CIMA REVISION CARDS Management Accounting Fundamentals Janet Walker Certificate Level Paper C1 AMSTERDAM l BOSTON PARIS l SAN DIEGO l HEIDELBERG SAN FRANCISCO l l l LONDON l SINGAPORE l NEW YORK SYDNEY l l OXFORD TOKYO Elsevier Butterworth-Heinemann Linacre House, Jordan Hill, Oxford OX2 8DP 30, Corporate Drive, Burlington, MA 01803 First published 2005 Copyright ß 2005, Elsevier Ltd All rights reserved No part of this publication may be reproduced in any material form (including photocopying or storing in any medium by electronic means and whether or not transiently or incidentally to some other use of this publication) without the written permission of the copyright holder, except in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of a licence issued by the Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London, England W1T 4LP Applications for the copyright holder’s written permission to reproduce any part of this publication should be addressed to the publisher Permissions may be sought directly from Elsevier’s Science & Technology Rights Department in Oxford, UK: phone: (+44) 1865 843830, fax: (+44) 1865 853333, e-mail: permissions@elsevier.co.uk You may also complete your request on-line via the Elsevier homepage (http://www.elsevier.com), by selecting ‘Customer Support’ and then ‘Obtaining Permissions’ British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalogue record for this book is available from the Library of Congress ISBN 07506 64770 For information on all Elsevier Butterworth-Heinemann publications visit our website at http://books.elsevier.com Printed and bound in Great Britain Welcome to CIMA’s Official Revision Cards These cards have been designed to: Save you time by summarising the syllabus in a concise form Jog your memory through the use of diagrams and bullet points Follow the structure of the CIMA Official Study Systems Refer to relevant questions found within the Preparing for the Assessment section of the study system Provide you with plenty of assessment tips and hints Ensure assessment success by revising with the only revision cards endorsed by CIMA TABLE OF CONTENTS 10 11 Basic aspects of cost accounting Materials 11 Labour 19 Overhead 25 Specific order costing 31 Continuous operation costing 37 Bookkeeping systems 55 Absorption costing and marginal costing 63 Breakeven analysis and decision-making 71 Budgetary planning and control 87 Standard costing and variance analysis 101 Basic Aspects of Cost Accounting The fundamental concepts of the framework of cost accounting Topics Key study system questions Cost behaviour High-low method Cost units and cost centres The classification of costs The coding of costs The elements of cost Cost behaviour patterns Analysing semi-variable costs Basic Aspects of Cost Accounting Cost units and cost centres Definitions The link between cost centres and cost units Þ Cost centre – a production or service location, function, activity or item of equipment for which costs are accumulated Þ Cost unit – a unit of product or service in relation to which costs are ascertained Cost unit examples Product: litre of paint, batch of cakes Service: restaurant meal, tonne-mile Cost centre examples Location: production department A Function: administration A cost centre acts as a collecting place for costs The total cost centre cost may then be related to the cost units which have passed through the cost centre to determine a cost per unit Activity: invoice processing Item of equipment: stamping machine —————————————————————————————————————————— –––––––––––––––––––––––––––––––––––––– Basic Aspects of Cost Accounting The classification of costs Costs are classified so that they can be arranged into logical groups for further analysis KK K K Nature of cost: material, labour or expense Direct or indirect Functional analysis: production, selling, distribution, administration Fixed or variable Controllable and non-controllable: important when preparing management information Normal and abnormal: highlighting abnormal events draws them to managers’ attention Relevant and non-relevant: in respect of a particular decision Þ Þ KKK Types of cost classifications Indirect costs are also referred to as overheads Semi-fixed, semi-variable or mixed costs are partly fixed and partly variable —————————————————————————————————————————— Basic Aspects of Cost Accounting The coding of costs KKK Advantages of a coding system A code is usually briefer than a description Reduces ambiguity Assists computerised processing of data KK KKK Code – a system of symbols designed to be applied to a classified set of items to give a brief accurate reference, facilitating entry, collation and analysis Requirements for efficient coding system K Definition Each code should be unique and certain Coding system should be comprehensive and capable of expanding to include new items Code numbers should be as brief as possible Incorporate check digits in computerised codes Only authorised personnel permitted to add new codes to system Code numbers should all be of the same length —————————————————————————————————————————— –––––––––––––––––––––––––––––––––––––– Basic Aspects of Cost Accounting The elements of cost A sound understanding of the difference between total direct cost, total production cost and total cost will help you in assessment questions on a variety of different topics Direct materials þ Direct labour þ Direct expenses ¼ Total direct cost þ Indirect materials þ Indirect labour þ Indirect expenses ¼ Total production cost þ Other overhead ¼ Total cost Remember this! Direct costs are those that can be specifically identified with a particular cost unit Þ Þ Þ Study tip Total direct cost is also referred to as prime cost Indirect materials, indirect labour and indirect expenses associated with production are also referred to as production overhead Other overhead includes selling, distribution and administration overhead —————————————————————————————————————————— Basic Aspects of Cost Accounting Cost behaviour patterns Cost behaviour patterns describe the way that costs behave in relation to changes in the level of activity Definition Fixed cost – a cost which, within certain activity limits, is not affected by fluctuations in the level of activity KK Examples of fixed costs Rent of the factory Accountant’s salary Definition Stepped fixed cost – a cost which remains constant for a range of activities, but which increases to the next step when a critical level of activity is reached KK Examples of stepped fixed costs Supervisors’ salaries Machine rentals —————————————————————————————————————————— Standard Costing and Variance Analysis Setting standard costs Sources of information The predetermined overhead absorption rate (OAR) provides the standard rate for production overhead: Standard labour rate KK OAR ¼ personnel department bonus scheme details KKK Standard labour times performance level: allowance for downtime? technical specifications results of work study exercises budgeted production overhead budgeted standard hours Standard hour is a useful way of measuring output when dissimilar items are manufactured It must always be used as an absorption base in standard costing systems, unless a single product is manufactured, in which case a rate per unit is suitable Example: standard Product A B hour Units output 1,000 1,800 Std hrs per unit Std hrs of output ¼ (1,000  2) þ (1,800  5) ¼ 11,000 104 —————————————————————————————————————————— –––––––––––––––––––––––––––––––––– Standard Costing and Variance Analysis Standard costing in today’s environment K K Developed when products and services were more standardised Nowadays need to respond to individual customer requirements K K Emphasis on labour variances not appropriate with more automated production methods K K K Performance to standard used to be acceptable Nowadays should strive for continuous improvement to compete effectively Addressing the criticisms Þ Þ Þ Þ Developed when business environment was stable Not appropriate for control purposes in today’s dynamic environment K Criticisms of standard costing Standards can be updated regularly to ensure they reflect current operating conditions and remain useful for control purposes Use of demanding performance levels and ideal standards encourages continuous improvement Standards can be developed for machine times and hourly machine operating costs Possible to identify a number of standard components and activities for which standards can be set and used for control 105 —————————————————————————————————————————— Standard Costing and Variance Analysis Variance analysis Example data Direct material price variance Standard material cost per unit ¼ kg @ £ per kg ¼ £ 32 Actual material cost for 500 units ¼ 2,100 kg  £ per kg ¼ £ 14,700 Measures how much of the total material variance was due to paying a different price per kg of material Direct material total variance 2,100 kg should have cost ( £ 8) But did cost Direct material price variance 500 units should cost ( £ 32) But did cost Direct material total variance Direct material usage variance Direct material price variance þ Direct material usage variance ¼ Direct material total variance £ 16,000 £ 14,700 £ 1,300 favourable £ 2,100 fav £ 800 adv £ 1,300 fav £ 16,800 £ 14,700 £ 2,100 favourable Measures how much of the total material variance was due to using a different quantity of material than the standard for the output achieved 500 units should have used ( kg) 2,000 kg 2,100 kg But did use Variance in kg 100 kg adverse Direct material usage variance ( £ std) £ 800 adverse 106 —————————————————————————————————————————— –––––––––––––––––––––––––––––––––– Standard Costing and Variance Analysis Variance analysis Example data Direct labour rate variance Standard labour cost per unit ¼ hr @ £ per hr ¼ £ 27 Actual labour cost for 500 units ¼ 1,550 hr  £ per hr *150 of these hours were recorded as idle time Measures how much of the total labour variance was due to paying a different rate per hour of labour Direct labour total variance 500 units should cost ( £ 27) But did cost (1,550  £ 8) Direct labour total variance £ 13,500 £ 12,400 £ 1,100 favourable Idle time variance ¼ 150 hrs  £ std ¼ £ 1,350 adv Direct labour rate variance þ Direct labour efficiency variance þ Idle time variance ¼ Direct labour total variance £ 1,550 £ 900 £ 1,350 £ 1,100 fav fav adv fav 1,550 hr should have cost ( £ 9) But did cost Direct labour rate variance £ 13,950 £ 12,400 £ 1,550 favourable Direct labour efficiency variance Measures how much of the total labour variance was due to using a different number of active labour hours than the standard for the output achieved 500 units should have used ( hr) 1,500 hr 1,400 hr But did use (active hours only) Variance in hr 100 hr fav Direct labour efficiency variance ( £ std) £ 900 fav 107 —————————————————————————————————————————— Standard Costing and Variance Analysis Variance analysis Example data Variable overhead expenditure variance Std variable o/h cost per unit ¼ hr @ £ per hr ¼ £ Actual variable o/h cost for 500 units ¼ £3,500 Labour hours as on previous card Measures how much of the total variable overhead variance was due to paying a different rate per active hour Variable overhead total variance 500 units should cost ( £ 6) But did cost Variable overhead total variance £ 3,000 £ 3,500 £ 500 adverse Variable o/h expenditure variance þ Variable o/h efficiency variance ¼ Variable o/h total variance £ 700 adverse £ 200 favourable £ 500 adverse 1,400 active hrs should have cost ( £ 2) £ 2,800 £ 3,500 But did cost Variable overhead expenditure variance £ 700 adverse Variable overhead efficiency variance Measures how much of the total variable overhead variance was due to using a different number of active labour hours than the standard for the output achieved 500 units should have used ( hr) 1,500 hr 1,400 hr But did use (active hours only) Variance in hr 100 hr fav Variable o/h efficiency variance ( £ std) £ 200 fav 108 —————————————————————————————————————————— –––––––––––––––––––––––––––––––––– Standard Costing and Variance Analysis Variance analysis Remember this! Fixed production overhead total variance The total fixed production overhead variance is equal to the under- or over-absorbed fixed production overhead for the period Overhead absorbed ¼ 1,340 std hr  £ ¼ £ 8,040 £ 7,370 Actual overhead incurred £ 670 fav Fixed production o/head total variance Budget 1,230 £ 7,380 Actual 1,340 £ 7,370 Þ Predetermined o/head absorption rate ¼ £ 7,380/1,230 ¼ £ per std hr Reasons for under/over absorption K Output (standard hours) Fixed production overhead Overhead over absorbed ¼ favourable total variance Overhead under absorbed ¼ adverse total variance K Example data Overhead expenditure different from budget (overhead expenditure variance) Output different from budget (overhead volume variance) Production is measured in standard hours The approach would be the same if output was measured in units 109 —————————————————————————————————————————— Standard Costing and Variance Analysis Variance analysis Fixed production overhead expenditure variance Check: Fixed production overhead: expenditure variance volume variance Measures the under/over absorption caused by the overhead expenditure being different from budget Budgeted expenditure Actual expenditure Fixed prodn o/h expenditure variance £ 7,380 £ 7,370 £ 10 fav £10 favourable £660 favourable Fixed production overhead total variance £ 670 favourable Fixed production overhead volume variance Remember this! Always indicate whether a calculated variance is adverse or favourable Measures the under/over absorption caused by the output being different from budget 1,340 standard hours 1,230 standard hours 110 standard hours x overhead absorption rate (£ 6) Fixed prodn o/h volume variance Þ Actual output Budget output Difference Favourable variance because output greater than budget ¼ potential over absorption of fixed production overhead £ 660 fav 110 —————————————————————————————————————————— –––––––––––––––––––––––––––––––––– Standard Costing and Variance Analysis Example Sales and production units Unit selling price Total unit cost K Total sales margin variance K Variance analysis Measures difference between actual margin at standard costs and budgeted margin Since analysis of cost variances explains differences caused by cost changes from standard, sales margin variance is based on standard cost, not on actual cost Total sales margin variance ¼ actual margin (based on standard unit costs) À budgeted margin ¼ (actual sales value less standard cost of sales) À (budgeted sales value less budgeted cost of sales) Budget 7,240 £ 27 £ 20 Actual 7,460 £ 25 £ 19 Solution Actual margin (based on standard unit costs) Actual sales value (7,460  £ 25) £ 186,500 £ 149,200 £ 37,300 Std cost of sales (7,460  £ 20) Budgeted margin Budget sales value (7,240  £ 27) Budget cost of sales (7,240  £ 20) Total sales margin variance £ 195,480 £ 144,800 £ 50,680 £ 13,380 adv 111 —————————————————————————————————————————— Standard Costing and Variance Analysis Variance analysis A profit reconciliation statement summarises the calculated variances, to demonstrate how they contribute to the difference between budgeted and actual gross profit Favourable variances are added to budgeted profit Adverse variances are deducted from budgeted profit Good practice to give a key Alternatively, could use ‘A’ for adverse; ‘F’ for favourable Þ Þ Þ Profit reconciliation statement for latest period £ £ Original budgeted profit xx xx Total sales margin variance xx Cost variances Direct material: price (xx) xx xx usage Direct labour: rate xx (xx) efficiency (xx) Variable overhead: expenditure xx xx efficiency (xx) Fixed overhead: expenditure xx xx xx volume xx Actual gross profit Note: variances in brackets are adverse 112 —————————————————————————————————————————— –––––––––––––––––––––––––––––––––– Standard Costing and Variance Analysis Variance analysis K K K Remember this! Compared with absorption costing variances, differences only arise where fixed production overhead features Only one variance for fixed production overhead ¼ fixed production overhead expenditure variance No variance for fixed production overhead volume variance Total sales contribution variance replaces total sales margin variance: contribution is used instead of margin; standard variable unit cost is used instead of standard total unit cost Þ K Standard marginal costing In a standard absorption costing system and in a standard marginal costing system, all ‘quantity’ variances (material usage, labour efficiency, variable overhead efficiency) are valued at the standard rate per kg, per hour, etc In a marginal costing system, under/over absorption of fixed overheads does not arise due to volume changes Study tip Be prepared for assessment questions which require you to work backwards from variance information to derive the data for actual costs 113 —————————————————————————————————————————— Standard Costing and Variance Analysis Interpreting variances Variance Direct material price Direct material usage Direct labour rate Direct labour and variable overhead efficiency Possible cause of favourable variance Lower quality material Standard usage too high Possible cause of adverse variance Less skilled employees used More skilled employees used Standard rate too low Ideal performance standard Idle time Standard price too low High level of waste Machine breakdown Variable overhead expenditure Standard hourly rate too high Higher variable power costs Fixed overhead expenditure Fixed overhead volume Lower cost for rent, salaries Increased demand for output Budgeted expenditure too low Budgeted volume too high 114 —————————————————————————————————————————— –––––––––––––––––––––––––––––––––– Standard Costing and Variance Analysis Interpreting variances For example higher quality material ¼ adverse price variance but favourable usage variance Ideal performance standard tends to produce adverse variances K Þ Þ Þ K A variance which exceeds, say, 5% of standard, might be investigated The significance of variances KK On the last card we gave a single possible cause for each type of variance Many other causes are possible In the assessment you should study the information available and select a cause which is consistent with an adverse or favourable variance It is probably not worth investigating every variance Factors which may be considered before conducting an investigation include the following K Study tip Size of variance Standards cannot be 100% accurate and costs will tend to fluctuate Likelihood of variance being controllable For example, labour rate variances may be caused by uncontrollable market forces Possible interrelationship of variances Likely cost of investigation Cost of investigation might outweigh saving from correction of variance Type of standard set 115 —————————————————————————————————————————— Standard Costing and Variance Analysis Standard cost bookkeeping K K K K K KK Note These are general rules Variations exist Record the actual variances as a debit (adverse variance) or a credit (favourable variance) in a separate variance account Entries described in the list opposite ¼ ‘other side’ of each variance entry Þ Record all variances at the point at which they arise Materials price variance in materials control stock account Labour rate variance in wages control account stock ‘Quantity’ variances (material usage, efficiency variances) in work in progress account Overhead variances in production overhead control account Sales values recorded at actual amounts No accounts are kept for sales variances Finished goods stock held at standard cost Transfer to cost of sales and to P & L made at standard cost Þ K Recording variances – general rules At period end, transfer all variance account balances to P & L to offset against standard cost of sales Adverse ¼ debit to P & L; favourable ¼ credit to P & L 116 —————————————————————————————————————————— –––––––––––––––––––––––––––––––––– Standard Costing and Variance Analysis Standard cost bookkeeping Material control account Balance b/d Creditors Price variance* xx xx xx xx WIP À (actual usage  std price) Balance c/d Wages control account Bank À net wages xx PAYE/NI creditor xx xx xx xx xx *This example shows a favourable price variance, which is credited to the material price variance account for later transfer to P & L For an adverse variance, the material control account would be credited and the material price variance account would be debited WIP À (actual hours  std rate) Labour rate variance# xx xx xx #This example shows an adverse rate variance, which is debited to the labour rate variance account for later transfer to P & L For a favourable variance, the wages control account would be debited and the labour rate variance account would be credited 117 —————————————————————————————————————————— Standard Costing and Variance Analysis Standard cost bookkeeping Production overhead control account Expense creditors Depreciation provn Expenditure variance* Work in Progress control account xx xx WIP À (standard hours  std rate) xx xx xx Volume variance# xx xx *Favourable variance is credited to overhead expenditure variance account Entry reversed if variance is adverse # Adverse variance is debited to overhead volume variance account Entry reversed if variance is favourable Balance b/d Material usage at std price Labour hrs at std rate Prodn o/h at std rate Efficiency variance* xx Finished goods (actual production  std cost) xx Usage variance# xx xx xx xx xx Balance c/d xx xx xx *Favourable labour efficiency variance is credited to variance account for later transfer to P & L # Adverse material usage variance is debited to variance account for later transfer to P & L 118 —————————————————————————————————————————— ... assessment tips and hints Ensure assessment success by revising with the only revision cards endorsed by CIMA TABLE OF CONTENTS 10 11 Basic aspects of cost accounting Materials 11 Labour... http://books.elsevier.com Printed and bound in Great Britain Welcome to CIMA s Official Revision Cards These cards have been designed to: Save you time by summarising the syllabus in a concise form Jog your... levels is caused by the change in variable cost Variable cost per unit of activity is determined by dividing change in total cost by change in activity level Fixed cost determined by substituting