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AS Accounting

Management accounting

Purpose of cost accounting


• Manages business effectively and efficiency
• Decision making

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Inventory costs
As inventory is usually purchased at different rates (or manufactured at different costs) over an
accounting period
Method needed to determine what cost needs to be assigned to inventory

-First In First Out (FIFO)


-Last In First Out (LIFO)
-Average Cost Method (AVCO)

FIFO

Oldest goods purchased are


the first ones removed from
the inventory account

+ve
Inventory asset recorded on
the balance sheet contains
costs quite close to the most
recent costs that could be
obtained in the marketplace.
-ve
Results in older historical
costs being matched against
current revenues and
recorded in the cost of
goods sold
gross margin may not reflect
proper matching of revenues
and costs.

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LIFO
Last item of inventory purchased is the first one sold

Assuming that price increases over time


cost of inventory < cost of goods sold

I.e. company can reduce its reported level of profitability = postpone income taxes

-ve
rarely encountered in practice

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AVCO
Average cost method

Average cost method (AVCO) calculates the cost of ending inventory and cost of goods sold for a
period on the basis of weighted average cost per unit of inventory

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Weighted Average = Total Cost of InventoryUnit Cost / Total Units in Inventory

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Cost classifications

Product costs

• Recognized for financial reporting when sold


• Costs assigned to the manufacture of products
Direct materials, direct labor, factory wages, factory depreciation, etc.

▪ Direct materials: Represents the cost of the materials that can be identified directly
with the product at reasonable cost.

▪ Direct labor: Represents the cost of the labor time spent on that product

▪ Manufacturing overhead (Indirect costs): Represents all other production costs


cost of an accountant's time in an organization, depreciation
on equipment, electricity, fuel, etc.

Period costs

• All costs other than product costs


Marketing costs and administrative costs, etc.

Prime costs

• sum of all direct costs such as direct materials, direct labor and any other direct costs

Conversion costs

• costs incurred to convert the raw materials to finished products

• sum of direct labor, other direct costs (other than materials) and manufacturing
overheads.

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Cost classifications (continued)
> Element
> Function
> Nature

1. Element

• Materials - Cost of goods used to manufacture product


• Labour - Wages & Salaries
• Expenses - ALL other COSTS including overheads
Direct Costs

Can specifically associated with manufacture of one unit of production


e.g Electrical parts used to make washing machine
Wages paid to workers/ production line operators
Expenses directly associated - royalties

indirect Costs

1. General and administrative costs (G&A)


Indirect expenses that are incurred in the general operation and management of the
business as a whole.
paying company-wide project coordinators or administrative staff
electric and phone expenses that the company as a whole incurs

2. Overheads
Overhead is ordinarily used for costs incurred that are not direct costs, but that can be
attributed to a job centre.

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Types of cost by behavior

FIXED COSTS:
Does not change with the level of activity within the relevant range
There are costs even if no units are produced
e.g. rent expense, straight-line depreciation expense

Fixed cost per unit decreases with increase in production.

Example

Total Fixed Cost


$30,000
$30,000
$30,000
÷ Units Produced
5,000
10,000
15,000
Fixed Cost per Unit
$6.00
$3.00
$2.00

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VARIABLE COSTS:
Change in direct proportion to the level of production.

Variable cost per unit stays constant

Total Variable Cost


$10,000
$20,000
$30,000
÷ Units Produced
5,000
10,000
15,000
Variable Cost per Unit
$2.00
$2.00
$2.00

MIXED COSTS (SEMI-VARIABLE):


Semi-variable costs have properties of both fixed and variable costs
e.g. telephone expense because it usually consists of a fixed component such as line rent
and fixed subscription charges as well as variable cost charged per minute cost.
e.g. delivery cost which has a fixed component of depreciation cost of trucks and a variable
component of fuel expense.

STEPPED-COSTS
Costs are fixed in nature until a certain output is reached where they rise to a new fixed level
e.g. When a capacity is reached on a fixed cost

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Cost Volume Profit Analysis

CVP analysis has following assumptions:


1. All cost can be categorized as variable or fixed.
2. Sales price per unit, variable cost per unit and total fixed cost are constant.
3. All units produced are sold

Formula

Price x quantity = ( Variable cost per unit + TFC + Profit )

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Absorption costing
<inventory and units produced must include a share of all production costs (fixed + variable)
incurred in getting them to their present condition>

Includes a portion of fixed costs in each unit cost - e.g. calculating selling price

Used for :
Preparing financial statements for external purposes
Inventory valuations
Profit calculations in financial statement

Records a lower profit than marginal costing

Marginal costing
• Variable costs incurred when producing one extra unit (ONLY WHEN ARRIVING AT COST PER
UNIT) Fixed costs are incorporated.

Calculated when a breakeven point has been reached

The usual variable costs included are labor and materials, plus the estimated increases in fixed
costs such as: administration, overhead, and selling expenses.

Used for :
Decision making
Identifies extra costs

Marginal Cost = (Change in Costs) / (Change in


Quantity)

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FORMULAS

1. CONTRIBUTION
1.1 CONTRIBUTION PER UNIT =

SELLING PRICE PER UNIT - VARIABLE COST PER UNIT

(Total revenue - Total variable costs) ÷ Total units

i.e. TOTAL CONTRIBUTION =

(TOTAL SALES( SP x Q )) - ( VC x Q )
Total revenue - Total variable costs

1.2 TOTAL REVENUE =

CONTRIBUTION-TO-SALES
FIXED COST/ (TOTAL CONTRIBUTION/SALES)

BREAK EVEN IN UNITS X SELLING PRICE

1.3 UNITS SOLD TO REACH TARGET PROFIT

TOTAL FIXED COST + TARGET PROFIT / CONTRIBUTION PER


UNIT

2. PROFIT =

TOTAL REVENUE - TOTAL COST ( FC + VC )

3. BREAK EVEN =

FIXED COST / CONTRIBUTION PER UNIT

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3.1 MARGIN OF SAFTEY =

NUMBER OF SALES - NUMBER NEED TO BREAK EVEN


WHERE NUMBER OF SALES EXCEED BREAK EVEN POINT

3.2 BREAK EVEN IN REVENUE =

REVENUE = TOTAL COST


(AT BREAK EVEN POINT)

THEREFORE:

BREAK EVEN IN UNITS X SELLING PRICE = BREAK EVEN


POINT IN REVENUE

3.3 PROFIT MARGIN =

PROFIT / REVENUE X 100

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JOB&BATCH

1)Job costing
Single contract, order

Business produces a good or services to specific customer requirements and each job is different.

Incur both direct material and direct labour as well as overheads -> total job cost (to base the
selling price

e.g. margin % and mark up %

2) Batch costing
Form of specific order costing (separate identifiable group of product unit)
Are in batches

Situation :
• where a customer orders a quantity of identical items; or
• where an internal manufacturing order is raised for a batch of identical parts.

1 batch : number of identical units but each batch will be different.


-Each batch is a separately identifiable cost unit which is given a batch number
-Common in the engineering component industry, footwear and clothing manufacturing industries.

COST PER UNIT IN BATCH = BATCH COST / NUM. OF UNITS

3) Unit costing
Measure company’s costs to produce one unit of a product.

UNIT COSTING =
TOTAL VARIABLE COST + TOTAL FIXED COST / NUM. OF PRODUCT
PRODUCED

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RATIO ANALYSIS

Liquidity Ratios
CURRENT RATIO

Current Assets / Current Liabilities

QUICK RATIO

Liquid Assets (Current assets - inventory) / Current Liabilities

Liquidity ratios measure a company's ability to pay debt obligations and its margin of safety.

Current liabilities are analyzed in relation to liquid assets to evaluate the coverage of short-term
debts in an emergency.

+ve Working capital ( CA - CL )


Indicates it has more current assets than current liabilities and in the event of an emergency, the
business can pay all of its short-term debts

Current ratio > = Basic analysis regarding coverage ability to pay debts obligation,

Quick ratio = Includes only cash marketable securities and accounts receivable. (CA - I)
Reflects the potential difficulty in selling inventory or prepaid assets in the result of an
emergency.

This information is useful to compare the company's strategic positioning in relation to its
competitors when establishing benchmark goals

GROSS MARGIN

Gross Profit/Net Sales X 100

MARK UP

Gross profit / Cost of sales X 100

PROFIT MARGIN

Profit for the year/Revenue X 100


Profit for the year (after interest) /Revenue X 100

RETURN ON CAPITAL EMPLOYED RATIO (ROCE)

Net Profit after Taxes/ Gross Capital Employed X 100


Profit before Interest / Capital employed X 100

EXPENSES / REVENUE RATIO

Expenses / Revenue X 100

RETURN ON INVESTMENT RATIO

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Net Profit After Interest And Taxes/ Shareholders Funds or Investments X 100

Working Capital/Efficiency Ratios

NON-CURRENT ASSET TURNOVER

Net revenue / NBV of non current assets

TRADE RECEIVABLES TURNOVER RATIO

Trade receivables / Credit sales X 365 days

TRADE RECEIVABLES TURNOVER

Total Sales / Account Receivables

INVENTORY TURNOVER (DAYS)

Average inventory / Cost of sales X 365 days

RATE OF INVENTORY TURNOVER (TIMES)

Cost of sales / Average inventory

CAPITAL TURNOVER RATIO

Cost of Sales / Capital Employed

TRADE RECEIVABLES COLLECTION RATIO

Receivables x Months or days in a year / Net Credit Sales for the year

FIXED ASSETS TURNOVER RATIO

Cost of goods Sold / Total Fixed Assets

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