Management Accounting

Which considerations should the company's management make when a standard is settled in the budget?

- The company should consider how to use the standard. Is it ok f. inst. to deviate from the standard? - The level of the standard should be considered, realistic, or should you fight for it, and how much should you fight? - Standards often freeze expectations and practice. Do you want that, or should you think about how to encourage new ideas and constant improvement?

Explain how the flexible budget is calculated and which variance you get by subtracting the flexible budget from the static budget.

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During process-costing, we can use two different methods to assign costs: FIFO (first in - first out) and WA (weighted average). Describe what differences can be observed in the accounts depending on which method is used.

. In the FIFO model, as the name indicates, the materials first arrived in stock will first be used. From an accounting point of view, it has the consequence that a possible extraordinary high purchase price in one single month quickly "gets out of the system", and that our valuation of the stock quickly gets back to normal again. Under WA (weighted average), we will take out goods proportionally, proportional to the amount that is in stock. If half the products are at a high price and the other half are at a low price, we will take out the same amount of each. This means that a purchase at a high price in one single month can be traced in the accounts for many months to come. Thus, the cost for our materials is affected for many months to come.

Account for the 5 overriding purposes of the accounting system

1. Formulate strategies and long-term plans 2. Allocation of resources 3. Planning and control of activities 4. Performance measurements and evaluation of employees 5. Fulfil demands on external reporting

Account for the concept "Cost object" and the use of it

A "Cost object" is any item of which we should like to measure costs / profitability. It could be a product, a product line or a department.

Into which 4 main groups are measurements in Balance Scorecard often divided?

A Balanced Scorecard typically consists of four main groups: the learning and growth perspective, the internal process perspective, the costumer perspective and the financial perspective.

Give two examples of a cost driver

A cost driver is a cost allocation base - a factor, which links systematically an indirect cost to a cost object. Page 34 in the textbook gives more examples. We have learned about cost drivers in Ch. 2, 3 and 11. Examples are machine hours, wage hours, no. of products, no. of set-ups, no. of production changes, no. of square meters etc. I.e. we take f. inst. DKK 100,000 and divide according to machine hours, which are totally 1000. I.e. DKK 100 per machine hour. Then we divide our costs according to which products that use how many machine hours.

Define the concept Cost object.

A cost object is "something" for which you want to allocate costs. It is the 3 primary output of the company. A cost object is typically a product, but it can also be a customer or a customer group. As a starting point the cost object is attached to what we sell, i.e. costs attached to production of products which are sold.

Explain the concept "Cost object".

A cost object is a product or a customer that creates turnover for the company. In connection with cost management, we are interested in allocating costs to cost objects with a view to estimating the profit for the individual cost objects.

Explain the concept of "Cost object".

A cost object is something we want to be able to make a financial calculation of. It can be a product, a product line, a department etc.

Explain what a joint cost is, and explain how the cost can be allocated to the products by means of the "sales value at split-off" method and the "physical measure" method (where the weight is used in the physical measure method).

A joint cost is a cost that cannot be allocated to the products at which the cost relates. F. inst. distillation that creates more products (main product and by-product), where the cost creates more products at the same time. Therefore, the allocation is difficult, because the products do not "draw" on the cost, and in this way, a good allocation base cannot be found. 4 Sales value at split-off: split-off is a point where products resulting of the process can be identified separately. Sales value at split-off allocates the overheads from the sales price of the products at the time of split off. The total sales value of all the products is calculated, and according to their share of the total sales value, the overheads are allocated to the products. Physical measure: The overheads are allocated from a physical measure of the products resulting of the process. F. inst. their weight (weight compared to total weight) or their volume (compared to total volume).

How is "a standard" in budgeting to be understood?

A standard is an in advance established fixed resource consumption and a price of a component, an activity or the like.

What does it mean that a cost is a Step-variable cost? Give a concrete example.

A step-variable cost is revised in leaps, most often because the capacity limit for a specific capacity is reached. Thus, the cost is increased at a particular production level. Up until the next capacity level, the costs will be fixed. An example could be a cafe where a waiter can serve 20 tables. In the interval 0 - 20 tables, the cafe can make do with one waiter. In the interval 0 - 20 tables, the wage cost for the waiter is fixed regardless of the activity level. If they want to increase the activity level to more than 20 tables, they will need to hire an additional waiter. This means that going from 20 to 21 tables, the wage costs rise, whereupon the total wage costs are again fixed (two waiter salaries).

Explain the basic principles of Target Costing.

A target cost is the estimated long-run cost per unit that, when sold at the target price, enables the company to achieve the target operating profit per unit. To derive the target cost, we first choose a target price based on customers' value for the product and the company's target operating profit per unit. The target cost is then determined by subtracting the target operating profit per unit from the target price. Usually, value engineering is performed to reduce current cost estimation to achieve target cost by analysing all value-chain business functions.

Explain how costs are allocated to cost objects in the "activity based costing" method.

ABC focusses on the activities that relate to a product, a cost object (e.g. a product, a service or a customer). Indirect costs are allocated to the activities, which are also called cost pools or activity cost pools, and for each activity, a cost allocation base/cost driver is calculated. Then, the indirect costs are allocated from the activities to the cost objects via their draw on the activities.

Explain how costs are allocated to cost objects in the "single rate cost allocation" method.

All indirect costs are placed in a pool, and an allocation base is calculated which is used to allocate the costs to the cost objects. There is no division of variable and fixed costs; all are placed together in this pool, which are then allocated.

What is Activity Based Costing (ABC)?

Allocates overhead based on use of activities. Results in more accurate product costing and scrutiny of all activities in the value chain.

How do we define and calculate ROI and EVA?

ROI = income / investment Income is typically the operating income EVA = operating income after Tax - (WACC x (total assets - short-term liabilities)

Explain which responsibility center an internal IT-department (which services the IT in a company) typically is organized as, and which performance targets such a responsibility center normally makes use of.

An internal IT-department will typically be organized as a cost centre. As it is an internal IT-department, you typically are of the opinion that the superior role of the department is that IT works in the company. I. e. the dept. is not to consider whether it pays, and they are also not to consider selling services to others outside the company. The dept. is to service IT, so the staff can perform their job. By making the IT manager responsible for costs to IT you define a financial frame for the IT-services in the company. To secure that all the money is not used for cola and pizza the IT-dept. will typically be measured on a series of non-financial service targets. It can be: how much of the working time networks function, how long time does it take to fix PC errors on a user's PC, etc.

Explain in your own words the concept opportunity cost and give a specific example.

An opportunity cost indicates that the asset you have maybe could have been used in another way. An important management task is therefore constantly to compare your present surplus target up against an alternative use. If the alternative is better, then you should choose this alternative instead of the present. An example would be a company producing at full capacity.

Explain why you should be careful calculating with "unit costs"

As long as we calculate with variable costs, there is no problem working with unit costs. The problem arises when we start distributing fixed costs on units. The unit cost appearing in this case is only valid for the present production size. If we multiply these total unit costs at other production sizes, the figures will not be correct anymore.

Explain the joint cost problem and how the sales value at split-off method mitigates this.

At joint cost production the challenge is to allocate the joint costs that are added before the split-off time, which are where the products are produced differently. F. inst. growing of tomatoes is processed further to tomato in a can and ketchup. The growing of tomatoes is then the joint production for which there are joint costs. The problem is that there is no logical connection (in the textbook the cause-effect criteria is mentioned) between extraction of the product - here tomatoes - i.e. the joint costs and the final products. Therefore, another logical connection has to be found. The sales value method takes as starting point the sales value of the end products. In this example tomato in a can and ketchup. Here, a weighting of the sales value is made, which it the weighting that is used for allocation of joint costs.

Describe the three most important factors that should be considered in connection with the price determination.

At price determination, the three most important factors are customers, competitors and costs. It is important to understand the perspective of the customers to be able to determine prices correctly. A price increase can f. inst. cause the customers to deselect a company's product. How the competitors take action also influences price determination, as market structure and number of competitors are decisive for our possibilities of price determination. I. e. an analysis of competition is essential before we increase or decrease the price to be able to understand how the market takes action afterwards. Costs are important, as of course we want to have our costs of our turnover covered. Here it is important to have knowledge of the cost structure and price variants - i. e. when a discount is granted etc.

Define the concepts: relevant revenue and relevant costs and explain how the concepts are connected to decision-making in a company.

Basically, we talk about decision-relevant information. By this we mean turnover or costs that are changed as a consequence of a given decision. When decisions have to be made from a financial rationale, then we want to find out which financial effect a given decision will get. When we isolate changed turnover and changed costs and look at the total effect of the decision, then we can see in isolation whether the decision can be expected to improve or worsen our economy.

Why is market-based transfer pricing the most congruent transfer pricing in markets with perfect competition?

Because the selling department of the company will get an incentive to be cost-effective, so their unit costs get down at market level. If they cannot get down there, the company ought to buy from the market, as it will be cheaper for the company. The buying department will get its products/services delivered from the other department at the market price, and if the selling department cannot make money at it, the buying department ought to get the possibility of buying the product/service in the external market instead, as it will be cheaper and in this way they can reduce their costs and make more money. Besides, the market-based price is difficult to manipulate, contrary to cost-based transfer pricing.

Why would we like to allocate indirect costs to cost objects?

Because we should like to have as accurate a picture as possible, i.e. knowledge about what our cost object costs. As today, there is a bigger and bigger pool of indirect costs in the companies, it is important to try to allocate these to the cost object primarily to be able to fix a price correctly. But also to be able to plan and budget correctly and in this way make the right decisions. (We have addressed the topic regularly).

Define the Break-Even Point (BEP) and what it can be used for. Please indicate the formula of the BEP sales volume either in quantity or sales revenue.

Break Even is the point where the result before tax is equal to zero. I. e. at the Break-Even Point sale minus variable costs are equal to fixed costs. We can calculate Break Even by means of three methods: the mathematical, contribution margin and graphic method. We use most the contribution margin method - we have focused on this method in class. The formula for this is (sales price per unit x number of units) - (variable unit costs x number of units) - fixed costs = result.

Explain briefly the pros and cons of variance analyses

Budget variance analyses are fundamentally about decomposing the superior deviations in a flexible budget where you take into account deviations in the activity level and then conclude the real price and efficiency deviations. Pros: - Amounts are put on the single deviation effects that often pull in different directions. - Give basis for correction of actions based on the actual reason for the deviations. - Give basis for promoting or punishing on a more real basis. Cons: - Demands a little more calculation - Is best on variable costs, as the deviation calculations are based on the connection Cost = # produced x (price per raw material unit x # raw material unit per finished good produced). When we talk capacity costs then the logical connection falls apart and therefore we cannot conclude on our calculations in the same way. - The use of standards can make our production static, i.e. we aim at a level whose prerequisites belong to the past, but what if the prerequisites of the present are something else?

The companies' results can be measured by means of Non-financial performance measures. What is understood by Non-financial performance measures? Give two further examples for Nonfinancial performance measures that can be used in a grocery shop. You must substantiate the examples by explaining how your examples can make visible the value creation in the shop.

By non-financial performance measures we understand a quantified measure of actions or effects of actions attached to concrete actions or processes that are believed to have an effect on the future income of the company. The measures are made in other units than money. In a grocery shop you could f. inst. measure no. of goods per customer. Such a measure says something about the type of 3 purchase that is made. Few goods maybe indicate not very planned purchases and maybe thereby possibility of making additional sales in the form of "impulsive campaigns". The big trolley maybe indicates a more considered purchase. On the cost side, few goods will result in a relatively long time of service to make the payment, as this money transaction must be expected to take the same time independent on whether there is to be paid a large or small amount. This sort of information can maybe be used for considering whether other forms of payment should be used. F. inst. in the chain Fakta where you can pay by means of an app, i.e. basically it is the customer who handles the cash register himself. Another measure could be wastage rate. I.e. how big a part of the purchased goods needs to be discarded due to exceeding their best before date. This measure gives an impression of how good one has been to predict the demand for goods. However, the downside to such a measure is that maybe you start ordering fewer goods, and then maybe some customers return empty-handed. This loss the wastage rate does not detect, so here there might be a possible pitfall in relation to use of non-financial performance measures.

Describe the concept; opportunity cost.

By taking one opportunity, you sacrifice earnings at another opportunity. This is called an opportunity cost. This happens at scarce capacity that we have to choose which orders we want to produce rather than possible other orders. We lose earnings at the orders we deselect. I.e. it is a fictitious cost and not a cost that is evident from the accounts. This was addressed in Ch. 10 but also sporadically during the lectures.

How do we calculate contribution margin and why is it an important measure in management accounting?

Contribution margin is revenue less variable costs. It shows what is left to cover fixed costs. We are interested in the contribution margin because it is what we can influence in the short term (revenue and variable costs). In the short term, production can continue as long as a positive contribution margin can be generated. In the case of scarce resources, the company's operations are optimized by producing the product that yields the largest CM per unit of constraining factor. In cost-volume-profit analyses we see that we work a lot with the contribution margin as it is the amount that covers our capacity costs and that we can influence in terms of marketing campaigns, sales price changes etc.

What does controllability mean for performance measurements?

Controllability means that people in a company can be measured, evaluated and held accountable for aspects of the company that they have the ability to influence. F. inst. a teacher cannot be responsible for the students´ grades, as the students´ grades to a high degree are influenced by factors outside the sphere of the teacher.

Account for the concepts "Cost tracing" and "Cost allocation"

Cost tracing is to relate the direct costs to the cost object. Cost allocation is to distribute indirect costs and cost objects from a predestined cost driver, typically; no. of units, labour costs, material costs or activities (in ABC).

Explain what input price variance and input efficiency variance express

Input price variance expresses how big a part of the flexible budget variance, the variance in the price of input, i.e. f. inst. raw materials, accounts for. Page 3 of 10 Input efficiency variance expresses how big a part of the flexible budget variance, the variance in the input consumption (i.e. f. inst. the consumption of raw materials per unit produced), accounts for

Give two examples of transactions that are treated differently in a cash budget compared to a budgeted profit statement.

Depreciation is a cost that is included in a profit statement but not part of the cash budget. For example, when a firm buys a new machine in cash, this disbursement of cash is accounted for in the cash budget. But because the machine is capitalized as an asset in the balance sheet, this cash disbursement does not resemble a cost at the time of purchase, but the machine is depreciated with corresponding depreciation cost amounts over its lifetime. A second example is the sale of a product to customers on credit. The revenue is recorded and becomes part of the profit statement at the time of the sale, but the corresponding cash amount will only be accounted for when the customer pays and the firm therefore receives the cash inflow.

Explain what direct, indirect, variable and fixed costs are.

Direct costs are costs that only relate to one cost object and therefore without any problem can be attributed directly to this cost object. Indirect costs are costs that relate to more than one cost object and therefore you have to allocate the costs to the cost objects by means of an allocation base. Variable costs are costs that vary according to the quantity of the cost object, and fixed costs are costs that do not 3 vary compared to the quantity of the cost object.

What does EVA tell us about the performance?

EVA tells us about the money that is left for the owners of a company, after all costs incl. costs for the funds that have been invested are paid. Therefore the name "economic value added".

When and for what do we use equivalent units?

Equivalent units are used in connection with the interim financial statements (accruals concept) in production companies with continuous production. The target with equivalent units is to create comparability between resource consumption and production in the period, but taking into account that the products are not always completed to the same degree and that the resource consumption for the production does not always take place proportionally with the real progress in the production.

State 3 performance targets that can be used in investment centers.

F. inst. ROI, RI, EVA. Other targets also involving both the profit and loss statement (profit) and the balance side are ok, too.

What is the difference between the FIFO method and the weighted average method in process costing?

FIFO and weighted average indicate how we calculate product costs in the production of similar products in process costing. By weighted average, we mix cost rates from previous periods with the current period in calculating unit cost. In FIFO we split these calculations. Thus, the unit costs will vary more over time (when using FIFO). Therefore, most companies choose to use weighted averages. This method gives a more even distribution and is easier to work and calculate with.

Explain differences and similarities between "Management accounting" and "Financial accounting"

Financial accounting is directed towards external stakeholders such as public authorities, creditors and investors. The arrangement of the report, which is typically at company level, follows fixed rules and norms to ensure the stakeholders that the reports give a correct picture of the financial situation of the company. Management accounting is directed towards managers internally in the company, and reports are made to give managers relevant information within their area of responsibility. In this way, the reports give information that can form the basis of management decisions. Thus, both systems draw on information in the accounting system of the company, but reports are constructed differently, depending on purpose.

Explain the principles behind Activity Based Costing, and explain the difference between calculations in ABC and a traditional contribution margin calculation.

In ABC we distribute indirect costs to cost objects (customers or products) based on the activities carried out to produce a given service or a product. Resources à activities (with cost pools) à Cost driver rates à cost obj. In a traditional contribution margin calculation, the decision-making is focused on the contribution margin, by which the focus on costs is concentrated on the variable costs. In ABC we open up for management of what you could call capacity costs.

Explain briefly the difference between Job order costing and process costing

In a job order costing, we focus on the single order. An order could f. inst. be a master carpenter who is to build a carport for a customer. This task is "an order". All direct costs such as labour hours and materials are registered at this order. In this way, we can calculate total costs and profitability per order. In a process production, we produce many identical products, why it is not possible to relate costs to the single product. We relate costs to the products that are produced per batch or within a given period. We might be able to separate costs added in different periods via the WA or the FIFO method. Unit costs appear by dividing the costs of the period by the production in pc. of the period.

What is the difference between job order producing and process producing companies?

In a job-order costing the order is the cost object. An order could f. inst. be a carpenter that builds a carport for a customer. It could also be a wind-turbine park. I.e. the content of the orders in this type of companies differs from one another. To build a carport for one customer often differs from building a carport for another customer in the form of materials, design etc. All direct costs such as labour hours and materials are registered on this order. Then we can calculate total costs and profitability per order. Here the product is the cost object. In a process production, we produce many products that are alike, why it is not possible to relate costs to the single product. We relate costs to the products that are produced per batch or within a given period. Here, we can maybe distinguish costs that are added in different periods via the WS or FIFO method. Costs per unit are found by dividing the costs of the period by the production in units of the period.

What is the cost object in process accounting? - elaborate the logic

In process accounting the cost object is the product(s) for which we allocate our costs. It is furthermore the units (equivalent units) that we calculate and their belonging costs, where we use the methods weighted average or FIFO. Generally, the cost object is what we want to direct our costs to. It can also be services, customers etc., but in process accounting it is the units/products. The logic is linked up with the former question about cost flow, where you are interested in getting as accurate a picture of what the units cost. In process accounting the units are identical/standardized, which means that we use average for calculation and allocation of the costs. (We have addressed the cost object topic in Ch. 2 and process accounting in Ch. 4, generally).

What are "equivalent units" used for in process costing?

In process costing, all units produced are assumed to be identical. Hence, it is exactly known how many resources are used for the production of one unit of output. These units are used as the allocation base for the cost calculation. However, at a specific point in time, the company might have some semi-finished work in progress units that do not resemble the final product yet and need to be converted into equivalent units of output to allocate the costs incurred for the production appropriately. This means that in order to calculate a unit cost, for example, two semi-finished products would be evaluated as one fully finished product.

Explain the concept of indirect costs and give examples of these.

Indirect costs are costs that are related to the particular cost object, but which cannot be directly linked or traced to the individual cost object. Examples can be costs for lighting, heating, management of production etc.

Explain the concept indirect costs

Indirect costs are costs that cannot directly be attributed to a cost object, as they are used for more cost objects. F. inst. it can be steel in a company that produces more different products, which are all produced by the same steel. In this example, steel is thus an indirect variable cost. Furthermore, indirect fixed costs are found, which f. inst. can be rent for a production facility or the like.

Explain the concept indirect costs.

Indirect costs cannot directly be assigned to the cost object. They are costs that support the production and which are not reversible with the production. Examples are production manager salary, production machine costs etc. They are costs that are necessary for the purpose in question, but which cannot precisely be assigned to exactly this purpose.

Explain what input price variance and input efficiency variance express.

Input price variance expresses the variance that derives from the fact that the price of a variable cost on inputs (overheads respectively) is different from the budgeted price. Differences in the quantity sold have been "cleansed" by the input price variance; therefore it expresses the impact of the price component alone. Input quantity variance expresses the variance which is due to the fact that the consumption of raw materials per output unit (waste and sometimes "yield" in English) is different from the budgeted raw material consumption. Current output quantity is calculated, but even though the output quantity is fixed, the input per output can vary, if the raw material consumption is higher or lower per produced unit.

Explain why companies use transfer prices.

Internal transfer prices become relevant in relation to profit centres or investment centres. Companies use internal transfer prices to form the basis of internal transactions in the company, where responsibility centre manager have the competency to influence price and amount traded.

Explain briefly the difference between Job order costing and process costing.

Job order costing is production solely on the basis of orders placed. F. inst. a shipyard or building contractor. Vestas is also a fine example that was mentioned in the lectures. The orders are characterized by being different, and therefore the productions are different, depending on orders. In job order costing the resource consumption (cost consumption, both direct and indirect) is used to realized exactly that order which it is allocated to. And by allocating it directly to the order, the contribution margin and profit of the order can be calculated, given that we know the selling price of the order. Process costing is characterized by mass production such as foods and office supplies. Lego and Carlsberg are good examples. Process costing has many units of a single homogenous product, which moves evenly through a continuous production process. In process costing resource consumption is allocated to the cost object which is for example the good, which is mass produced. In that way the contribution margin and profit of the mass produced good can be calculated, given that we know the selling price of the good.

Explain what non-financial performance measures mean and give two concrete examples.

Many firms evaluate the performance of the company, subunits or managers based on measures that are not captured in financial terms and therefore not measure results in terms of revenues, costs or profit. These non-financial performance measures often supplement financial measures. The advantages of non-financial measures are, for example, a closer link to long-term goals and strategies, their use as an indicator of future financial performance, and a closer link to managerial action. Examples include measures of customer satisfaction (e.g., measured by a survey) and a measure of on-time customer delivery (in %).

Explain "the transfer pricing guideline" formula and what it means for fixing of transfer prices.

Minimum TP = incremental cost + opportunity cost of the buying division. TP = transfer price It can give full points if they write that incremental costs are variable costs, as we have not distinguished between these in the lectures.

Explain the difference between controlling and planning

Planning is when we look ahead and plan f. inst. a percentage increase in sales prices. I.e. a budget is a planning tool. According to the book Ch. 1 (Exhibit 1.1) control consists both of something active, such as actually to change the prices in the accounting system and at the sales invoices. But most important is that control consists of the subsequent control of what has actually happened in the period. I.e. we look back now. A variance analysis is f. inst. a control element. Also, see slides 24, 25 & 26 from the first lecture.

Why should a manager not use product unit contribution margin in decision-making about the product- mix under capacity constraints? Which alternative information is relevant for the decisionmaking?

Product unit contribution margin in product-mix does not relate to capacity constraints, which is important to increase the profit. When we have a constraint resource, then in the short run we optimise the production by choosing the product that gives the highest CM per scarce resource unit. This ensures that we get the highest surplus.

Explain how the Return on Investment (ROI) and Economic Value Added (EVA) can be used inside the organization for performance evaluation purposes.

ROI and EVA can be used to evaluate performance purposes of business units/divisions/organization units, which apart from being responsible for profit creation (turnover and costs) also are responsible for managing some funds, which have been invested (i.e. responsible for investments). If they are not responsible for investments, other performance purposes should be chosen due to the controllability criterion. This means that the managers of these organisation units are held responsible for the ROI/EVA achieved.

What does ROI tell us about the performance?

ROI tells us the return on the investment in % and shows how much money in the operating income the organization unit earns per invested DKK.

State 3 performance measures that can be used in investment centers

ROI, EVA, RI The performance measures ought to take into account the investment, why profit and loss statement measures such as operating profit, contribution margin and profit ratio are not suitable.

With reference to fixed costs, describe why the concept of the relevant range is important in determining unit costs under different production volumes.

Relevant range is the band of the level of activity or volume in which a specific relationship between the level of activity or volume and the cost in question is valid. Hence, within the relevant range, a unit cost would decrease at an increase of the level of production. However, once the production level exceeds the relevant range, additional capacity would, for example, need to be purchased, resulting in turn in a (stepwise) increase in unit costs due to the higher total costs.

What is residual income and how is it calculated?

Residual income = The result of the period before financing and tax - risk-adjusted profit of the invested capital. I.e. the residual income is an absolute figure which expresses how much money for the company's operations that is left after the risk premium of the investors has been deducted. The residual income is actually an alternative account where you compare the actual result produced in the company with alternatively to invest the same capital in financial assets that pose the same risk as the concrete company.

Explain what a segment margin expresses.

Segment margin is the profit generated from the activity in relation to a given segment, f. inst. customer group or a product. If you only include direct costs and these costs are almost reversible, then the segment margin reflects what the segment contributes to the total bottom line of the company.

Explain what step costs are.

Step costs are costs that are fixed within a given quantity of the cost object, but vary between these quantities and in this way vary in 'steps'. If f. inst. a machine is to be installed by an engineer every time it produces 10,000 units, and this installation costs DKK 5,000, then this cost of DKK 5,000 is a step cost and it varies for every 10,000 units.

Explain what the Controllability principle means and why it is important in connection with management and control of a company.

The Controllability Principle states that managers should only be held accountable for those performance measures and results that they can actually influence. In performance evaluation, all uncontrollable items (costs, revenues, etc.) should either be excluded or segregated from controllable items. Otherwise, managers can lack motivation to achieve their targets and bear additional risk in their performance evaluation. However, controllability is difficult to pinpoint in practice because of, for example, team decisions, interdependencies, and a long time period between decisions and their effects. Managers should therefore not overemphasize controllability.

Give three examples of non-financial indicators

The areas can be customer satisfaction measurements, measurements of effectiveness and efficiency and measurements of learning and innovation. Examples can be customer satisfaction, employee satisfaction, no. of returned goods, product turn around time, no. of course days, no. of new products, no. of customer visits, no. of errors in the production etc.

What does the concept "Goal congruence" mean?

The concept of goal congruence means that we aim to design our own performance management system in a way that the goals of the employees and the company overlap. Hence, we measure in a manner which is most likely to produce a behaviour among the employees resulting in the achievement of the goals of the company.

Describe the typical cost flow in a production company

The cost flow in a production company is as follows: Raw material stock (direct material) Goods under production (here further direct labour costs and indirect production costs are added) End product warehouse Cost of goods sold. Furthermore, we can distinguish between order accounting and process accounting, but this is not a demand!

Which budgets do you normally have to prepare to be able to budget the total profit and loss statement and balance sheet of the company?

The entire budgeting process starts with a sales budget, so the expected sale drives our budget. Based on the sales budget, a production budget is prepared, however in consideration of the stock policy, i.e. a stock budget is also made. When we know our expected production we can make material, labor and the material budget. These budgets are in some connections called operational or operating budgets. The operational budgets are then passed to the financial budgets: result budget, cash flow budget and budgeted balance. All these budgets and their interrelationships are called for the master budget.

Explain what the 4 perspectives in BSC contain and how they are connected.

The financial perspective (F): Evaluation of the profitability of a given strategy through financial goals, f. inst. operating income or ROI. The customer perspective (C): Identifies the customer segments and measures the success of the organizations in these segments. F. inst. through goals as market share, customer profitability, rebuy rates or other customerrelated goals. Internal processes (IP): Internal processes set goals for how the internal processes ought to run to create the customer value that the company wants to offer its customers. F. inst. this can be through current product innovation, stable delivery times, high quality and after-sales service levels. Learning and growth (L&G): This perspective identifies the capabilities (e.g. education and competences) that have to be present in an organization to be able to obtain the process quality and the customer goals that appear from the two perspectives above. This also applies to f. inst. access to data from IT systems as to servicing the customers when they contact the company, and which IT systems and information that should be accessible to different employees. The last part of this perspective applies to motivation and empowerment of employees. The perspectives are causally related, so that the lowest creates the conditions for the next that creates the conditions for the next etc. I. e. L&G creates the conditions for being able to perform at IP, which creates the conditions for being able to obtain the goals in C, which again creates the conditions for being able to 5 obtain your goals in F. I. e. they are causally related.

Explain how the flexible budget is calculated, and which variance you get by deducting the flexible budget from the static budget

The flexible budget is calculated by taking all the budgeted figures, but regulate them for the present amount sold. I.e. it is budgeted unit prices and unit costs that are multiplied by the present amount sold. When the flexible budget is deducted from the static budget, the sales volume variance is found, which expresses how big a part of the level 1 variance is a result of the fact that the amount sold is different from the budgeted amount sold.

Explain what the four costs of quality are, and how can an organization evaluate quality performance? Provide an example.

The four costs of quality are 1) prevention costs, 2) evaluation costs, 3) internal failure costs, 4) external failure costs. When you evaluate the quality performance you can do it either by making a cost of quality (COQ) calculation of these four costs of quality (total costs of quality, f. inst. by means of ABC allocation of indirect costs of quality) or by using nonfinancial quality performance goals. F. inst. a company can measure the quality of the output they produce by making random checks of the production, or they can make an actual financial COQ calculation, which results in the costs of quality in DKK/penny.

What ideas are Activity Based Costing based on?

The idea about ABC is to get a more transparent cost system. This means that firstly we try to identify more directly linked costs. Secondly, we divide the indirect costs more specifically according to certain activities. In this way, we normally get more cost pools with belonging cost drivers. This causes a more accurate and nuanced cost system, as it is more detailed, and as one focus on having to argue for all activities and link costs to these. This was addressed in Ch. 11.

Explain the principles behind the Economic Order Quantity decision model.

The model calculates the optimal quantity of a product to order for stock. It considers only ordering costs and carrying costs as relevant costs in its calculation and minimizes the sum of relevant ordering and carrying costs. The model highlights the tradeoff between these two types of costs: A higher order quantity per order increases the carrying costs because the average stock level over the year increases. At the same time, the total ordering costs are lower because we order our total demand in fewer (but larger) orders. Therefore, if one purchase order becomes more expensive, the optimal order quantity increases, and if carrying stock becomes more expensive, the optimal order quantity decreases.

Why are market-based transfer prices the most congruent transfer price in markets with complete competition?

The paper must comprise that the market price, in markets with full completion, is the most optimum TP, as it reflects the price at which the buying division can buy in the market and the selling division can sell in the market. If the transfer price is higher than the market price it will be better that the buying division buys in the market, and if TP is lower than the market price, then from an economic perspective it will be best that the selling division sells at the higher price in the market.

Explain the physical measure method to allocate joint costs.

The physical measure method allocates joint costs on the basis of the relative proportions of each product with respect to a common physical method such as, for example, weight. That is, if we cut up a chicken and use legs for one product, wings for another product and feathers for a third product, we will weigh the whole chicken and each of these parts of the chicken (% wise in relation to total weight) and then we will allocate the joint costs according to this weighting. The physical measure method often lacks a comparable common physical measure for the weighting.

What is the difference between the profit and loss budget and the cash flow budget?

The profit and loss budget reflects the profit and loss statement. The cash flow budget reflects payments and withdrawals in the bank. As normally there are lag in payments as to different payment terms, which normally happens later than invoicing. Therefore, we have two different registrations: invoice date and payment date. Invoice date is part of the profit and loss statement. Payment date is registered in the bank versus f. inst. balance due from debtors (account receivables) or creditors (accounts payable). Another difference is depreciations, which form part of the profit and loss budget, but which normally have been paid at an earlier stage. Furthermore, we have instalment payments on loans etc., which are not registered in the profit and loss budget.

Explain the main principles behind and the connection between; Profit and loss budget, Cash budget and Balance sheet budget.

The profit and loss budget shows the accounting consequence (revenue, costs and results) of the plans and conditions which have formed the basis of the budget. The cash budget shows the anticipated cashflows that will be the consequence of the sales and production plans, stock policies and investments adopted for the budget period in question. The balance sheet budget at the beginning shows where we start and at the end the expected status. From a managerial point of view the budget balance is not that interesting, but since it concerning the accounts is connected to the profit and loss budget and the cash budget, the balance is important, because this is where you can check if the results and cashflows are drawn up correctly.

Explain briefly the various purposes of budgets!

The purpose of the budget and the budgeting processing is to communicate the targets and strategies of the company for the coming period. This target has a number of management and managerial effects: - Budgets help define and concretize the targets and strategies of the company and show the expected financial results of the specific strategies. - The budget and maybe especially the budgeting process is part of communicating the targets and strategies of the company out into the organization. - The budgeting process forces the parties involved to think about how to realize the targets of the company. Often you have to think in new ways. Coordinate activities and resources in another way. - The budget helps committing the parties involved to reach the targets set.

Explain the concepts; ROI (Return On Investment), RI (Residual Income) and EVA (Economic Value Added), and describe at which type of responsibility center they are typically used.

The return on investment (ROI) is calculated as the annual result divided by the average asset mass in the relevant period. The return on capital employed is a relatively small figure, comparable to a rate of return percentage. Residual income = result of the period before financing and taxes - risk adjusted return of invested capital. This means that the residual income is an absolute figure expressing the amount of money from the operation of the company left after the deduction of the risk premium of investors. The residual income is in reality an alternative consideration comparing the concrete result generated in the company to the alternative to invest the same capital in financial assets involving the same risks as the concrete company. RI and ROI are to two sides of the same coin, but where the return on capital employed will have a tendency to imply making increasing demands on ROI and thereby accepting increasingly fewer projects/investments, RI will increase growth as long as projects can meet the risk requirements of the market. Both concepts can be employed to evaluate investment centres since they focus on the rate of return of the capital invested.

What does a split-off point mean, and when are we using this term?

The split-off point is a term we use re. 'joint costs' products. I.e. products, which have some joint processes where they cannot be separated, and thereby joint costs. It is typically mining of raw materials. The split-off point itself is when the process is separated and transforms from being joint to be separate. An example is on slide no. 5 re. Ch. 6 about tomatoes. We plant and grow tomatoes, but when they are picked we divide them, and some are used for tomato juice, others for tomato sauce or pure. It is when we take the tomatoes and divide them into the three furthering processes that we have the split-off point.

Which are the two main causes for a spending variance of variable overhead costs? Give one example for each of the two causes.

The two main causes are (1) that the actual prices of individual items included in variable overhead differ from their budgeted prices and (2) that their actual usage differs from the budgeted usage. This can be explained using the example of energy costs as an overhead cost. An unfavorable spending variance can either be due to (1) a higher price per kWh of energy than budgeted or (2) that more kWh of energy per machine hour were used than budgeted.

Describe the different approaches used to account for the amount of over/underallocated overhead costs in Job Costing.

There are three different methods: adjusted allocation rate approach, proration approach, and the immediate write-off to cost of goods sold. The adjusted allocation rate approach goes back to re-calculate the allocation rates based on actual data and adjusts accordingly the cost allocated to the single jobs. The proration approach spreads the missing cost allocation amount between the accounts of work in progress, finished goods, and cost of goods sold. The amount is allocated between the three accounts based on the closing balances or allocated overhead costs (before proration). The third method allocates and writes off the entire amount to cost of goods sold.

What can "cost control" variances give information about?

They can provide an insight into the underlying factors behind more general budget discrepancies. Price variations and quantity variations and their individual influence on the general discrepancy.

Explain what an opportunity cost is.

This is a cost that does not figure in the profit and loss statement. On the contrary it is a cost that you have by forgoing a possibility rather than another. I.e. you forgo a potential earning. This is often used at scarce capacity - where you have to choose between production of orders. Here, you lose an earning by taking another earning. This earning that you lose - the opportunity cost - must be included at calculation of alternatives.

Explain what the difference is between the FIFO method and the weighted average method in process costs and why these two methods end in a different cost transferred to the end product warehouse.

This is about how the stock value is made up. At FIFO, first the cost of the goods that ended first at the end product warehouse is transferred to the profit and loss statement, and then the next ones etc., where the unit costs at the warehouses are calculated as weighted average compared to the units that are sent to the warehouse from the production as weighted average. Therefore, there will be a difference as to how the unit cost with which the finished goods are sold charges to the profit and loss statement. Both methods use equivalent units to ensure that semi-manufacture does not influence the end product warehouse.

Explain when a business unit is to be organized as cost centre and when a business unit is to be organized as profit centre.

This is primarily about controllability as to the responsibility and the decision rights, the manager of a business unit has. If the business unit can only control cost levels (i.e. they can influence cost levels and 6 the efficiency through management decisions and the behavior of the employees), these ought to be organized as a cost centre, and if the manager is responsible for both the cost side and also the turnover side (as the business unit is also responsible for the sale of products or service and in this way can influence the turnover), they ought to - according to the controllability criterion and the congruence criterion - be organized as a profit centre. The reason is that the employees get most motivated if the controllability is high, and from the company's point of view the best incentives are created if the responsibility of the employees is congruent with the goals of the company - i.e. the company must seek against a high degree of controllability and goal congruence at the same time in their organization design (responsibility centre design) and their performance measures system.

Describe the cost-plus pricing method and mention for which type of companies it is most suitable, e.g. as opposed to target costing.

This method takes the cost information as the starting point in the calculation and applies an appropriate mark-up to it to determine the selling price. This costing technique is most suitable for those companies that are in a "price making" position, i.e. that offer highly differentiated products and can decide the selling price with a reasonable range (e.g. informed by the expected ROI). When the company is instead in a "price taking" situation, target costing is more suited as it determines the cost level starting from the sales price that is possible in the market.

Define the concept contribution margin.

Turnover - Variable costs = Contribution margin The contribution margin is the surplus target showing what is left to cover fixed costs, cost of capital and wages to the owner

What is cost-based transfer pricing?

Transfer pricing is the price a business unit charges for supplying a service or a product to another business unit. There are market-based, cost-based and negotiated transfer pricing. A cost-based transfer pricing means that you use the cost itself as transfer pricing. I.e. the costs the business unit has had at f. inst. producing a product - this means both the variable and fixed costs. This we learned about in Ch. 18.

Give a thorough description of the differences between the three methods, direct-, step down- and reciprocal method, for allocating costs from service departments. Describe the advantages and disadvantages of the individual methods.

Under the direct method, the costs of the service departments are allocated directly to the producing departments. Thus, any work between the service departments is not taken into account. This will especially have an effect if one service department provides much work for another service department, and this service department then provides most of its work for a production department. Then, this production department shows a lower cost allocation as it is not financially burdened by the costs of the first mentioned service department. This is a disadvantage for the application of the method. The advantage is that the method is very easy to calculate. Under the "step down" method it is chosen to allocate one service department's costs to other service departments (but only some) and production departments. This minimizes the problem mentioned above, but does not remove it totally. Thus, the disadvantage is minimized, and at the same time, the method is fairly easy to carry through. Under the reciprocal method all mutual provision of resources between the service departments are included in the allocation of the costs. This gives a precise calculation and allocation, but it is more difficult to understand the calculation and in this way also to explain to the users.

When you calculate unit costs you can choose to do it either with variable costs per unit or total costs per unit. Explain the problem of using these unit costs for future decision making, associated with 1) variable costs per unit, and 2) total costs per unit.

Unit costs are typically an average of some costs that you divide by a certain number of units. Total costs per unit are the total variable costs and fixed costs divided by number of units whereas variable costs per unit are the variable costs divided by the number of units. To get the most accurate information for future decision making, the company ought to focus on the total costs, where only variable costs are allocated on the units to get the variable costs per unit, and the fixed costs are not allocated on units. The reason is that total costs per unit does not give an accurate picture, as this requires a precise forcast on the number of units, which normally cannot be done.

Explain the difference between variable costing and absorption costing. Explain why there can be a difference in how big a profit that appears from the profit and loss statement of a company, depending on whether the company follows the principles in variable costing or absorption costing.

Variable costing and absorption costing relate to stocks. At variable costing, all variable production costs are allocated to the stock, and at absorption costing all variable and fixed production costs are allocated to the stock. I. e. the stock "absorbs" all production costs at absorption costing (hence the name). All fixed costs get directly into the profit and loss statement at variable costing, whereas only the part of the fixed production costs that is allocated to the sold number of units ends up in the profit and loss statement at absorption costing (because they are booked to the stock account and not get into the profit and loss statement until the units are sold). This makes a difference on the profit you can see from the profit and loss statement,

Explain why WACC is a very important part of EVA

WACC is used for calculating the cost of the capital used for creating the operation of the company. Therefore, WACC is important, as it makes sure that the cost for the capital to the calculation of economic value added is charged correctly, so that the most precise estimate of the real value creation that the operation of the company creates is found.

Describe the problems according to fixed costs in calculating whether to produce or outsource (make or buy)

We have learned about this in Ch. 10. We are to consider whether we maintain the fixed costs if we outsource a function. Actually, we will often maintain the fixed administration costs etc., even though we outsource. This can give a wrong picture of what you can actually save by outsourcing instead of producing yourself, because often we allocate more Page 3 of 14 of these fixed costs to our cost objects. Therefore, we might wrongly believe that it is the total costs re. production of a certain product we can save, but often we still maintain a major part of the fixed costs.

Explain the process of preparing an operating budget.

When preparing an operating budget, we go through different steps. We always start by forecasting the sale. In this way, we are in control of the turnover. It is not until we have budgeted the turnover that we can start planning the production. When we plan the production, we must relate to the stock where opening stock is added and closing stocks are deducted. This applies to both the raw material stock, goods in production and stock of finished products. In this way, we relate separately to purchase of goods, as maybe we are to purchase more or less depending on what our target closing stocks are. Before we can relate to the closing stocks, we are to calculate the production labour cost budget and the division of indirect production costs, as these costs are part of our goods in production and stock of finished products. Finally, we calculate the total production costs and thereafter at last prepare a total operating budget.

Analyse whether the profit is higher or lower under absorption costing compared to variable costing, if the production exceeds the sales amount.

When production is greater than sales, the profit will be higher with the absorption costing method, as more costs (the allocated fixed production costs) are moved to the inventory value.

Explain the drawbacks of decentralization of decision rights in organizations.

When we decentralise, the management surrender their responsibility at the risk of someone doing something different from what the management would have done. We then risk getting a more unclear decision and execution process. Another drawback is that the individual responsibility centre managers are asked to optimise their small area of business. The decentral optimisation may happen at the expense of other people in the organisation. Thus, we may experience suboptimisation.

What is the method for settling optimum product mix, when it concerns a limited resource?

When we have a limited resource, also called scarce capacity, we will optimise on shortterm production by choosing the product which yields the highest CM per scarce resource unit. This simply ensures that we make the highest profit. Even though we may have products which sell at a higher CM per unit, we might not be able to produce as many units as a product with a lower CM per unit. Hence, it is the amount sold which drives a higher total CM.

How do we determine whether a cost is variable?

Whether a cost is variable or fixed depends on whether or not it changes in relation to output (activity level or volume), e.g., in relation to sales or production volume of a product or service. For example, direct material costs are considered to be variable, as the total amount changes with the units produced. On the other hand can rent often be considered to be a fixed cost as total rent cost is in the short run NOT depending on the production and sales volume.

At the choice between producing yourself or outsourcing a product line (make or buy), which cost considerations should you make?

You ought to consider which overheads you cannot avoid by outsourcing, but which you still have. Often, it is maybe not that favorable at all as assumed at first, if a part of the costs at producing yourself is irreversible. However, you should also consider sunk costs, where investments defrayed should not be included in the alternative possibilities. You could also consider using f. inst. a production apparatus for another purpose or to sell it.