management accounting ASSIGNMENT 2

Cost accounting is an accounting process that measures and analyzes the costs associated withproducts, production and projects so that correct amounts are reported on financial statement

ASSIGNMENT 2 FRONT SHEET Qualification BTEC Level 4 HND Diploma in Business

Unit number and title Unit 5: Management Accounting (489)

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Assignment Brief 2 (RQF) Higher National Certificate/Diploma in Business Student Name/ID Number:

Unit Number and Title: Unit 5: Management

• The test will 90 minutes long and it will be conducted after slot 40

Unit Learning Outcomes:

LO2 Apply a range of management accounting techniques

LO3 Explain the use of planning tools used in management accounting

LO2 Apply a range of

management P3 Calculate costs usingappropriate techniques

of

M2 Accurately apply

accounting

techniques cost analysis to

prepare an income statementusing marginal and absorption costs

range of management accounting techniques and produce

appropriate financial reportingdocuments

reports that accurately apply and interpret data for a range

of business activities

LO3 Explain the use

budgetary control.

M3 Analyze the use

of different planningtools and their application for preparing budgetsand forecasts

LO2 Apply a range of management accounting techniques

P3 Calculate costs using appropriate techniques of cost analysis to prepare an income statement using marginal and absorption costs

• Microeconomic techniques:

What is meant by cost?

According to the official terminology of CIMA (2005), it defined Costing as the technique andprocess of ascertaining cost These costing techniques comprise principles and rules to ascertaincost of products or services

Cost is the amount of resource used in exchange for goods or services The

resources used can be money or money’s worth, which is usually expressed in monetary units Cost accounting is an accounting process that measures and analyzes the costs associated withproducts, production and projects so that correct amounts are reported on financial statements.Cost accounting aids in decision-making processes by allowing a company to evaluate its costs.Some types of costs in cost accounting are direct, indirect, fixed, variable and operating costs

Different costs and cost analysis

Production expense

Production or product costs refer to the costs incurred by a business from manufacturing a product

or providing a service Production costs can include a variety of expenses, such as labor, rawmaterials, consumable manufacturing supplies, and general overhead Product costs may alsoinclude those incurred as part of the delivery of a service to a customer Taxes levied by thegovernment or royalties owed by natural resource-extraction companies also are treated asproduction costs

External cost

An external cost is the cost incurred by an individual, firm or community as a result of an economictransaction which they are not directly involved in External costs, also called ‘spillovers’ and ‘thirdparty costs’ can arise from both production and consumption

Many, if not most transactions create external costs – examples include:

• Purchasing consumer goods commonly creates waste in terms of packaging, as well as otherenvironmental costs including carbon emissions resulting from travelling to stores andoutlets

• Environmental costs can also arise from the production process, including direct costs fromemissions and costs from transportation and distribution

• Excessive fishing can deplete fish stocks and lead to unemployment in the fishing industry inthe future

Where the goods are ‘demerit goods‘, such as cigarette and alcohol consumption, governments mayimpose taxes to discourage consumption and reduce external costs Information failure may result

in a lack of awareness of external costs, and hence a sub-optimal level of consumption

Product costs include costs incurred in connection with the production of

products, so these costs combine to create the value of products formed through the productionstage (called production cost) or factory price) Under the product cost, it includes the costs ofdirect raw materials, direct labor and production overheads Considering the relationship with thedetermination of income in each accounting period, product costs are only calculated and carriedforward to determine the profit in the accounting period corresponding to the volume of productsconsumed in the period there The cost of unused inventory at the end of the period will be stored

as inventory value and will be carried forward to determine income in the periods after they areconsumed For this reason, product costs are also known as inventorial costs

Period costs

A period cost is any cost that cannot be capitalized into prepaid expenses, inventory, or fixed assets

A period cost is more closely associated with the passage of time than with a transactional event.Since a period cost is essentially always charged to expense at once, it may more appropriately becalled a period expense A period cost is charged to expense in the period incurred This type ofcost is not included within the cost of goods sold on the income statement Instead, it is typicallyincluded within the selling and administrative expenses section of the income statement Examples

of period costs are:

• General and administrative expenses

• Executive and administrative salaries and benefits

• Office rent

• Interest expense (that is not capitalized into a fixed asset)

The preceding list of period costs should make it clear that most of the administrative costs of abusiness can be considered period costs

Items that are not period costs are:

• Costs included in prepaid expenses, such as prepaid rent

• Costs included in inventory, such as direct labor, direct materials, and manufacturingoverhead

• Costs included in fixed assets, such as purchased assets and capitalized interest

Thus, if the entire use to which a cost can be put is consumed in the current accounting period(such as rent or utilities) it is probably a period cost, whereas if its use is linked to a product or isspread over multiple periods, it is probably not a period cost

Variable costs

A variable cost is a corporate expense that changes in proportion to production output Variablecosts increase or decrease depending on a company's production volume; they rise as productionincreases and fall as production decreases Examples of variable costs include the costs of rawmaterials and packaging

Variable cost can be contrasted with fixed cost

Fixed costs

A fixed cost is a cost that does not change with an increase or decrease in the amount of goods orservices produced or sold Fixed costs are expenses that have to be paid by a company,independent of any specific business activities In general, companies can have two types of costs,fixed costs or variable costs, which together result in their total costs Shutdown points tend to beapplied to reduce fixed costs

Mixed costs

A mixed cost is a cost that contains both a fixed cost component and a variable cost component It

is important to understand the mix of these elements of a cost, so that one can predict how costswill change with different levels of activity Typically, a portion of a mixed cost may be present in theabsence of all activity, in addition to which the cost may also increase as activity levels increase Asthe level of usage of a mixed cost item increases, the fixed component of the cost will not change,while the variable cost component will increase

Controllable costs and uncontrolled costs

Controllable costs : This is a cost that can be altered based on a business decision or need Thesecosts have a direct relationship with a product, department or function Examples include directlabor, direct materials, donations, training costs, bonuses, subscriptions and sues, and overheadcosts just to name a few

Uncontrolled costs : This is a cost that cannot be altered based on a personal business decision orneed The costs are allocated by the top management to several departments or branches.Examples include depreciation, insurance, administrative overhead allocated and rent allocated just

to name a few

Direct and indirect costs

Direct costs are expenses that a company can easily connect to a specific "cost object," which may

be a product, department or project This includes items such as software, equipment and rawmaterials It can also include labor, assuming the labor is specific to the product, department orproject

Indirect costs go beyond the expenses associated with creating a particular product to include theprice of maintaining the entire company These overhead costs are the ones left over after directcosts have been computed, and are sometimes referred to as the "real" costs of doing business

Differential costs

A cost that varies with every alternative This is useful in decision-making wherein each alternativehas different cost and revenues

Opportunity costs

Opportunity costs represent the benefits an individual, investor or business misses out on whenchoosing one alternative over another While financial reports do not show opportunity cost,business owners can use it to make educated decisions when they have multiple options beforethem Bottlenecks are often a cause of opportunity costs

Cost-benefit analysis

A cost-benefit analysis is a process businesses use to analyze decisions The business or analystsums the benefits of a situation or action and then subtracts the costs associated with taking thataction Some consultants or analysts also build models to assign a dollar value on intangible items,such as the benefits and costs associated with living in a certain town

Cost-volume profit and cost variances

Cost-volume-profit (CVP) analysis is used to determine how changes in costs and volume affect acompany's operating income and net income In performing this analysis, there are severalassumptions made, including:

• Sales price per unit is constant

• Variable costs per unit are constant

• Total fixed costs are constant

• Everything produced is sold

• Costs are only affected because activity changes

• If a company sells more than one product, they are sold in the same mix Break Even Sales =

Total Fixed Cost / Contribution Margin or

Break Even Sales = Variable Costs + Fixed Costs

Contribution Margin = Sale Revenue – Variable Costs

Cost variance analysis is a control system that is designed to detect and correct variances from

expected levels It is comprised of the following steps:

• Calculate the difference between an incurred cost and an expected cost

• Investigate the reasons for the difference

• Report this information to management

• Take corrective action to bring the incurred cost into closer alignment with the expectedcost The most simple form of cost variance analysis is to subtract the budgeted or standardcost from the actual incurred cost, and reporting on the reasons for the difference A morerefined approach is to split this difference into two elements, which are:

• Price variance That portion of the variance caused by a difference between the actual andexpected price of the goods or services acquired

• Volume variance That portion of the variance caused by any change in the volume of goods

Also referred to as full costing, it is a costing system whereby all manufacturing costs, including variable and fixed costs, are assumed to be product costs The period costs, in this case, include administrative, selling and general costs which do not go into the cost of the product but are

expensed at the period incurred The product costs including variable manufacturing overhead, direct labor, fixed manufacturing overhead, and direct material are costs that go into the product

The advantages associated with absorption costing include:

• It is GAAP (Generally Accepted Accounting Principles) compliant

• Takes into account all production costs

• It helps in the estimation of job costs and profits on jobs by absorbing overheads into thecosts of products

It, however, has some disadvantages

• It provides a poor analysis of the costs of products

• It can negatively affect a company’s profit level because all fixed costs are not subtractedfrom revenue unless the products are sold

• It is complex to operate

Marginal Costing

A marginal cost is the cost of one additional unit of output Marginal costing is a costing technique whereby the marginal cost is charged to units of costs while the fixed cost is completely written off against the contribution

Marginal costing is helpful in certain decision making in a business on matters such as whether to carry on with a service or product, replacement of machinery and in ascertaining the appropriate level of activity, through the break-even analysis This helps in the reflection on how the overall profit is affected by the decrease or increase in production levels

In marginal costing:

• The prices are determined on the basis of marginal contribution and marginal cost

• Costs involved are variable and fixed costs and are classified on the basis variability

• The profitability of a product is based on the contribution margin

• Only variable costs are taken into account when valuing the finished goods and work inprogress

Advantages of marginal costing are;

• Fixed costs are classified as a period cost and are charged in full to the period in mention

• It is helpful in the decision-making process

• It prevents under or over-absorption of overheads

• Contribution per unit is constant and does not change in change volumes

• It is simple to operate

It, however, has some disadvantages

• The closing is not valued according to accounting standards

• Fixed production costs are not spread out between units of production

Cost allocation is the assigning of a cost to several cost objects such as products or departments

The cost allocation is needed because the cost is not directly traceable to a specific object Since the cost is not directly traceable, the resulting allocation is somewhat arbitrary Because of the

arbitrariness, some people describe cost allocation as the spreading of a

cost Accountants have made efforts to improve the cost allocation techniques Over time,

manufacturers' overhead allocations have moved from a plant - wide rates to departmental rates Some allocations that were allocated on the basis of direct labor hours are now based on machinehours In order to improve those bases of allocations, some accountants are implementing activitybased costing The goal is to reduce the arbitrariness by identifying the various root causes of the overhead costs

Normal Costing

Normal costing for manufactured products consists of following:

• Actual cost of materials

• Actual cost of direct labor

• Applied manufacturing overhead cost based on a predetermined manufacturing overheadrate

The three product costs are used for calculating the cost of goods sold and the cost of the variousinventories

If there is a difference between the total amount of overhead costs applied to the products and the total amount of actual overhead costs incurred, the difference is referred to as a variance If the

amount of the variance is not significant, it will usually be assigned to the cost of goods sold If the variance is significant, it should be prorated to the cost of goods sold, the work - in - process

inventory , and the finished goods inventory based on their amounts of applied overhead

Standard Costing

Standard costing for manufactured products consists of the following:

• Predetermined materials costs

• Predetermined direct labor costs

• Predetermined manufacturing overhead costs

These standard costs are used to calculate the manufacturer's cost of

goods sold and inventories If the actual costs vary only slightly from the standard costs, the

resulting variances will be assigned to the cost of goods sold If the variances are significant, they should be prorated to the cost of goods sold and to various inventories based on their amounts of the standard costs

The role of costing in setting price

In business management, production cost is one of the important criteria that is always paid specialattention by entrepreneurs Through the data gathered by the accounting department, managers can always know the actual operation and results, thereby devising effective and timely measures

to lower production costs and product costs, making decisions consistent with business

development and corporate governance requirements

The analysis and evaluation of the results of production and business activities can only be based

on the accurate cost of products On the other hand, the cost of the product has to be influenced

by the result of aggregating production costs Therefore, a well organized accounting work collects production costs and calculates product costs to ensure the correct determination of the content, scope of cost constituents in product costs, and the amount of value of expenses The fee has been translated into products that are important and urgent Because we know that in a market

economy, the relations of production, business, finance and credit are becoming more and more complex Competition becomes increasingly fierce, businesses can stand firm and grow in the market requiring effective management and management This has a great impact on the cost accounting system, cost accounting not only follows the current accounting regime but also

conforms to management requirements to be able to make business decisions respectable This is related to timing, timeliness, and accuracy as information may face value if there is a delay and decisions can be erroneous due to inaccurate information Starting from the management

requirement that requires accounting of production costs and product cost calculation, it must perform the following tasks:

• Identify the right accounting object that gathers the production costs and the object that calculates the product cost To perform accounting well, it must be based on the