the organisation wide

communication of the strategies & goals.

• Motivating staff – motivation for staff to achieve performance

levels (agreed KPI).

• Conflict resolution – facilitate resolving conflict between

departments and groups in the organisation.

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Budgeting – Improving Performance

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Risks Associated with Budgets

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Pressure from senior management – affected by budgetary process

Internal conflict – conflict between departments and management for budget approval

Lack of alignment with strategic goals – operational conflict and budget reductions

Over-budgeting – providing for wasteful expenses (inflate budgets) to absorbed possible reductions

Causes of Budget Failures

Reasons Budgets Fail

• Lack of clear purpose of budgets – performance measure vs

strategies planning.

• Unrealistic expectations – lack of detailed planning in setting

budgetary goals.

• Improper communication – lack of information about the

budgetary process and the budgets.

• Improper metrics – lack of proper monitoring and evaluation

processes.

• Top-down cost allocation – cost are allocated with negotiations or

agreement.

• Fixed budget – budgets are viewed as cast in stone and cannot

be changed (agility of budgets).

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Budgeting Process

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Effective Budgeting Process

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Structure: Strong organisational structure promotes authority, responsibility & accountability

Research: research and analysis of data and environment promotes goal driven operations

Approval: acceptance of budgets at all levels promotes commitment and motivation to implement

Monitoring: regular and continuous monitoring and evaluation ensures risks are identified and action taken

Budgeting Techniques

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Incremental Budgeting:Current budget is prepared by

making adjustments to the previous budget or actual

results by considering inflation and economic factors

Traditional Budgeting:Current budget is based on

previous budgets as a baseline, while adjustments are made for inflation rate,

market situation, demand, etc.

Activity-based Budgeting:A budgeting method where the

budget based on the cost drivers and requires an in

depth analysis of the business activities

Zero-based Budgeting:Current budget is prepared

from scratch without considering previous budget or

results

Budgeting Methods

Forecasting Techniques

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Master Budget

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Sales Budget

Production Budget

Direct labour

Budget

Direct materials

Budget

Manufacturing

overheads Budget

Selling & Administrative

expense Budget

Budgeted income

statement

Capital Expenditure

BudgetCash Budget Balance sheet

Budget

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Financial Budget

Sales Budget Process

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Market share & competition

Market trends & product life cycle

Price sensitivity & substitute products

Advertising & promotion strategy

Historical performance &

changes in technology

Production Budget

• Production budget is based on the

costs associated with the

manufacturing process (variable

and fixed costs)

• Production consists of a resource

requirements budget as well as a

cost budget

• Materials and labour cost budgets

must take into account the normal

wastages occurring in the

production process

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Production Budget - Inventory

• Inventory budgets should be based on the inventory management

strategy of the organisation

• Inventory budgets is driven by the sales strategy of the

organisation

• Inventory budget must account for the risk associated with the

warehouse management

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Units

Sales volume budget XXX

Add: Closing inventory plan XXX

Add: Inventory shrinkage/loss XXX

Subtotal XXX

Less: Opening inventory XXX

Inventory purchase/production requirement XXX

Cash Budgeting

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Statement of Cash Flow Cash Budget

Report on management of the past

cash flows

Planning of the cash flow for the

coming period

Report on the effective

management of cash flows in

strategic areas

Planning of cash flows for

operating & transactional activities

Used to review the cash flow

performance of the business

Used to plan cash flows and

utilisation of resources to achieve

the operating goals

Used to evaluate the performance

of management is controlling the

liquidity risk of the business

Used to monitor and evaluate

utilisation of cash to maintain the

liquidity status of the business

Cash Budgeting

• Conversion of operating and capital expenditure budgets to a

periodic cash flow plan.

• Excludes all non-cash transactions such as depreciation, bad

debts and accruals.

• Transactions are inclusive of VAT and the payment of VAT is

treated as a separate.

• Cash flows from customers and suppliers is based on the

payment terms.

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Break-even Analysis (Cost – Volume-Profit)

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Break-even Analysis - Content

▪ Introduction

▪ Difference between profit and contribution

▪ Calculation of break-even point

▪ Break-even points with targeted profit

▪ Break-even points for multiple products

▪ Break-even points with production constraints

▪ Preparation of a production plan

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Profit vs Contribution

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Break-even Analysis

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Beak-even Point

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Break-even with Target Profits

Total Target Profit:

▪ The total target profit is treated similar to the fixed costs when

calculating the break-even point

(Total fixed costs + Target profit)

Contribution per unit

Target Profit per Unit:

▪ The target profit per unit is treated similar to variable costs when

calculating the break-even point Total fixed costs

(Contribution per unit – target profit)

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Break-even – Multiple Products

▪ If the fixed costs are maintained separately for each product,

then the break-even point can be determined independently.

▪ If the fixed costs are not maintained separately for each product,

then the break-even point should be determined based on the

weighted average contribution per unit

▪ The basis of allocating weights to each product depends on

the product/sales mix, nature of operations, resources used,

etc.

Total fixed costs

Weighted average contribution

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Break-even with Constraints

Production without Constraints:

▪ Profit is maximised by producing and selling products with the highest contribution margin.

▪ Products are ranked based on their contribution – profitability ranking.

Production with Constraints:

▪ When there are production constraints then the planned production may not be achieved – scarce resources.

▪ Products are ranked based on their contribution per constraint (contribution per usage of the scarce resource).

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Break-even with Constraints

Resource Allocation:

▪ Under conditions of production constraints, the resources are

allocated to products based on their contribution per constraint

Contribution per Constraint:

▪ The contribution per constraint measures the profitability based on

the utilization of the scarce resource.

Contribution per unit

Usage per constraint

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Relevant Costing

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Relevant Costing - Content

▪ Introduction

▪ Types of relevant costs

▪ Applying relevant cost to make investment and operating

decisions

▪ Applying relevant costing methods for material costs

▪ Applying relevant costing methods for labour costs

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Introduction

▪ Relevant costing attempts to determine the objective cost of a

business decision. An objective measure of the cost of a

business decision is the extent of cash outflows that shall result

from its implementation. Relevant costing focuses on just that

and ignores other costs which do not affect the future cash flows.

▪ The principle of relevant costing is primarily applicable where

decisions have to be made - inclusion of irrelevant information

during the process, could lead to the incorrect decision being

made.

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Relevant Costs

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Decision-Making –Differential Costs

▪ Make or Buy decision

▪ Compare relevant costs for the alternatives

▪ Only recognise the differential costs

▪ Consider the opportunity and avoidable costs

▪ Discontinuing decisions

▪ Determine the opportunity and avoidable cost

▪ Identify the irrelevant costs

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Identifying Relevant Costs

▪ Any costs that is a future cost or cash flow

▪ Any cost that differ amongst alternatives and that will

influence the outcome/decision

▪ Future costs and revenue that differ amongst alternative

options

▪ Compare to indicate how they differ under each

alternative

▪ Sunk costs are never relevant costs

▪ Any cost that is avoidable

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Relevant Costing - Assumptions

▪ All variable costs are relevant costs

▪ All fixed costs are sunk costs

▪ Unit costs:

▪ Based on absorption costing and include irrelevant

costs

▪ Unit costs are fixed irrespective of the level of

production – economies of scale

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Relevant Costing - Material

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Relevant Costing - Materials

Management Accounting Training 88

Relevant Costing - Labour

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Questions?

Public Sector Financial Reports 90

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91Management Accounting Training