Management Accounting

Define "*Controllability*" and How It is Relevant to *Controllable Costs*

"*Controllability* is the *degree of influence* a specific manager has over costs, revenues, or related items for which he/she is responsible" "*Controllable Costs* are any costs that are primarily *subject to the influence* of a given responsibility centre manager" NB: Few costs are clearly under the sole influence of one manager. Also, with a long enough time span, all costs will come under somebody's control.

Define the Following Terms: *Standard Input*, *Standard Price*, and *Standard Cost*

"A *Standard Input* is a carefully determined quantity of input required for one unit of output" "A *Standard Price* is a carefully determined price that a company expects to pay for a unit of input" "A *Standard Cost* is a carefully determined cost of a unit of output"

Define "*Cost Hierarchy*"

"A categorisation of various cost pools on the basis of different cost drivers, cost-allocation bases or different degrees of difficulty in determining the cause-and-effect relationships"

What is a *Learning Curve*?

"A function that measures how labour hours per unit decline as units of production increase because workers are learning and are becoming better at their jobs" NB: Thus nonlinear functions also result from learning curves

What is an *Experience Curve*?

"A function that measures the decline in cost per unit in various business function of the value chain"

What Are *Responsibility Centres* and What Are the *4 Types*?

"A part, segment, or subunit of a an organisation whose manager is accountable for a specified set of activities" 1. Cost Centre 2. Revenue Centre 3. Profit Centre 4. Investment Centre

What is *Customer Relationship Management (CRM)*?

"A type of strategy that integrates *people* and *technology* within all business functions to deepen the relationships with customers, partners, and distributors."

What are "*Inventoriable Costs*"?

"All costs of a product that can be considered as assets in the balance sheet when they are incurred and transform into COGS when the product is sold"

Describe the *Adjusted Allocation-Rate Approach*

"All overhead entries are restated in the general ledger and subsidiary ledgers using actual cost rates rather than budgeted cost rates." NB: Yields the benefits from both the timeliness & convenience of normal costing during the year and the allocation of actual manufacturing overhead costs at year-end

Define the Concept of a *Static Budget*

"Also known as the *Master Budget*, it is based on the level of output planned at the start of the budget period." NB: It is "*static*" because the budget for the period is developed around *a single planed output level*

Define "*Cost Object*"

"Anything for which a measurement of costs is needed or desired"

Describe "*Sensitivity Analysis*"

"Assessing how an outcome will change if the original predicted data are not achieved or if an underlying assumption changes" NB: The goal of sensitivity analysis is to recognise that there is a certain uncertainty level

*Rolling Budgets* can be described as..?

"Budgets that are always available for a specified future period" NB: Also known as *Continuous Budgets*

Describe the *Proration Approach*

"Contrary to the *adjusted allocation-rate approach*, the *proration approach* spreads the under-allocated and over-allocated overhead among ending work-in-progress inventory, finished goods inventory, and COGS"

Define "*Value-Added Costs*"

"Costs that, if eliminated, would reduce the actual or perceived value or utility that customers experience"

Describe "*Lifecycle Budgeting*"

"Estimating revenues and business function costs across the entire value chain from a product's initial R&D to its final customer service & support (i.e. across the *Product Lifecycle*)

What is "*Kaizen Budgeting*"?

"It explicitly incorporates continuous improvement anticipated during the budget period into the budget numbers"

What is the *Margin of Safety*?

"It gives the band within which the 'what if' question of the sensitivity analysis is fulfilled"

What is a *Step Cost Function*?

"It is an example of a nonlinear cost function. It s a cost function in which the cost remains the same over a range of various levels of an activity but the cost increases by discrete amounts as the level of activity increases from one range to the next"

Discuss "*Static-Budget Variance*"

"It is the difference between the actual result and the corresponding budgeted amount in the static budget" - *Favourable Variance* means increased operating income relative to the budgeted amount - *Unfavourable Variance* means decreased operating income relative to the budgeted amount NB: These effects only hold when looking at these variances in isolation

What is *Cost-Volume-Profit (CVP) Analysis*?

"It is used for studying the behaviour of & relationship between *revenues, costs, and income* as changes occur in the *number of units sold, the selling price, variable costs per unit, or the fixed costs* of a product"

What Does the Term "*Responsibility Accounting*" Refer to?

"Looks at the measurement of plans, budgets, actions, and actual results of each responsibility centre" NB: It helps managers to first focus on whom they should ask to obtain information and not on whom they should blame

Define "*Management Accounting*"

"Primarily used for helping managers make decisions. It measures, analyses, and reports both financial and non-financial information." NB: *Cost Accounting* provides the information necessary for management and financial accounting purposes.

Define *Manufacturing Overhead Allocated (or Applied)*

"The amount of manufacturing overhead costs allocated to individual jobs based on the *budgeted rate* × *actual quantities of the cost-allocation base*

Define "*Cost Accumulation*"

"The collection of cost data by means of an accounting system"

What is *Operating Leverage*?

"The effects that fixed costs have on operating income as changes occur in units sold & contribution margin" NB: May also be described as the *Risk-Return Trade-Off* across several cost structures

Define "*Management by Exception*"

"The practice of focusing management attention on areas that are not operating as expected and devoting less time to areas that are"

Define "*Budgetary Slack*"

"The practice of underestimating budgeted revenues or overestimating budgeted costs to make budgeted targets more easily achievable" NB: It provides a hedge against unexpected adverse circumstances

What is a *Budget*?

"The quantitative expression of a proposed plan of action by management for a specified period" - Most useful when integrated with a company's strategy

What are "*Product Costs*"?

"The sum of the costs assigned to a product for a specific purpose." Different purposes can result in different measurements of products costs: - Pricing & product-mix decisions - Contracting with government agencies - Preparing the financial statements

Define "*Strategy*"

"The way in which an organisation matches its own capabilities with the external opportunities to accomplish certain objectives... it provides information about the company's sources of competitive advantage."

What is a *Flexible Budget*?

"When budgeted revenues & budgeted costs are calculated based on *actual output* in the budget period"

Describe the Idea of a "*Balanced Scorecard*"?

"a performance metric used in strategic management to identify and improve various internal functions of a business and their resulting external outcomes" - Promotes *causal thinking* which is a major benefit of this method - Tells the story of a company's strategy, communicates the strategy to all members, limits the number of measures to those that are most critical, highlights less-than-optimal trade-offs that managers may make when operational & financial measures are not considered together

Formula for *Price Variance*

(Actual Price of Input - Budgeted Price of Input) × Actual Quantity of Input = *Price Variance*

Formula for *Efficiency Variance*

(Actual Quantity of Input Used - Budgeted Quantity of Input Allowed for Actual Output) × Budgeted Price of Input = *Efficiency Variance*

Formula for the *Contribution Margin Method* of Analysing CVP Relationships

(Contribution Margin per Unit × Quantity of Units Sold) - Fixed Costs = *Operating Income*

*3 Sectors* of the Economy and the Relevant *Types of Inventory*

*3 Sectors*: Manufacturing, Merchandising, Service *Types of Inventory*: Direct materials, work-in-progress, finished goods, merchandise inventory NB: First 3 types of inventory are relevant for manufacturing companies

Advantages & Disadvantages of *Budgets*

*Advantages*: promotes *coordination & communication* among subunits, provides a *framework* for judging performance and facilitating learning, *motivates* managers & other employees *Disadvantages*: *time-consuming* to appropriately manage the budgeting process, requires *commitment* of all managers & employees within the company

*2* Key Formulas for *Breakeven Point (BEP) Analysis*

*Breakeven Number of Units* = Fixed Costs ÷ Contribution Margin per Unit *Breakeven Revenues* = Breakeven Number of Units x Selling Price

*Contribution Margin Percentage*

*Contribution Margin Percentage* = Contribution Margin per Unit ÷ Selling Price

*Contribution Margin* Formula

*Contribution margin* = Total Revenues - Total Variable Costs NB: For contribution margin per unit, use *selling price* (instead of total revenues) and subtract *variable cost per unit*

Define the Terms "*Cost Driver*" and the "*Relevant Range*"

*Cost Driver*: a variable that can influence costs over a given time span (e.g. level of activity or volume) *Relevant Range*: range in which there is a stable relationship between the level of activity/volume and the cost in question

Describe the terms "*Cost Pool*" and "*Cost-Allocation Base*"

*Cost Pool*: a grouping of individual indirect cost items *Cost-Allocation Base*: a systematic way of linking indirect costs or a group of indirect costs to certain cost objects NB: In the case that the cost object is a job, product, or customer, the cost-allocation base may also be called a *cost-application base*

Mention & Describe the *2* Important *Learning-Curve Models*

*Cumulative Average-Time Learning Model*: looks at the *cumulative average time* per unit decline by a constant percentage each time the cumulative quantity of units produced doubles *Incremental Unit-Time Learning Model*: looks at the *incremental time* needed to produce the *last unit decline* by a constant percentage each time the cumulative quantity of units produced doubles

Formula for *Operating Leverage*

*Degree of Operating Leverage* = Contribution Margin ÷ Operating Income

Describe "*Direct*" and "*Indirect*" Costs

*Direct Costs*: costs that can be traced to a specific cost object in an economically feasible way; assigned to cost objects by *cost tracing* *Indirect Costs*: costs that are related to a certain cost object but *cannot* be traced in an economically feasible way; assigned to cost objects by *cost allocation*

Formula for *Flexible-Budget Variance*

*Flexible-Budget Variance = Actual Results - Flexible Budget Amount*

What is the Difference Between *Gross Margin* and *Contribution Margin*?

*Gross Margin* uses COGS as the cost component, whereas *Contribution Margin* uses ALL variable costs

Describe the Concepts of "*Job Costing*" and "*Process Costing*"

*Job Costing*: appropriate when a cost object is constituted by one or many units of a distinct product/service (job) *Process Costing*: appropriate when a cost object is constituted by masses of identical or similar units of a product or service NB: Best seen as two ends of a continuum

Describe the Different *Levels of Variance Analysis*

*Level 1*: the *static-budget* variance for operating income *Level 2*: *flexible-budget variance for operating income* and *sales-volume variance for operating income* *Level 3*: flexible-budget variance can be further split into *price variance* and *efficiency variance* (e.g. direct manufacturing labour price variance & direct manufacturing labour efficiency variance)

Distinguish Between *Line Management* and *Staff Management*

*Line Management*: concerned with production, marketing, and distribution management *Staff Management*: concerned with management accountants, human resources, and IT

*2* Ways in Which the *Margin of Safety* is Determined

*Margin of Safety* = Budgeted (or Actual) Revenues - Breakeven Revenues *Margin of Safety (in Units)* = Budgeted (or Actual) Sales Quantity - Breakeven Quantity NB: Margin of Safety Percentage = Margin of Safety in Dollars ÷ Budgeted (or Actual) Revenues

What are *Over-allocated* and *Under-allocated* Indirect costs?

*Over-Allocated*: occurs whenever the allocated amount is *greater* than the actual amount in a given period *Under-Allocated*: occurs whenever the allocated amount is *less* than the actual amount in a given period

Provide a Definition for "*Predatory Pricing*", "*Dumping*", and "*Collusive Pricing*"

*Predatory Pricing*: Deliberately setting prices below costs as an effort to drive competitors out of the market *Dumping*: the act of a foreign company to sell products in another country for a lower price than the market value in the country it is produced in *Collusive Pricing*: when companies in an industry conspire in their pricing and production decisions to achieve a price above the competitive price

What is *Price Discrimination*? What is *Peak-Load Pricing*?

*Price Discrimination*: charging different prices to different customers for the same product or service *Peak-Load Pricing*: setting a higher price whenever demand for a product or service approaches the physical limit of the capacity to produce that product or service

Describe *Prime Costs* and *Conversion Costs*

*Prime Costs*: all direct manufacturing costs *Conversion Costs*: direct manufacturing labour costs and manufacturing overhead costs

*Target Operating Income* Formula HINT: For a given target operating income, it is necessary to determine the number of units that must be sold to reach it

*Quantity of Units Required to be Sold* = (Fixed Costs + Target Operating Income) ÷ Contribution Margin per Unit

Define "*Relevant Costs*" and "*Relevant Revenues*"

*Relevant Costs*: expected future costs *Relevant Revenues*: expected future revenues that differ among the alternative courses of actions being considered NB: To be relevant, costs/revenues must *occur in the future* and *differ among the alternative courses of action*

Important Formulae for *Sales-Volume Variance*

*Sales-Volume Variance for Operating Income = Flexible Budget Amount - Static Budget Amount* *Sales-Volume Variance for Operating Income* = Budgeted Contribution Margin per Unit × (Actual Units Sold - Static Budget Units Sold) *Sales-Volume Variance for Operating Income* = *(Budgeted Selling Price - Budgeted Variable Cost per Unit) × (Actual Units Sold - Static Budget Units Sold)

Formula for *Selling Price Variance*

*Selling Price Variance* = (Actual Selling Price - Budgeted Selling Price) × Actual Units Sold

Formula for the *Equation Method* of Analysing CVP Relationships

*[*(Selling Price × Quantity of Units Sold) - (Variable Cost per Unit × Quantity of Units Sold)*]* - Fixed Costs = *Operating Income*

What are the *Building Blocks of Costing Systems*? HINT: There are 5

- *Cost Object* - *Direct costs* of a cost object - *Indirect costs* of a cost object - *Cost Pool* - *Cost-Allocation Base*

*3* Important Costs Involved in the *Manufacturing Process*

- *Direct Material* costs - *Direct Manufacturing Labour* costs - *Indirect Manufacturing* costs: all those costs related to a cost object but which cannot be traced in an economically feasible way NB: 2 other terms for indirect manufacturing costs are *manufacturing overhead* costs and *factory overhead* costs

*4 Methods* to Estimate Costs

- *Industrial Engineering Method* - *Conference Method* - *Account Analysis Method* - *Quantitative Analysis Method*

*2 Approaches* for Pricing Decisions

- *Market-Based* (highly competitive markets) - *Cost-Based* or Cost-Plus (less competitive markets)

*4* Levels of the ABC System *Cost Hierarchy*

- *Output Unit-level Costs*: the costs of activities performed on *each individual unit* of a product or service - *Batch-Level Costs*: the costs of activities related to *a group of units* of a product or service rather than each individual unit of a product or service - *Product-Sustaining Costs*: the costs of activities undertaken to *support* individual products or services *regardless of the number of units or batches* in which the units are produced - *Facility-Sustaining Costs*: these are the costs of activities that *cannot* be traced to individual products or services but that *support the organisation as a whole* NB: Along with these cost hierarchies, costs are *categorised*

*2 Types* of Indirect Labour

- *Overtime Premium*: the wage rate paid to employees in excess of their normal time wage rates - *Idle Time*: wage paid to employees for unproductive time due to a variety of reasons (e.g. lack of orders or machine failures) NB: both are considered *overhead costs* as they are not directly related to a certain good

*Flexible-Budget Variance* Can be Further Subdivided into Which *2* More Detailed Variances

- *Price Variance*: reflects the difference between an actual input price and a budgeted input price (also known as *Input-Price Variance* or *Rate Variance*) - *Efficiency Variance*: reflects the difference between an actual input quantity and a budgeted input quantity (also known as *Usage Variance*)

*Six* Primary Business Functions of a *Value Chain*

- *R&D* - *Design* of Products & Processes - *Production* - *Marketing* - *Distribution* - *Customer Service*

Describe *Sales-Mix Variance* and the Concept of a "*Composite Unit*"

- *Sales-Mix Variance*: the difference between the budgeted contribution margin for the *actual* sales mix and the budgeted contribution margin for the *budgeted* sales mix - *Composite Unit*: a hypothetic unit with weights based on the mix of individual units

Cause-and-Effect Relationships Arise as a Result of *One* of Which *Three Factors*?

- A *Physical Relationship* between the level of an activity and costs - A *Contractual Arrangement* - *Knowledge of Operations*

*Industrial Engineering Method*

- Also called the *work-measurement method* - Estimates cost functions by analysing the relationship between inputs & outputs *in physical terms* - Detailed & thorough, thus can be time-consuming to conduct

Describe the Role of the *Chief Financial Officer (CFO)*

- Controllership - Treasury - Risk management - Taxation - Investor relations - Internal audit NB: The person who is primarily responsible for the management & financial accounting of the firm is the *controller*

What is the *Master Budget*?

- Document at the core of the budgeting process - Expression of management's *operating & financial plans* for a specified period and it includes a set of *budgeted financial statements* - Budgeted financial statements can sometimes also be called *pro forma statements*

*Account Analysis Method*

- Estimates cost functions by classifying various cost accounts as *variable*, *fixed*, or *mixed* with respect to the identified level of activity - To improve credibility, it can be supplemented by the conference method

*Conference Method*

- Estimates cost functions on the basis of *analysis and opinions* about costs & their drivers gathered from various departments of a company - Encourages interdepartmental cooperation - Can be developed quickly as it does not require a detailed analysis of data

*4* Elements of a *Balanced Scorecard*

- Financial Perspective - Customer Perspective - Internal-Business-Process Perspective - Learning-and-Growth Perspective

Describe the Concept of "*Normal Costing*"

- Form of job costing - Traces direct costs to a cost object by using the *actual direct-cost rates* multiplied by the *actual quantities of the direct-cost inputs* - Indirect-cost rates are allocated using the *budgeted indirect-cost rates* multiplied by the *actual quantities* of the cost-allocation bases --> *Budgeted Indirect-Cost Rate* = Budgeted Annual Indirect Costs ÷ Budgeted Annual Quantity of the Cost-Allocation Base

Describe the Concept of "*Actual Costing*"

- Form of job costing - Traces direct costs to a cost object by using the *actual direct-cost rates* multiplied by the actual quantities of the direct-cost inputs - Indirect costs are allocated using the *actual indirect-cost rates* multiplied by the *actual quantities* of the cost-allocation bases --> *Actual Indirect-Cost Rate* = Actual Total Indirect Costs ÷ (Actual Total Quantity of the Cost - Allocation Base)

Describe *Activity-Based Management (ABM)*

- It is a method of management decision-making that uses activity-based costing information to improve *customer satisfaction* & *profitability* - Activity-based costing systems are used for decisions that concern *pricing & the product-mix*, *cost reduction & process improvement*, *design*, and *planning & managing*

Describe the *Regression Analysis Method* of Quantitative Analysis

- It is a statistical method that measures the average amount of change in the dependent variable associated with a unit change in one or more independent variables - *Simple Regression* looks at the relationship between the dependent variable and one independent variable - *Multiple Regression* looks at two or more independent variables - The difference between the actual cost & estimated cost for each observation of the cost driver is reflected in the *Residual Term*

*Quantitative Analysis Method*

- Makes use of a *formal mathematical method* to fit cost functions to past data observations - There are two techniques: the *High-Low Method* and *Regression Analysis*

What is *Variance Analysis*?

- Often used to evaluate employees - Assesses the *effectiveness* & *efficiency* of the employee - The former implies looking at the degree to which a predetermined objective/target is met, the latter means looking at the relative amount of input used to achieve a given output level - Favourable variance does not always imply "good news": the *purpose* of variance analysis is to understand *why* variances arise, to *learn* and to *improve future performance*

Describe *Activity-Based Costing (ABC)*

- One of the best methods for refining a costing system - Identifies *individual activities* as the fundamental cost objects - "*Activity*" includes events, tasks, or units of work with a *specified purpose*

What is a *Refined Costing System*?

- Reducing the use of broad averages for assigning the cost of resources to cost objects - Provides more accurate measurements of the costs of indirect resources used by the different cost objects

Describe the *High-Low Method* of Quantitative Analysis

- Simplest form of Quantitative Analysis, aims to fit a straight line to data points - Line is estimated using the format *y = a + bx* - Slope (coefficient "b") is calculated as: *Slope Coefficient* = Difference Between Costs Associated with Highest & Lowest Observations of the Cost Driver ÷ Difference Between Highest & Lowest Observations of the Cost Driver

*3 Features* of Cost Accounting & Management

1. *Calculating the cost* of products, services, and other cost objects 2. Obtaining information for *planning, controlling, and performance evaluation* 3. *Analysing* the relevant information for making decisions

*5 Steps* for Developing Target Pricing & Cost Under the *Market-Based Approach*

1. *Develop a product* that satisfies the needs of potential customers 2. Choose a *Target Price* 3. Derive the *Target Cost* per unit by subtracting target operating income per unit from the target price 4. Perform *Cost Analysis* 5. Perform *value engineering* to achieve target costs NB: *Value Engineering* refers to the systematic evaluation of all aspects of the value chain with the objective of reducing costs and achieving a quality level that satisfies customers

*3 Methods* to Analyse CVP Relationships

1. *Equation* Method 2. *Contribution Margin* Method 3. *Graph* Method

Describe the *Decision-Making Process* HINT: 5 steps

1. *Identify* the problem & uncertainties 2. Obtain *information* 3. Make *predictions* about the future 4. Make *decisions* by choosing among alternatives 5. *Implement* the decision, *evaluate* performance, and *learn* NB: First *4* steps are collectively referred to as *planning*. The *budget* is a quantitative expression of the proposed plan. *Control* is concerned with taking actions to implement the decisions, deciding about an evaluation plan, giving feedback, and learning to improve future decision-making (i.e. step 5)

*3 Factors* That Influence the *Classification* of Costs as Direct or Indirect

1. *Materiality* of the cost in question 2. Available *information-gathering technology* 3. *Design* of operations

*3 Criteria* to Determine the Nature of Costs (Fixed/Variable)

1. Choice of *Cost Object* 2. *Time Horizon* 3. *Relevant Range*

*4* Possible Classifications of Costs

1. Direct & Variable 2. Direct & Fixed 3. Indirect & Variable 4. Indirect & Fixed

*3 Criteria* to Decide Which Cost Drivers Need to be Used in a Cost Estimation Method

1. Economic Plausibility 2. Goodness of Fit 3. Significance of the Independent Variable

*7-Step* Job Costing Approach

1. Identify the job that is the chosen cost object 2. Identify the direct costs of the job (direct materials & direct manufacturing labour costs) 3. Select the cost-allocation bases to use for allocating indirect costs to the job 4. Identify the indirect costs associated with each cost-allocation base 5. Compute the rate per unit of each cost-allocation base used to allocate indirect costs to the job 6. Compute the indirect costs allocated to the job 7. Compute the total cost of the job by adding all direct and indirect costs assigned to the job

*3 Principle Reasons* for Refining a Costing System

1. Increase in *product diversity* 2. Increase in *indirect costs* 3. *Competition* in product markets

*4 Steps* of the *Budget Process/Cycle*

1. Managers & management accountants plan the performance of the company as a whole and the performance of its subunits 2. Senior managers give subordinate managers a frame of reference: expectations against which actual results are compared 3. Management accountants help managers take into account market feedback, changed conditions, and own experiences as they begin to make plans for the next period 4. Management accountants help managers investigate variations from plans, such as an expected decline in sales

*2 Consequences* of Averaging With Respect to Costs

1. Product Under-Costing 2. Product Over-Costing NB: This will eventually lead to other mistakes. For example, *Product-Cost Cross-Subsidisation* can occur and implies that when a company under-costs one of its products, it will over-cost at least one of its other products, and vice versa.

*2* Reasons for Using *Longer Periods* When Dealing With *Indirect Costs*

1. The *Numerator Reason* (Indirect Cost Pool): the shorter the period becomes, the greater the influence of seasonal patterns on the amount of costs 2. The *Denominator Reason* (Quantity of the Allocation Base): to avoid spreading monthly fixed indirect costs over fluctuating levels of monthly output and fluctuating quantities of the cost-allocation base

*2 General Assumptions* for *Cost Functions*

1. Variations in the level of a single activity explain the variations in the related total costs 2. Cost behaviour is approximated by a linear cost function within the relevant range

What are "*Period Costs*"?

All costs included in the income statement other than COGS

Formula for *Sales-Quantity Variance*

Budgeted Contribution Margin Based on Actual Units Sold of All Products - Contribution Margin in the Static Budget = *Sales-Quantity Variance*

What is the Key Formula for the *Cost-Plus Approach*

Cost Base + Markup Component = *Prospective Selling Price*

How Can a *Markup Component* be Determined for the *Cost-Plus Approach*?

The *Markup Component* is determined by setting a *Target Rate of Return on Investment* (= Operating Income ÷ Invested Capital)