ACCA f5 passcards BPP 2011

Activity basedcosting ABC Life cycle costing Environmental accounting Throughput accounting Target costing Determine product concept Determine currently-achievable cost Establish target

Fundamentals Paper F5 Performance Management

Fifth edition November 2010ISBN 9780 7517 8893 8 (previous edition ISBN 9780 7517 6746 9)

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Page iii

Contents

Preface

Welcome to BPP Learning Media’s ACCA Passcards for Paper F5 Performance Management.

 They focus on your exam and save you time.

 They incorporate diagrams to kick start your memory.

 They follow the overall structure of the BPP Study Texts, but BPP’s ACCA Passcards are not just a

condensed book Each card has been separately designed for clear presentation Topics are self containedand can be grasped visually

 ACCA Passcards are still just the right size for pockets, briefcases and bags.

 ACCA Passcards should be used in conjunction with the revision plan in the front pages of the Kit The plan

identifies key questions for you to try in the Kit

Run through the Passcards as often as you can during your final revision period The day before the exam, try

to go through the Passcards again! You will then be well on your way to passing your exams.

Good luck!

3 Cost vloume profit (CVP analysis) 13

8 Objectives of budgetary control 59

10 Quantitative analysis in budgeting 71

11 Budgeting and standard costing 79

Page

13 Behavioural aspects of standard costing 99

15 Divisional performance measures 111

16 Further performance management 117

1: Costing

Topic List

Costing

Absorption costing

Absorption costing vs marginal costing

You will have covered the basics of these costing methods

in your earlier studies but you need to make sure you arefamiliar with the concepts and techniques so you cananswer interpretation questions

Absorption costing

vs marginal costing

Absorption costing

Costing

A management informationsystem which analyses past,present and future data to provide

a bank of data for themanagement accountant to use

The process of determining thecost of products, services oractivities Methods includeabsorption costing and processcosting

Cost accounting

Costing

Absorption costing

vs marginal costing

Absorption costing

 Establishing profitability of products

Practical reasons for using absorption costing

What is absorption costing?

Absorption costing is a method of sharing out overheads incurred amongst units produced

 When sales fluctuate because of seasonality in

sales demand but production is held constant,

absorption costing avoids large fluctations in profit

 Marginal costing fails to recognise the importance

of working to full capacity and its effects on pricing

decisions if cost plus method of pricing is used

 Prices based on marginal cost (minimum prices)

do not guarantee that contribution will cover fixed

costs

 In the long run all costs are variable, and

absorption costing recognises these long-run

 By using absorption costing and setting aproduction level greater than sales demand, profitscan be manipulated

 Separating fixed and variable costs is vital fordecision making

 For short-run decisions in which fixed costs do notchange (such as short-run tactical decisionsseeking to make the best use of existingresources), the decision rule is to choose thealternative which maximises contribution, fixedcosts being irrelevant

Arguments in favour of marginal costing

Absorption costing

vs marginal costing

Absorption costing Costing

2: Modern management accounting techniques

Target costing

Life cycle costing

Environmental accounting

Throughput accounting

Activity based

costing (ABC)

Outline of an ABC system

1 Identify major activities

2 Identify cost drivers (factors which determine the

size of an activity/cause the costs of an activity)

3 Collect costs associated with each activity into

cost pools.

4 Charge costs to products on the basis of thenumber of an activity’s cost driver they generate

Cost drivers

 An increase in support services, which are unaffected

by changes in production volume, varying instead

with the range and complexity of products

 An increase in overheads as a proportion of total

costs

Features of a modern manufacturing

environment

 Implies all overheads are related to production volume

 Developed at a time when organisations produced

only a narrow range of products and overheads were

only a small fraction of total costs

 Tends to allocate too great a proportion of overheads

to larger products

 Leads to over production?

Inadequacies of absorption costing

 Volume related (eg labour hrs) for costs that varywith production volume in the short term (eg powercosts)

 Transactions in support departments for other costs(eg number of production runs for the cost of setting-

up production runs)

2: Modern management accounting techniques

Page 7

Example

Cost of goods inwards department = $10,000

Cost driver for goods inwards activity = number of

deliveries

During 20X0 there were 1,000 deliveries, 200 of

which related to product X 4,000 units of product X

were produced

Cost per unit of cost driver = $10,000 ÷ 1,000 = $10

Cost of activity attributable to product X = $10 ×

200 = $2,000

Cost of activity per unit of X = $2,000 ÷ 4,000 =

$0.50

Merits of ABC

 Simple (once information obtained)

 Focuses attention on what causes costs toincrease (cost drivers)

 Absorption rates more closely linked to causes ofoverheads because many cost drivers are used

Activity based

costing (ABC)

Life cycle costing

Environmental accounting

Throughput accounting

Target costing

Determine product concept

Determine

currently-achievable cost

Establish target price Establish

desired profit margin Set target

cost Calculate cost gap

Try to close the gap

The target costing process

 Involves setting a target cost by subtracting adesired profit margin from a competitive marketprice

 The target cost may be less that the initialproduct cost but it is expected to be achieved

by the time the product reaches maturity

 There is a focus on price-led costing, customerrequirements and design

Target costing

Activity based

costing (ABC)

Life cycle costing

Environmental accounting

Throughput accounting

Target costing

2: Modern management accounting techniques

Page 9

Life cycle costing

This method tracks and accumulates costs

and revenues over a product’s entire life

 Design costs out of products

 Minimise the time to market

 Minimise breakeven time

 Maximise the length of the life span

 Minimise product proliferation

 Manage the product’s cashflows

Maximising the return over the product

life cycle

 Cost visibility is increased

 Individual product profitability is better

understood

 More accurate feedback information is provided

on success or failure of new products

Advantages

DevelopmentIntroductionGrowth

1 2

4

3

5

MaturityDecline

Activity based

costing (ABC)

Life cycle costing

Throughput accounting

Environmental accounting

Target costing

 In the short run, all costs except materials are fixed

 The ideal inventory level is zero and so unavoidable, idlecapacity in some operations must be accepted

 WIP is valued at material cost only, as no value is addedand no profit earned until a sale takes place

Principal concepts of throughput

accounting

Throughput accounting ratio

= Return per factory hour

Total conversion cost per factory hour

An approach to production management

which aims to turn materials into sales as

quickly as possible, thereby maximising the

net cash generated from sales It focuses on

removing bottlenecks (binding constraints)

to ensure evenness of production flow

Theory of constraints (TOC)

Throughput accounting

Developed from TOC as an alternative

system of cost and management accounting

in a JIT environment

2: Modern management accounting techniques

Page 11

Activity based

costing (ABC)

Life cycle costing

Throughput accounting

Environmental accounting

Target costing

Evironmental management accounting (EMA)

Typical environmental costs

 Identifying environmental costs associatedwith individual products and services canassist with pricing decisions

 Ensuring compliance with regulatorystandards

 Potential for cost savings

Why environmental costs are

important

The generation and analysis of both financial and

non-financial information in order to support

environmental management processes

 Consumables and raw materials

 Transport and travel

 Waste and effluent disposal

 Water consumption

 Energy

Environmental accounting

Activity based

costing (ABC)

Life cycle costing

Throughput accounting

Target costing

Life-cycle costing

Operates on the principal that what comes in must

go out Output is split across sold and stored goods

and residual (waste) Measuring these categories in

physical quantities and monetary terms forces

businesses to focus on environmental costs

Environmental costs are considered from thedesign stage right up to end-of-life costs such asdecomissioning and removal

This may influence the design of the product itself,saving on future costs

Environment driven costs such as costs relating to

a sewage plant or an incinerator are attributed tojoint environmental cost centres

Environmental related costs such as increaseddepreciation or higher staff wages are allocated togeneral overheads

Material flows through an organisation are divided

into three categories

 Material

 System and delivery

 Disposal

The values and costs of each material flow are

calculated This method focusses on reducing

material, thus reducing costs and having a positive

effect on the environment

Flow cost accounting

3: Cost volume profit (CVP analysis)

Topic List

Breakeven point

C/S ratio

Sales/product mix decisions

Target profits and margin of safety

Multi-product breakeven charts

Further aspects of CVP analysis

You need to be completely confident of the aspects

of breakeven analysis covered in your earlier studies.

It is vital to remember that for multi-product breakeven

analysis, a constant product sales mix (whenever x

units of product A are sold, y units of product B and z

units of product C are also sold) must be assumed.

Further aspects

of CVP analysis

Multi-product breakeven charts

Target profits and margin of safety

Sales/product mix decisions C/S ratio

Breakeven

point

Example (J Co) used

throughout this chapter

(where appropriate)

J Co produces and sells two products

 The M sells for $7 per unit and has a

total variable cost of $3 per unit

 The N sells for $15 per unit an.d has a

total variable cost of $5 per unit

For every five units of M sold, one unit of N

will be sold

Fixed costs total $30,000

How to calculate a multi-product breakeven point

Calculate the contribution per unit

Calculate the contribution per mix

Calculate the breakeven point in number of mixes.Calculate the breakeven point in units and revenue

1

4 3 2

Example (J Co)

M = $4 N = $10($4 × 5) + ($10 × 1) = $30Fixed costs ÷ contribution per mix = $30,000 ÷ $30

= 1,000 mixes

M 1,000 × 5 = 5,000 units5,000 × $7 = $35,000 revenue

N 1,000 × 1 = 1,000 units1,000 × $15 = $15,000 revenueTotal breakeven revenue = $50,000

1 2 3

4

Target profits and margin of safety

Sales/product mix decisions

C/S ratio

3: Cost volume profit (CVP analysis)

Page 15

How to calculate a multi-product C/S (or profit volume or P/V) ratio

Calculation of breakeven sales: approach 1

Calculate the revenue per mix

Calculate the contribution per mix

Calculate the average C/S ratio

Calculate the total breakeven point

Calculate the revenue ratio per mix

Calculate the breakeven sales

Fixed costs ÷ C/S ratio = $30,000 ÷ 0.6

= $50,000($7 × 5) : ($15 × 1) = 35 : 15 or 7 : 3

M = $50,000 × 7/10 = $35,000

N = $50,000 × 3/10 = $15,000 _

$50,000 _

1 2 3 4

5 6

Target profits and margin of safety

Sales/product mix decisions

C/S ratio

4

Calculation of breakeven sales: approach 2

You may just be provided with individual C/S ratios

* from example on page 15

Any change in the proportions of products in the mix will change the contribution per mix and the average C/S ratio and hence the

breakeven point.

Target profits and margin of safety

Sales/product mix decisions

C/S ratio

3: Cost volume profit (CVP analysis)

Page 17

Most profitable mix option

Suppose J Co (from our example) has the option of changing the sales ratio to 2M to 4N Which is the optimalmix?

Calculate breakeven point in number of mixes 2 Calculate breakeven point in units and revenue

1

Example (J Co)

Mix 1: 1,000 mixes (calculated earlier) Mix 1: $50,000 (calculated earlier)

Mix 2: Contribution per mix = ($4 × 2) + ($10 × 4) Mix 2: M 625 × 2 = 1,250 units

2 1

Target profits and margin of safety

Sales/product mix decisions

C/S ratio

Calculate the revised overall C/S ratio

Alpha Beta TotalC/S ratio (as in ) 0.5713 0.6667Market share (2/7:5/7) × 0.2857× 0.7143 _ _

0.1632 0.4762 _ _ _ _ 0.6394

Changing the product mix

ABC Co sells products Alpha and Beta in the ratio 5:1 at the same selling price per unit Beta has a C/S ratio of66.67% and the overall C/S ratio is 58.72% How do we calculate the overall C/S ratio if the mix is changed to 2:5?

Calculate the missing C/S ratio

 Calculate original market share (Alpha 5/6,

Beta 1/6)

 Calculate weighted C/S ratios

Beta: 0.6667 × 0.1667 = 0.1111

Alpha: 0.5872 – 0.1111 = 0.4761

 Calculate the missing C/S ratio

2

Target profits and margin of safety

Sales/product mix decisions C/S ratio

3: Cost volume profit (CVP analysis)

Page 19

Target profits: approach 1

Calculate the contribution per mix

Calculate the required number of mixes

Calculate the required number of units and

sales revenue of each product

$M: (1,830 × 5) units for (× $7) 64,050N: (1,830 × 1) units for (× $15) 27,450

3

You should remember from your earlier

studies that the contribution required to earn

a target profit (P) = fixed costs + P.

Target profits and margin of safety

Sales/product mix decisions C/S ratio

Target profits: approach 2

Calculate the average C/S ratio

Calculate the required total revenue

2

1

Margin of safety

Calculate the breakeven point in revenue

Calculate the margin of safety

2

1

Example (J Co)

60% (from earlier)Required contribution ÷ C/S ratio

= (fixed costs + profit) ÷ C/S ratio

= $54,900 ÷ 0.6 = $91,500

2 1

Example (J Co)

Suppose J Co has budgeted sales of $62,000

$50,000 (from earlier)Budgeted sales – breakeven sales

= $(62,000 – 50,000) = $12,000

= 19.4% of budgeted sales

1 2

Target profits and margin of safety

Sales/product mix decisions C/S ratio

3: Cost volume profit (CVP analysis)

Page 21

A multi-product breakeven chart can only be drawn on the assumption that the sales proportions are fixed.

There are three possible approaches to preparing multi-product breakeven charts

Output in $ sales and a constant product mix

Target profits and margin of safety

Sales/product mix decisions C/S ratio

On the chart, products are shown individually,

from left to right, in order of size of decreasing

3: Cost volume profit (CVP analysis)

Page 23

 The overall company breakeven point

 Which products should be expanded in output (the most profitable in terms of

C/S ratio) and which, if any, should be discontinued

 What effect changes in selling price and sales revenue would have on breakeven

point and profit

 The average profit (the solid line which joins the two ends of the dotted line)

earned from the sales of the products in the mix

What the multi-product P/V chart highlights

Target profits and margin of safety

Sales/product mix decisions C/S ratio

 Graphical representation of cost and revenue

data can be more easily understood by

non-financial managers

 Highlighting the breakeven point and margin of

safety gives managers an indication of the level

of risk involved

Advantages of CVP analysis

 It is assumed that fixed costs are the same intotal and variable costs are the same per unit atall levels of output

 It is assumed that sales prices will be constant

at all levels of activity

 Production and sales are assumed to be thesame

 Uncertainty in estimates of fixed costs and unitvariable costs is often ignored

Limitations of CVP analysis

4: Limiting factor analysis

Topic List

Formulating the problem

Finding the solution

Slack, surplus and shadow prices

Limiting factor analysis is a technique used to determine

an optimum product mix which will maximise contributionand profit

Linear programming is used where there is more thanone resource constraint

Slack, surplus and shadow prices

Finding the solution

Formulating the problem

Example

A company makes two products, standard and deluxe

Relevant data are as follows

Standard Deluxe Availability

per monthProfit per unit $15 $20

Labour hours

Kgs of material

Step 1 Define variables

 Let x = number of standards producedeach month

 Let y = number of deluxes producedeach month

Step 2 Establish constraints

Slack, surplus and shadow prices

Finding the solution

Formulating the problem

4: Limiting factor analysis

Page 27

There are two methods you need to know about when

finding the solution to a linear programming problem  Graphical method

Material

Feasible region

Labour y

x

Slack, surplus and shadow prices

Finding the solution

Formulating the problem

 Calculate profit at each intersectionpoint to determine which is theoptimal solution

Step 2 Establish the feasible area/region

This is the area where all inequalities are satisfied (area

above x axis and y axis (x ≥ 0, y ≥ 0), below material

constraint (≤) and below labour constraint (≤)

Step 3 Add an iso-profit line

Suppose P = $3,000 so that if P = 15x + 20y then if x =

0, y = 150 and if y = 0, x = 200 and (sliding your ruler

across the page if necessary) find the point furthest from

the origin but still in the feasible area

Step 4 Use simultaneous equations to find the x and y

coordinates at the optimal solution, the intersection of the

material and labour constraints (x = 300, y = 250)

Slack, surplus and shadow prices

Finding the solution

Formulating the problem

4: Limiting factor analysis

Page 29

Slack

Occurs when maximum availability of a resource

is not used

The resource is not binding at the optimal solution

Slack is associated with ≤ constraints

It is the maximum premium an organisation should be willing to pay for an extra unit of a resource.

It provides a measure of the sensitivity of the result.

It is only valid for a small range before the constraint becomes non-binding or different resources becomecritical

Notes

Price strategies

Profit maximisation Demand

Pricing policy and the market

 Most important factor based on economic analysis of demand

 Varies amongst purchasers If cost can be passed on –not price sensitive

 How customers react to prices If product price ↑, buymore before further rises

 eg operating systems on computers User wants widerange of software available

 Prices may move in unison (eg petrol) Alternatively, pricechanges may start price war

PERFECT COMPETITIONMany buyers and sellers, one product

MONOPOLYOne seller who dominates many buyers

Demand increases as prices are lowered

 If organisation’s product price ↑,suppliers may seek price rise in supplies

 Price changes to reflect increase in price

of supplies

 Customers tend to judge quality by price

 When household incomes rising, price not

so important When falling, important

 Exploit short-term shortages throughhigher prices?

Price strategies

Profit maximisation

Demand

Pricing policy and the market

Price elasticity of demand ( ηη)

A measure of the extent of change in market demand for a good, in response to a change in its price

= change in quantity demanded, as a % of demand ÷ change in price, as a % of price

Inelastic demand

 η < 1

 Steep demand curve

 Demand falls by a smaller % than % rise in price

 Pricing decision: increase prices

Elastic demand

 η > 1

 Shallow demand curve

 Demand falls by a larger % than % rise in price

 Pricing decision: decide whether change in cost

will be less than change in revenue

 The price of the good

 The price of other goods

 The size and distribution of household incomes

 Tastes and fashion

 Expectations

 Obsolescence

Variables which influence demand

5: Pricing decisions

Page 35

The total cost function

Q is the quantity demanded

a is the price at which demand = 0

b is

quantityinchange

priceinchange

Cost behaviour can be modelled using equations and linear regression analysis A volume-based discount

is a discount given for buying in bulk which reduces the variable cost per unit and therefore the slope of the

cost function is less steep