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1 COST ACCOUNTING AND CONTROL Study Unit 1 (text book unit 1.1 – Function & Environment of Cost and Management Accounting) Cost accounting = process and procedures used to obtain, record and report cost data. Used with other accounting info by management when planning and controlling activities of the entity. Cost control = comparing the actual results with the expected results, determining the causes of deviations and making management decisions to ensure that planned results are achieved, or to amend the initial plan because of the changed conditions. Cost & Management Accounting pg 4 Cos of new international business environment management needs relevant and timely accounting info for accurate product cost info. Also essential to have accurate costing info when making pricing decision. Users of financials made up of : management of entity shareholders of entity & other interested parties (creditors, staff and government) So need to have info for all these people either : financial accounting – provides financial info bout entity by general purpose financials and used by parties NOT involved in day-to-day management of entity (parties outside the entity). General purpose financials give report of how management has handled the activities of the enterprise for period that has already happened (so financials are historical). Prepared in accordance with GAAP and financials MUST be objective so DOESN’T show personal view of preparer of financials. Aim of financial accounting – provide external reports by means of general purpose financial statements management accounting – process of identifying, measuring, analysing, interpreting and communicating info that is in line with entity’s goals, so therefore involves planning and control. Cos for internal decision-makers and will influence decisions in future, the management accounting reports are future-orientated (although still use historical data for planning and decisions). No external criteria so management accounting reports are subjective, but future estimates normally based on historical data. Management decides the type and extent of info that is needed e.g. : is info relevant to question on hand? does info equip management to make better decisions? is info timely? does info provide all possible variables? NOT of general nature – management accounting reports contain SPECIFIC INFO. Differences between financial accounting and management accounting : Financial accounting Management accounting Users External users e.g. stockholders, SARS, creditors or investors Internal users e.g. decision-makers, budget controllers Purpose GENERAL PURPOSE financial statements SPECIFIC PURPOSE statements and reports Timeliness Reports on historical financial events Current and future orientated reports Restrictions Must conform to external standards e.g. GAAP Not subject to external standards. Management needs info in format that meets strategic, operational, planning and controlling needs Type of info Financial measures only Financial measures as well as customer, business processes and organisational learning perspectives Nature of info Objective, precise Scope Highly aggregated reports on entity reliable, consistent and Subjective, judgmental, valid, relevant and reasonably accurate Disaggregated internal reports for managers and decision makers Although financial and management reports use historical data, the financial accountants report on historical costs and income, while management accountants use the historical info and estimate future costs and income, but both use cost accounting (where current data is collected and assimilated to provide info.) Place and function of cost accounting 2 Cost accounting = process of compiling costs of producing products, providing services or undertaking activities. Management uses cost info for decision making. Easier to measure and determine production costs, but more difficult to determine cost of non-manufacturing activities like marketing and admin. Essential for non-profit organisation – can only be effective if can determine cost of products and services that they buy and render e.g. church, schools etc. Function of management accounting Management accounting = planning and control decisions : planning decisions – setting of goals for entity and designing actions that will attain that goal. Normally needs estimates of future costs and future income and will use historical data as start for future orientated estimates. control decisions – comparing the actuals with expected results and imposition of accountability for deviations from original standards. Also entails further management decisions to ensure that planned results are achieved or that initial plan is changed cos of current conditions (so choosing between possible alternative actions). Financial accounting External reporting based on GAAP Internal reporting based on relevance Cost accounting (common data base) Planning Management accounting Control Cost accounting systems Set of systematic processes and procedures used to measure, record and report on cost accounting data : cost determination – data collected to determine the costs of specific product or activity, using info (like hours worked, materials used etc) that has been collected from different departments of entity cost recording – cost accounting system is part of basic accounting system of entity which gathers accounting info used for both management and financial accounting. Info needed is taken from various source documents e.g. wage sheets or supplier invoices cost analysis – cost accounting system provides large amounts of info, but will only be useful or meaningful if info is analysed by people who know how to use cost accounting methods cost management – preparation of info in a different report format for requirement of management to effectively manage the enterprise. e.g. cost accountant uses cost analysis to make meaningful recommendations for cost management (e.g. saving on costs) and therefore strategically helps with allocation of scarce resources in entity. To get meaningful info accountants collect, analyse and report the costing info in different way. cost reporting - process by which relevant info is given to decision makers using detailed internal cost reports. Relevant info = accounting info of the entity which is needed by a particular manager for making a specific decision. Cost accounting system must provide relevant and necessary info timeously to anyone who needs it. Ethical conduct Managers and accountants sometimes take actions that are not in line with entity’s goals mainly cos of inappropriate performance measures e.g. if performance is measured by return on assets (i.e. net income / total assets) then managers won’t want to replace inefficient equipment cos will reduce the return on investment may keep redundant or obsolete inventory in the books to avoid showing lower profit may purchase goods from friend rather then getting competitive quotes may allocate costs to different projects rather then go over budget on a specific project could base budget on over optimistic sales forecasts. Must have ethical standards and anyone breaking these, or failing to report unethical behaviour, could loose career. summary of Standards of Ethical Conduct of Practitioners of Management Accounting and Financial Management are on pgs 10/11 of text book. Chartered Institute of Management Accountants (CIMA) promotes professionalism and competence in management accountants in SA. Cost accounting = assimilation and evaluation of cost data 3 Management accounting = use of this cost data in internal planning, control and decision-making. 3 primary uses of cost data : 1. allocation of costs between cost of sales and finished goods inventory to calculate profit 2. cost data for long and short-term decisions 3. cost data for planning and control decisions Summary : cost accounting = process of calculating cost of products and services or an activity cost accounting system = part of basic accounting system that accumulates accounting info for use in management and financial accounting cost analysis = evaluation of cost data cost management = preparation of info in a report to adhere to requirements of management to effectively manage the entity cost recording = updating the entity’s double entry accounting system using source documents cost reporting = process by which relevant info in the form of a report is given to decision-makers financial accounting = financial info about the entity given to external stakeholders by means of general propose financials management accounting = process of identifying, measuring, analysing, interpreting and communicating info in pursuit of entity’s goals Management accountants use accounting and other info to prepare specific reports to be used by internal users for planning, controlling and decision making Study Unit 1 cont. (text book unit 1.2 – Cost Classification and Terminology) Thorough understating of cost accounting entails understanding : nature of costs cost terminology cost classification Expenses = value offered where it is not determined if the expenses will be applied effectively Cost = if expenses are applied effectively Wastage / loss = if expenses aren’t applied effectively. So difference between total expenditure and the effective expenditure Expenses must be applied as effectively as possible to obtain resources i.e. the minimum expense must be applied to obtain the best possible advantage, but effectiveness must be measured economically NOT technically (so replacing obsolete computer that is still functioning adequately is effective cos new equipment can result in cost saving). Effectiveness of application of resources must be measured in terms of economical results and NOT technical results. If materials are used effectively then unused pieces aren’t wastage, so wastage is a loss, but NOT all losses are wastage. Other causes of wastage = ineffective admin, working methods, bad marketing etc. Wastage = all expenses not necessary for processing a product or delivering a service. Costs = expenses that are economically unavoidable and technically essential for production of goods or service. Each specific expense has a norm and if expense = norm then it is a cost, BUT known wastages are NOT costs. To measure costs accurately and satisfy management’s needs for specific type of cost report then need a careful description and identification of product to be reported on. Costs are necessary sacrifices to deliver a product or service. Unnecessary expenditures NOT taken into account as part of cost of product or service. Cost objectives To determine the cost of product or activity must first define cost objective which is any product activity or project requiring that costs must be measured. Cost objectives NOT actual costs – just products. Services, departments, divisions etc that require the costs that must be determined. In manufacturing entity products are primary cost objective but also includes marketing costs and cost of admin. Classification of costs : Expired and unexpired costs – outlay of cost represents offer made to obtain economic benefit. Can have already received the benefit (e.g. payment for past rent) or for benefit useful in future, and then until time that benefit is used then it is a deferred or unexpired cost (e.g. prepaid insurance, raw material stock on hand and net book value of equipment). All deferred / unexpired costs are assets in Balance Sheet and represent future benefits. 4 If benefit has been received then outlay is expired cost and is in the Income Statement. If no benefit will arise from the outlay then it is an expired cost and is a loss in the Income Statement Balance Sheet Deferred / unexpired Outlay or expenditure Expense / cost Income Statement Loss Expired cost Costs = total resources used to achieve specified aims Classification of costs by their nature Cost = monetary measure of resources given up to acquire goods or services that will benefit the enterprise at present or future date. Either : manufacturing costs – sum of costs incurred in manufacturing process, direct materials, direct labour and manufacturing overheads commercial costs : marketing costs – including all costs with promotion of product, acquisition of orders, admin of marketing function and delivery of finished goods. Costs for obtaining orders for and delivery of manufactured products administrative costs – relate to executive, organisational and clerical costs of enterprise, but EXCLUDING costs for manufacturing and marketing functions. All costs relating to day-to-day function of entity. Total operating costs Manufacturing costs Commercial costs Marketing costs Administrative costs Period costs = costs associated with given accounting period rather then given product e.g. marketing and admin costs are incurred to generate income in specific period but not related to sale of given number of units. Also rent paid for shops to market goods are not influenced by the volume of sales. In accounting match costs against income earned during the same period. Deferred costs = unexpired period costs and shown as asset in Balance Sheet (cos haven’t received benefit of outlay yet – so can’t be expensed against income for that period). Product costs = associated with products that are manufactured and can be either expired cost or unexpired cost. Unexpired cost = when product hasn’t been sold e.g. cost of finished goods on hand. Shown as asset in Balance Sheet. Expired cost = if the product has been sold and is COS and in Income Statement. If no sales take place in month then amount of purchased goods for resale is shown as stock in BS and only when sales occur is the sales and corresponding purchases taken to the IS so that can calc profit made on those items. Balance of unsold items will be shown as unexpired cost in BS (as stock on hand) cos of matching concept in financial accounting. Total costs Period costs Expired (items sold) Charged in period during which product was sold / cost expired Unexpired (items unsold) Costs in Income Stmt Production costs of total products produced Expired (items sold) Unexpired (items unsold) Inventory still on hand / prepaid costs Assets in Balance Sheet 5 Cost classification in relation to product Cost of goods in manufacturing entity determine by knowing which are product costs in entity and also having an understanding of the flow of costs through the accounts of entity. Production costs classified as : direct material – primary materials and easily traced to manufacturing of goods or services rendered. Integral part of end product and normally in predetermined measurable quantities proportional to the volume of production usages. Direct material forms cost element on its own! indirect material = secondary material that isn’t part of the end product and quantity used is not directly related to volume of production and can’t be linked directly to particular product. Not part of cost element and normally under manufacturing overheads. direct labour – cost of all essential labour physically expended on manufacturing the product and traced conveniently to manufacture of goods or services rendered. Indirect labour costs can’t be directly linked to particular cost objective and are classified under manufacturing overheads manufacturing overheads – refers to all other costs expended in manufacturing process, EXCLUDING direct material and direct labour costs, but INCLUDING indirect material and indirect labour costs. e.g. depreciation, insurance costs etc. So basically they occur during course of production, but can be attributed directly to the production unit and amount applied to specific unit can only be estimated by determining total of the overheads for the period and allocating all those cost to the units manufactured in that period. see example and explanation pgs 22/23 of text book Primary cost = total of direct material and direct labour costs Conversion costs = total of direct labour costs and manufacturing overheads (so total cost of converting the raw material to a finished product). Total operating costs Manufacturing costs Direct material Primary costs Direct labour Commercial costs Manufacturing overheads Marketing costs Administrative costs Conversion costs Direct costs = cost that can be accurately traced to a particular cost objective even if not only direct materials or labour, but rather something that is directly related to the objective Indirect costs = cost that is not direct so can’t be accurately traced to specific cost objective. Normally part of the common costs relating to more then one cost objective and can’t be traced individually to products or processes. Summary Costs necessary sacrifices to deliver products and services. Any unnecessary expenditure not used as part of cost of product or service is wastage. Cost object is not actual costs, but rather any product, service, activity or project which must be measured. Expired costs (expenses) are when benefit has already been received – shown in Income Statement. Unexpired costs are deferred costs and shown as assets in Balance Sheet. Manufacturing costs = direct materials, direct labour and manufacturing overheads. Commercial costs = total of marketing and administrative costs. Period costs = costs associated with given accounting period NOT a specific product. Product costs = any cost associated with a specific product. Primary costs = total of direct materials and direct labour costs Conversion costs = direct labour costs and manufacturing overheads. Variable cost is constant per unit, but changes in proportion to number of units made Fixed costs do not change in relation to the output charges Direct costs are costs that can be traced to particular cost objective Indirect costs cannot be accurately traced to a specific cost objective. Administrative costs exclude costs relating to manufacturing or marketing functions. 6 Cost objectives are products, services, departments, divisions or any other activity or object where costs must be measured. If expense is applied effectively it is a cost. Indirect costs are any costs, other then direct costs, that cannot be allocated to a specific cost objective. Manufacturing costs = direct materials + direct labour + manufacturing overheads Manufacturing overheads = all costs expended for efficient continuation of the manufacturing process, excluding direct material and direct labour costs. Product costs = all costs associated with the products that are manufactured Relevant range = range of production levels in which fixed cost remains fixed in total. do exercises on pgs 29 to 31 of text book Study Unit 1 cont (text book unit 2.1 – Material) Cost & Management Accounting pg 36 Material, labour and overheads are cost elements and used for grouping of all costs. Material is all costs relating to physical raw materials used in manufacturing process as well as all costs and activities associated with making a finished product. Primary / direct material = basic raw material that is converted to finished product e.g. wood into furniture. Secondary / indirect material = material used in manufacturing process that contributes to conversion of primary material, but doesn’t normally form part of the finished product e.g. sandpaper used on wood to make furniture Work in progress / incomplete work = primary material which has entered manufacturing process but isn’t complete and so can’t be called finished product. Normally portion of labour and overheads already allocated to it. Finished goods = finished product converted during manufacturing process from primary material Commercial inventories = finished products obtained from factories or wholesalers for resale purposes. So no raw materials, work in process or finished goods stock – only commercial inventory Inventory = all material (primary and secondary), work in progress and finished goods at a given moment. If commercial entity then only commercial inventory. Inventory piling Normally timing difference between purchasing material and using it, so held as inventory in meantime. Must have material available when needed to prevent unnecessary costs or losses. Normal inventory – material in stock for necessity cos it is in process of production, about to enter production or has finished production. Buffer inventory – where keeping a stock of this inventory is a buffer between production and erratic usage of the item. Safety inventory – more then just buffer inventory and normally kept to ensure that entity can continue with production if there is a shortage of a specific material or if it is not delivered within the correct lead-time (normal delivery period). Basically extra inventory carried to prevent a stock-out. Stock-out – when material is not available for production purposes or when there is a demand for a product that is not available Strategic inventory – when more quantity is purchased then normal in order to cope with possible unavailability in future. So kept for strategic reasons Speculative inventory – held for economic reasons e.g. expecting huge price increase and so purchase more just before it goes up Inventory-in-transit – inventory that has been purchased but not yet received. Technical inventory – inventory that is physically in the entity’s possession Economic inventory – amount of inventory after all adjustments have been taken into account e.g. adjusted for inventory-in-transit or inventory sold but not yet delivered Overstocking – when amount of inventory held is not justified by volume of production Under stocking – when amount of inventory held is too low for volume of production Maximum inventory – greatest possible inventory. Normally more then the order size and safety inventory and normally when an order is delivered earlier then the normal delivery period. Average inventory – either calculated the average inventory precisely or use : average inventory = (opening inventory + closing inventory) 2 or average inventory = (order size) + safety inventory 2 Study Guide pg 3 Must always be sufficient material available to ensure constant flow to the production process. Normally use printed prenumbered forms to exercise control over the purchasing procedure. Person acquiring the stock has to sign forms to isolate responsibility. Documentation of material purchases : 7 bill of quantities – used by engineers or planning departments to work out necessary material specifications and states quantity and quality of the material needed for specific job. Gives storekeeper advance notice of what material will be needed purchase requisitions – used by storekeeper or production department to purchase material or equipment that isn’t in stock. Written document authorises purchasing department to purchase the material needed – must have accurate description and exact number of items needed. Cost & Management Accounting pg 39 Inventory piling activities are : acquisition storage distribution and consumption inventory value Acquisition function – normally done by purchasing department and problems include : if too little purchased then entity runs out of inventory if too much purchased then too much capital invested in inventory and storage space is wasted if wrong material purchased then unnecessary losses can result if material not received timeously then unnecessary losses Specifications must be prepared before purchasing can proceed – must indicate quality, dimensions and combination of material needed. How much of what is required when? Cycle of inventory levels of material with constant usage : 100 normal maximum inventory normal delivery period 80 60 see pg 40/41 of text book for explanation order point 40 20 0 safety stock 2 4 6 8 10 12 Time in weeks Safety inventory = maximum usage x (maximum lead time - normal lead time) Order point = (order period x normal usage) + safety inventory Order size is made up of : cost of placing the order and cost of holding inventory But need to find balance cos of amount of capital involved. If reduce cost of one then will increase cost of another. Use formula EOQ C U H = = = = economic order quantity cost of placing an order yearly usage inventory-holding cost per unit But also have to take the cost of the inventory into account. Either interest paid if money borrowed to pay for stock or interest received that is lost as the money had to be used for stock instead. EOQ = EOQ C 2 x C x U (P + i) + H = economic order quantity = cost of placing an order 8 U H P i = = = = yearly usage inventory holding cost per unit cost per unit interest rate If high interest rate then should place smaller orders more often that that will reduce capital in investment. Ordering – once have order quantity and order point then place written order. Must take into account which supplier is most favourable but also most reliable. Must be control over purchase function and only authorised person can sign. Must keep record of all orders placed and check that goods delivered in agreed period of time and are correct. Study Guide pg 6 To calc number of orders that should be place annually : no. of annual orders = total annual demand economic order quantity (EOQ) . Cost price of material Cost price – obtained from supplier’s invoice and must make adjustments for discounts, packing and transport costs etc Trade discount – price that wholesalers supply to retailers less trade discount. NOT shown in books of either seller or buyer Quantity discount – bulk discount. Subtracted from invoice price to get cost price Cash discount – if paid within certain time. This is income NOT reduction of cost price Packing and transport costs – paid for separately, but should be taken as part of purchase price. Stock systems : perpetual stock system – continuous record kept of movement of stock and every time items received or issued then stock figures are adjusted. So stock figure in GL will always show the actual stock on hand. Still do stock-take but system is just control over the perpetual stock records periodic stock system – systematic and physical count made of each item in stock at least once a year Cost & Management Accounting pg 44 Storage Once stock received and checked then GRV issued and goods stored in warehouse. Design of warehouse mustn’t hinder efficient flow of inventory and must take into account : orderly way of storing according to predetermined classification policy of stock safety for certain products unique characteristics of each product e.g., perishable or dangerous goods etc easy access to inventory near entrance that is regularly issued entrances to warehouse to be kept to minimum only authorised staff to have access to warehouse. Either centralised or decentralized warehouse – decided by nature of enterprise and product that has to be stored. Cos computers more in use can have greater classification and codification of inventory and numerical code of item can tell what it is from the classification, but still need “bin card” (record of quantity of each type of material in warehouse, showing all receipts, issues, order points, order quantity and safety inventory), but can now be on computer which makes it faster and more efficient. (If use continuous / perpetual stock then bin card is control over daily ordering). Ledger card used to calculate the value of stock items. At least once a year MUST do physical count and compare bin cards and inventory ledger cards to the stock and then differences must be investigated and adjusted. Issuing of inventory – must ensure control over issues from warehouse using requisitions as base document. Requisition provides authorisation for storekeeper and is the source document for accounts. Must show reason for issuing of stock. Inventory valuation – purchased material is valued at cost price, but if materials are stored then used later purchase price will change (due to inflation, exchange rates, etc). Then must ensure valuation method used kept for ENTIRE year and not changed from year to year. Valuation methods either : FIFO – first in first out – stock used in order it was received. So if received first then issued first at the price that was paid for that stock LIFO – last in first out – material received last is issued first. 9 AVCO – weighted average cost – uses actual average purchase prices weighed by the applicable qualities to calc the issue price, BUT means have to calc new price after each receipt standard price – uses predetermined standard unit price and all price differences between predetermined price and actual price paid are price variances market price – uses ruling market price as basis for issue price of inventory. When valuing inventory must : 1. Prepare ledger card using 4 columns showing date, receiving, issuing and balancing columns each with quantity, unit price and total amount 2. Stock received transactions must be entered into receiving columns and stock issuing in the issued column 3. After each transaction must update unit and total amount balances, so that have stock balance after each transaction 4. Cost of sales value is sum of the issuing column see example of card and also how to use FIFO, LIFO and AVCO on pgs 47/48 of text book Study Guide pg 7 In big entity normally 3 copies of GRN – 1 each for purchases department, 1 for creditors department and 1 for person who submitted requisition. GRN – written confirmation of quantities and kinds of goods delivered by the supplier Material returns vouchers – gives proof of goods that are returned Coding – each item in warehouse is marked with commodity number so that identification is easier. Speeds up dispatch of material to correct section of warehouse and also helps with counting and recording stock. If materials need for specific job and know quantities and just standard material then use material schedule not requisitions. So materials are ordered in bulk by requisition, but only drawn in accordance with material schedule. Method of stock valuation effects cost price and selling price of item as well as the value of the finished and unfinished products, raw material and profit made by enterprise. All stock must be valued as accurately as possible at end of accounting period so profit is calculated as precisely as possible. FIFO – any stock on hand at end of financial year is valued at price of the last purchases. Advantage = easy to calculate stock value cos valued at purchase values Disadvantages : if periodic system followed then stock value in BS may be too high if prices rise and unrealised profits are made on old stock on hand. Or stock value too low in BS if prices drop (and if prices drop below cost price then stock is valued at net realisable value) IS can be misleading cos unrealised profits on stock are taken into account LIFO – material is issued at prices as close as possible to the prevailing market prices. LIFO will show a smaller profit then FIFO if there are rising prices, and will show bigger profit if there are falling prices. Advantages : profits conductive to greater stability cos net profit determined according to most recent cost prices stock values more conservatively shown in BS then with FIFO method Disadvantages : if large quantities stock are kept and seldom issued then when is eventually issued it will be at “old” prices no guarantee that issue price is in accordance to current economic values AVCO / weighted average method – if large price fluctuations then this is best option for dealing with price highs and lows, but average price is fictitious and may never be related to actual market price. Standard price method for each stock item Advantages : interim profits calc is simplified acceptable for year end valuations if standard prices is conservative and in line with price from previous year Disadvantages : standard prices can be radically different from actual prices at the end of the year and must adjust the difference using Stock Valuation Adjustment Account in IS Market price method Disadvantage – system is not conservative and not in line with normal cost concepts. Not really accepted basis for stock valuation unless make year-end adjustments. 10 Cost & Management Accounting pg 44 Just in Time (JIT) inventory holding – stock received just before it is to be used so not much inventory on hand. Advantages : inventory holding limited to minimum capital investment in inventory minimised less storage space used But needs very careful planning and scheduling of production activities. Must determine exactly time that inventory must be ordered and make sure that orders are placed in time and that supplier will deliver on time. Disadvantages : increased ordering and handling cost cos of increase in deliveries must be compared to saving of holding less stock and storage space that is saved may not be able to rely on suppliers to deliver on time. Late deliveries will increase costs. Study Guide pg 11 Efficient planning means can have low stock levels by using JIT stock system. Basically only raw materials for one day are carried and products completed are sent to clients immediately so there is little or no stock being carried. So raw materials are received just in time for production and products are completed just in time for dispatch! Then no stock kept and no need for warehouse. Also material delivered is by fixed price and no material left over after production so there is no stock valuation. Can improve delivery service cos fewer suppliers and so can place long-term orders, so JIT strengthens purchasessupplier relationship (cos supplier assured of long-term sales) and leads to better quality product. Also said that holding stock involves wastage and also increases inefficiency and that JIT reduces ordering costs (cos long-term). see calc’d example pg 13 of study guide Although use bin cards in warehouse need to have GL account for stock control of materials, uncompleted work and completed work. In separate system control accounts are in the costs ledger In integrated system control accounts are in the GL. Cost transactions When purchases made then entered into Purchases Journal and allocated as materials and then allocated to material control account and actual material account in ledger at end of month. Invoices or credit purchase invoices are the source documents. Can also use a stock ledger card which is not T-account, but rather subsidiary ledger which is controlled by the Material Control Account in GL. Materials returned are recorded in Return-out Journal and effect the same accounts only as a reversal. Materials issues (out of stores) Would then credit specific materials account in the materials ledger and debit the unfinished goods account with the amount of the materials that were issued. If are materials issued and returned, then will use material returns requisition and reverse above transaction. see example of these ledgers and the flow of materials & docs on pgs 15, 17 & 18 of study guide see example of accounting entries on pgs 49 to 51 text book Stock adjustments Differences between current and periodic stock counts must be recon’d and theoretical stock MUST ALWAYS be adjusted to physical stock. Done against manufacturing overheads if : relatively small differences if reason for difference hasn’t been established and cause is economically unavoidable Done against account in Income Statement if : relatively large differences if reason for difference has been established and the cause is negligence or something similar. Cost & Management Accounting pg 56 Labour control Productivity = ratio between output and input. Can compare ratios of different period and note the trend which gives benchmark of productivity. Labour productivity = output to labour hours worked (input). But difficult to determine standard productivity level cos varies from person to person and circumstances affect productivity. Personnel functions closely related to cost control : determining labour requirements 11 employment procedures job description job evaluation time and motion studies resignation. Labour control comparison between what must be done and the labour time allowed for it / what was done and the labour time taken to do it. read balance of info unit 2.2 sections 1 to 9 in text book pgs 56 to 65 Cost & Management Accounting pg 66 Labour remuneration Remuneration = compensation for labour done Direct labour costs = costs to compensate production employees for time they worked to convert materials into finished goods. Costs are allocated to specific products Indirect labour costs = costs to compensate employees who do not work in production but who support the production process e.g. cleaners, supervisors & storekeeper etc. Cannot be accurately allocated to specific products or production lines so overheads. Idle time = when production ceases to operate and direct laborers are idle. Overheads Manufacturing costs = all manufacturing costs EXCEPT direct materials and direct labour costs e.g. indirect labour, idle time, overtime premium and PAYE, UIF etc Learning curve – any one who does something over again will make less mistakes and take less time to complete the task. Will take less time until reaches optimum speed. Use learning curve effect to estimate the number of labour hours (cos labour hours will decrease in fixed pattern as laborer gains experience and becomes competent when completing task). Learning curve effect works on : new activities or activities with new production methods new employees not experienced with specific task usage of new type of material short production runs, prior to subsequent activities. Learning curve effect used for : calc of prices to be quoted determination of labour standards compiling of budgets control (actual hours worked are compared to learning curve to evaluate labour output). see explanation, examples and graph on pgs 74 to 76 of text book read balance of info unit 2.3 sections 1 to 12 in text book pgs 66 to 81 Study Guide pg 19 Job cards – used to keep record of worker’s activities in factory. Shows the time a job is started and when the job is finished as well as telling worker exactly what to do. Gets new card for each new job and once finished gives card to supervisor to record time of completion. If can’t continue cos of delay on production line or something like breakdown, then doesn’t use job card, but fills in idle time card instead Timesheets – job cards reconciled and then summary of clock cards and job cards made on timesheet every day or every week. Use timesheets to allocate labour costs to cost centers, products or jobs Wage sheet – info on clock cards summarised onto wage sheet / register and then used to calc total wages owed. If worker permanently employed on one job then can allocate labour costs directly from wage sheet, but if different jobs then have to draw up wage sheet showing direct / indirect labour, admin wages etc. see example of wage sheet and wage analysis sheet on pgs 21 & 22 of study guide Cost & Management Accounting pg 82 Classification of manufacturing overheads Overheads divided into : manufacturing overheads – all manufacturing costs necessary for efficient continuation of production process excluding direct material and direct labour costs e.g. : hire of factory premises maint of machinery and equipment depreciation supervision quality control 12 administrative overheads marketing costs Problems with overheads – largest problem is how to proportion manufacturing overheads to the different products. Must allocate the cost on the basis of causal relationship between products i.e. the cause (cost) is linked to the effect (product) Classification of manufacturing overheads : fixed manufacturing overheads / period costs– costs that are constant in total for certain time and NOT linked to number of units manufactured during that time. So basically cost of being in business or costs incurred for the capacity (the production line) e.g. factory rental. So fixed cost remains constant in total and NOT changed by number of units produced BUT if calc’d the cost per unit will decrease as the volume of production increases. Fixed costs are fixed for period only and given capacity level (relevant range or minimum and maximum limits within which the fixed costs won’t change, but if manufacturing capacity is expanded to level more then relevant range then amount of fixed costs will also increase e.g. if increase production to more then there is space in current factory then will have to rent additional factory and therefore fixed cost of rental per month will increase variable manufacturing overheads / direct overheads – direct bond with, and vary directly in relation to number of units produced cos the cost per unit is only constant. Also incurred in utilisation of the available capacity i.e. also part of costs of doing business. semi-fixed manufacturing overheads – have a variable and a fixed element e.g. transport cos if have truck then can carry certain number of units, but if want to increase number of units transported, then must either buy new truck or make two trips semi-variable manufacturing overheads – have a variable and a fixed element e.g. cost of running emergency generator cos must make provision for petrol used by generator, so more generator is used the more the cost of petrol will be Total manufacturing overheads and linear function Cos can use linear function to show the variable and fixed overheads, can also use this linear function to solve for ; T = a + bx Total manufacturing overheads = fixed costs + (variable costs x volume in units) total overheads C osT tso t a l variable overheads fixed overheads Production volume c Study Guide pg 23 o Handling overheads in cost accounting system : n collection – collecting andsposting expenses from financial or suspense accounts to the cost accounts allocation – analysing the uvarious expenses so that they can be placed in the cost groups where they belong : m manufacturing overheads p service overheads t marketing overheads i distribution overheads o administration overheads n apportionment – post overheads of the service and admin sections to the following cost recovery groups : s manufacturing overheads marketing overheads p distribution overheads e n recovery / absorption ofdoverheads – costs that have been allocated over the period to products or jobs (cost bearers) are bought into account and recovered. i n g Cost & Management Accounting pg 87 Techniques for dividing manufacturing overheads Must divide manufacturing overheads into fixed and variable elements cos easier for control purposes. 13 Fixed variable overheads quite easy to control cos the total amount is constant – if amount is exceeded then there is wastage or ineffective use of funds and can determine the cause Variable manufacturing overheads can be controlled cos the cost per unit is constant. Then can calc total variable manufacturing overheads by taking variable costs per unit and multiplying by number of units manufactured, and that can be used to determine if there is any wastage or if ineffective usage has taken place. Can be easy to divide some manufacturing overheads into fixed and variable elements, but in some cases impossible to divide and must then use either : regression analysis high-low method simple regression multiple regression Regression analysis Draw scatter diagram on graph of the number of units manufactured (XY-axis axis) against the total manufacturing overheads (Y axis) and then draw Total costs a straight line between the different points. Then draw line from where the line between the points intersects the Y-axis parallel to the X-axis Costs and that will give you a graph representation of the fixed and variable elements of the total manufacturing overheads. The intersection of the fixed overheads “fixed overheads” line then gives you the amount that is the fixed cost 0 and can divide by the number of units to get the variable cost per unit. Production volume Disadvantages : not accurate cos could estimate line through points with different gradient and that would mean that could be different fixed and variable amounts, but is still acceptable for control purposes. High-low method Basically uses the same basis as regression analysis BUT only uses the highest and lowest volumes. So would then take the manufacturing overheads of the highest number of units made and subtract the manufacturing overheads of the lowest number of units made and that will give you a difference total of units made with a difference total of manufacturing overheads. Divide the manufacturing overheads by the number of units and that will give you the cost per unit and so that is then the variable amount (cos we used cost per unit). To calc the fixed costs just take the highest volume of units and working with the total overhead figure calc the variable cost by multiplying the highest volume by the variable cost per unit that we have worked out above and then subtract that from the total overheads and that will give you the fixed costs. Do the same with the lowest volume figures. Cannot be used if highest and lowest volumes are very different as then will be unrealistic amount for fixed costs. Simple regression Instead of using scatter profile and drawing line which can have different totals if different people draw it, use the simple regression (least squared method) which gives the relationship between one fixed and one variable factor. see formula and explanation on pgs 90 / 91 of text book Multiple regression Shows the influence of fixed component and two or more variable components – using formula : Y = a + bx + b1x1 + ……… bnxn Total costs = fixed costs + variables with influence on Y & values of the variables to n level e.g. x might be the man hours or machine hours and b would be the rate per man hour / machine hour see example pg 91 of text book Cost & Management Accounting pg 97 Budgeted manufacturing overheads Budgeted overheads = estimated amount of future overheads. Must be calc’d carefully so that are close to actual situation, but also must be guideline for expenditure without concealing wastage and spillage. Done by dividing each overhead item into fixed and variable elements and then determining the expected production volume (used in allocation tariff calc) and taking into account the economic trend. Applied overheads – amount of overheads that were applied to the production process according to a predetermined rate which is based on the budgeted overheads. Basically the amount of overheads received during the year and bought into account when determining the cost price and total production costs. Actual manufacturing overheads = what it has actually cost. But only available after processing in books are finished and so is then not valuable for price determination. Applied manufacturing overheads 14 Overheads allocated to production process and / or products manufactured during production according to predetermined rate based on budgeted overheads and expected capacity utilisation. Calc of predetermined rate : allocation rate = budgeted manufacturing overheads suitable basis When calc’ing predetermined overhead allocation rate must choose suitable basis for the rate – either : product unit basis – when calc’d will give a price per unit and that is the amount of overheads that will allocated to the manufacturing process for each unit. Then after budgeted production of units is met the budgeted overheads for the year will have been recovered. Best used in entity which only produces a single type of product allocation rate = budgeted manufacturing overheads budgeted number of units produced labour hour basis – when calc’d will give you an allocated rate of labour per hour. Must then multiply by the labour hours taken to make each unit and that will give you a unit cost. Used in entity which is very labour intensive or where a wide range of products are produced allocation rate = budgeted manufacturing overheads budgeted labour hours labour cost basis – must be calc’d as a % using budgeted labour costs and the will give you a % of the direct labour costs which will be your applied overhead. But if used in very labour intensive entity where there is little or no machinery then overheads (normally depreciation or maintenance of machinery) using labour costs will be higher then they should be allocation rate = budgeted manufacturing overheads x 100 budgeted labour hours 1 machine hour basis – use budgeted machine hours and give you a price per machine hour. Used for entity which is very mechanised and also gives output of the machinery, but must remember to take into account the maintenance, repair and adjustments of machinery as well as idle time allocation rate = budgeted manufacturing overheads budgeted machine hours material cost basis – also calc’d as % and gives % of material costs, but not very accurate as there isn’t really a connection between material costs and overheads allocation rate = budgeted manufacturing overheads x 100 budgeted material cost 1 primary cost basis – uses budgeted material costs and budget labour costs but also not very accurate cos no real connection between material cost and overheads, but more accurate then material cost basis allocation rate = budgeted manufacturing overheads x 100 budgeted material costs + budgeted labour costs 1 combination of above Normally composition of products and the way that they are manufactured will determine the basis used for the calc of the predetermined overhead rate. Must use most logical and accurate method with greatest connection between costs and product. Actual manufacturing overheads only calc’d after product is finished and sold so NOT anything to do with allocation rate. Study Guide pg 24 Requirements for good basis of overhead apportionment : system should be easy to calculate cost of applying it should be reasonable basis used should be related to the time factor of fixed overheads it should be possible to do the calcs on the departmental basis so that causes of deviations can be ascertained apportionment should be fairly accurate so that under application / over application of overheads are kept to minimum Cost & Management Accounting pg 102 Actual manufacturing overheads – amounts actually spent as in financials. Cost items under manufacturing overheads : depreciation of machinery and equipment – either : reducing balance method – as per book value straight line method – set amount as per cost price 15 fixed installment method – value of machinery is written off over its expected useful economic life (period for which asset can be profitable employed). Can deduct scrap value at end of contract and then depreciation is reduced by that amount interest on capital – if machine purchased on credit interest normally capitalised and recovered in depreciation, but if machine purchased by cash or on credit then interest received is sacrificed and should be classified as overhead indirect material usage indirect labour rental and maintenance of factory buildings Normally keep an Overhead Control Account to which all manufacturing overheads are coded Over applied / under applied manufacturing overheads Difference between the applied manufacturing overheads and the actual manufacturing overheads. To calc if over / under applied overheads : determine overheads rate at beginning of the period : predetermined overheads rate = budgeted manufacturing overheads estimated units apply the manufacturing overheads during the period : manufacturing overheads applied = predetermined overhead rate actual units determine if over / under applied overheads at end of period : under / over applied overheads = manufacturing overhead applied - actual overheads Over applied overheads = when applied manufacturing overheads exceed actual manufacturing overheads. If at end of year more of the overheads are recovered then must correct at the end of the year (by cr COS and reducing account by the amount that was over applied during the year) Under applied overheads = when applied manufacturing overheads are below actual manufacturing overheads. If at end of year all the overheads are not recovered then must apply the under applied overheads at the end of the year (by dr COS and therefore increased COS by the amount that was under applied during the year) see example pgs 104 / 105 of text book and pgs 26 / 27 of study guide (USE METHOD IN STUDY GUIDE) Causes for over / under applied overheads : incorrect predetermined overhead rates actual overheads that are more / less then budgeted figs more / less activity in the base that the overheads were applied to Cost & Management Accounting pg 108 Departmentalisation of manufacturing overheads Can’t use only one overhead recovery rate for all departments of the same factory cos some divisions generate more overheads then others. Must therefore have accurate allocation rate for each department separately. Must first divide factory into cost centers where the activities performed in each cost centre have approx the same exposure to overheads (i.e. approx the same use of same machinery, degree of uniformity and share proportionally in overheads of cost centre). Cost carrier = product or job in process of manufacturing which accumulates costs near completion and against which overheads are allocated according to a pre-determined tariff. Departmentalisation of overheads divided into : primary departmentalisation / primary allocation – where manufacturing overheads are divided among all departments / cost centers (including service departments). Must have suitable basis that used to divide costs e.g. number of employees. Each item must be analysed separately to determine which basis is best secondary allocation – where costs of service departments are allocated to production departments. Cannot allocate costs directly to final product so have to divide them first amongst the production departments and then to the final product or jobs. Can be possible to allocate costs directly according to worksheets or timesheets Tariff or rate at which overheads of production departments are calc’d and applied (normally basis used is labour hours or machine hours). MUST departmentalise budgeted overhead first and then calc predetermined overhead rates. Then must departmentalise actual manufacturing overheads and calc if under applied or over applied overheads. see example pgs 109 to 111 of text book and pgs 27 to 33 of study guide Cost & Management Accounting pg 112 Activity based costing (ABC) 16 Doesn’t use allocation of fixed costs by fixed tariff per labour hour or % of direct labour cost, rather assumes that activities that cause cost and that products are created by those activities, so the costs are allocated on the basis of the utilisation of activities. Activity based costing allocates costs to final product by : identifying the most important activities of the company identifying the factors that influence the cost of the activities (cost drivers are factors that determine the extent of the cost of the activities) create a cost centre for each activity (to accumulate the cost of each activity) allocate the cost center (cost of each activity) to the products according to the extent that the products used the activities – use cost drivers to determine the extent to which the activities are used. Allocate costs by allocating : cost to the cost centres the cost centres to the products with the cost drivers as basis. 3 types of activities : unit level activities – activities each product is subjected to e.g. machine – all the costs for machining would be allocated to that specific product batch level activities – activities each batch is subjected to e.g. setting machinery for production run. Costs aren’t allocated to individual product but to the actual production line product support activities – activities aimed at supporting the different products that are part of the product range e.g. admin, financial services, management or factory lighting. All considered general costs and written off against income of all production lines. So basically have to calc a contribution : per product each production line and for the whole product range that is being manufactured Study Unit 2 (text book unit 5.1 – Product Orientated Cost Systems) Study Guide pg 36 Job costing Costing system is specific method according to which the manufacturing costs of product or group of products are accumulated, processed and reflected. Costing systems – production costings systems developed to calc unit cost of products. If unit cost of product or products are known then can calc value of stock, cost of sales and net profit. Also need unit cost to prepare the budget cos complied using expected cost at various production levels. Also need to distinguish between types of production costing systems, either : job or product oriented systems – costs are accumulated separately for each job / product and then added together in offer to obtain the total manufacturing costs for the period e.g. building industry with different products process oriented systems – total cost calc’d for each process then divided by number of units in order to obtain the cost per unit e.g. chemical industry or canning factory using identical products see diagram 5.1.1 on pg 206 of text book Method of calc cost per unit (unit costing) used where goods manufactured according to client’s specs when different products manufactured using same production facilities e.g. garage where repair on diff vehicles and each job card calc’d separately. Service enterprises cost per activity e.g. accountant billing each client for job done. Consultants cost per project. Cost & Management Accounting pg 205 Most important aim of product costing is to calc unit manufacturing costs – vital for financial reporting and for valuation of inventory and determination of cost of goods sold. Absorption approach / total cost approach – provides for absorption of all manufacturing costs (fixed and variable) by the units produced Types of product costing systems : job costing systems – used where different (heterogeneous) production using same manufacturing facilities e.g. shipbuilding, engineering repair shops process costing systems – large range of identical (homogeneous) products using same manufacturing facilities e.g. oil refinery, sawmill. Here total costs incurred in production process calc’d first and then cost per product calc’d by dividing total costs of process by number of units manufactured Normal overheads are allocated to the job by pre-determined overheads rate. 17 Job description – done by production planning department before job is begun and shows execution of job (special order or repeat orders). Copies of job description with other specs sent to all manufacturing sections to ensure have required material, labour, tools etc Study Guide pg 38 Expansion of accounts Costs of direct materials, direct labour and manufacturing overheads are collected separately for every job (either single product or group of identical products, or specific service). If job costing used then must be adjusted to record the cost per job. Separate ledger account is opened for each job and cost of that job dr to that account. (subsidiary ledger) GENERAL LEDGER Cost ledger is subsidiary ledger and has all different jobs and then shown in GL as Production Account which is control account (summary) of cost ledger Job costing system documents : REQUISITION Initiates work to be done on job PRODUCTION ORDER MATERIAL REQUISITION DIRECT LABOUR TIME CARD OVERHEADS ALLOCATION STATEMENT Job card forms basis for calculation of unit costs, valuing closing stock and cost of goods sold JOB COST CARD Accumulates production costs in accounts department Flow of manufacturing costs through GL accounts when using costing system : 18 Cost & Management Accounting pg 207 Inventory ledgers in job costing system comprises of : control accounts : Raw Material Control account Production account / Incomplete Work / Work In Progress account Finished Goods Control account / Completed Goods subsidiary ledgers – supporting ledger that has detailed accounts & ties up to the balances in the control account : materials ledger – quantities and unit costs of each type of material recorded on separate ledger card see example pg 208 of text book cost ledger – job cost card kept for each job. Is supporting record for work in progress and shows cost of direct material, direct labour and applied overheads relevant to the job. When job is completed the total costs are divided by the number of units to get the unit cost see example pg 208 of text book finished goods ledger – every card identified by item number and description of the product and shows quantities, unit costs and total costs see example pg 209 of text book Supporting ledger is kept up to date when used, but control account are only updated periodically. see example of T-accounts pg 209 of text book Example of job costing system recording of material costs – material purchase is shown on relevant material inventory card and at end of period total of material purchases are posted from purchases journal to the Material Control account (balance in Control account must agree with total on various cards in the Material Ledger account). When materials are requested (using material requisition) the issues are recorded on Inventory Cards and in Control account. Requisitions for direct materials are recorded on relevant job cards and debited to the Production account, while indirect material is debited to the Overheads account recording of labour costs – use time cards to determine time spent by employees on various jobs and also to identify labour costs for specific jobs. Normally use hourly wage rate to determine the labour costs for each job. Details are transferred periodically from the time cards to the job cards. Time card will show direct labour cost (time employee work on particular job) and indirect labour (time taken to repair a machine). Daily time sheets of all employees are totaled on labour summary sheet and analysed so that can be apportioned properly. recording of manufacturing overheads – indirect materials and indirect labour charges are recorded in the production overheads account. Other overhead items are transferred to production overheads account from account where they were allocated when expenses. Direct material and direct labour costs are allocated by material requisition forms and time cards directly to the products, but can’t allocate the indirect manufacturing costs directly to cost of particular product so use predetermined overheads rates for allocation of indirect manufacturing overheads 19 As actual manufacturing costs arise they are debited to overheads control account Overheads allocated to products during the period are debited to production account (and job cards) by using overheads rate and applied overheads account is credited. Once all overheads have been entered onto the job care it contains all the cost elements incurred in respect of each job to date. Must then dr / cr the under / over applied overheads to Cost of Sales Account. Balance of Overheads account has bearing on incomplete goods still in inventory as also cost of goods sold – if balance is material then can be allocated to each of categories using reasonable basis. recording of completed / finished goods – when job completed then unit cost of items for that job are obtained by dividing the total costs by the number of units produced. Job cards can be removed from production ledger and are filed and must make entries to the Finished Goods Ledger on applicable inventory cards to show quantity, unit costs and total costs. At end of period must dr Finished Goods Accounts and cr Production Account. When goods are sold then must be recorded on inventory cards and at end of period cr Finished Goods Account and dr Cost of Goods Sold Account with cost price of the goods that have been sold. Various supporting records contain detailed analysis of total amounts and balances of control accounts in GL Selling of finished goods means that must make entries for the cost price and also selling price of the goods. see comprehensive example pgs 210 to 221 of text book and example on pgs 42 & 43 of study guide Raw Materials & Materials Stock o/b of raw material andDirect raw material materialstransferred to production Purchases of raw materialIndirect material used in and materialsfactory Finished Goods Stock o/b stock of finishedCost of finished goods on handgoods sold Production Account Manufacturing Overheads Indirect materials usedProduction overheads in factoryallocated to production Other overheads e.g. elect / deprec Indirect labour costs o/b of incomplete workTotal costs of goods completed Raw materials put into production process Cost of goods completed Overheads allocated to production Direct labour used in production process Cost of Goods Sold Transfer from finished goods Production Wages Total wages payableIndirect labour wages (including direct and indirect labour)Direct labour wages Study Guide pg 44 Spoilt units Goods that aren’t up to scratch and don’t make quality standards – called spilled products. If can reprocess spilt products then they can be sold as finished goods (costs relating to the re-processing are either recorded and disclosed according to either process or job related methods). If very badly defective and can’t be sold then wasted units Waste / losses either : normal (unavoidable) abnormal (avoidable) If scrap or waste material can be sold then the actual overheads must be reduced by the money received from the sale of the scrap or waste. Cost & Management Accounting pg 222 Shrinkage and evaporation Wastage occurs with units that aren’t up to standard and then either sold for scrap or re-processed and sold as finished goods, but also have to worry about shrinkage and evaporation. Here no spoilt product, but rather case of more materials are needed to complete a job or process products. Changes in temperatures can cause evaporation during chemical process and so lower units produced. 20 Normal wastage - wastage that is inherent in product or manufacturing process so anticipated wastage and occurs repeatedly. So must make provision in planning of the production and normal wastage is part of the cost of production and is allocated to acceptable units that are manufactured. Abnormal wastage - not anticipated and could be avoided (so should be controllable). Cos not anticipated have to write it off as loss in Income Statement. Scrap – waste material that arises from the manufacturing process. Has little value and not shown in inventory as asset. If sold then dr Cash or Debtors and credit Actual Overheads Account (this will then be part of the calc for overheads recovery rate). Accounting for spoilt work in job costing systems : general manufacturing cost – normal wastage expected if jobs for clients to their specs cos have to use the same machinery and labour for all the jobs even if they are not the same. MUST associate the costs of normal wastage with ALL the tasks carried out and so NOT for one specific task, so should provide for normal wastage in the predetermined overheads rate. So must estimate the cost of the normal wastage at the beginning of the period for the entire period and include that estimate as part of the total estimated overheads and use it to calc the overheads rate. Actual cost of normal wastage dr to Actual Manufacturing Overheads Account cos estimated normal wastage already cr to same account and then allocated to Production account as part of the overheads rate. see example pg 224 of text book job related normal wastage – if specific job and know going to have extra waste then that must be build into the cost and can calc the cost of this wastage and add it to the cost of the units that are “normal” and can be sold. So it will then increase the average cost of the units and will be an additional cost of completing that specific job see example pgs 225 / 226 of text book re-processing costs – can sometimes re-process some of spoilt units so that they are up to standard although this will mean additional costs for materials, labour and overheads. Can treat these costs by : dr to Actual Manufacturing Overheads Account if they are process related and then allocated to the total production costs for the year by using the overheads rate dr to the Production Account for that specific job if the costs are job related (so caused by special requirements of the job.) Study Guide pg 44 Summary – job costing is method of cost accumulation normally used by entity that manufactures products according to the user’s specs. In job costing system material and labour are accumulated per job – overheads are first accumulated per department and then allocated to the various jobs. Normal and abnormal wastage has to be accounted for. see example & solution on pgs 44 to 48 of text book Study Unit 3 (text book unit 5.2 – Contract Cost Accounting) Cost & Management Accounting pg 233 Contract costing is form of job costing used to account for cost of contract for the construction of asset e.g. construction of bridges, building, ships. Either : fixed price contract – client agrees to pay a fixed price (can be escalation clause) cost plus contract – contractor is reimbursed for defined costs plus a certain percentage NOT IN EXAM Cos major construction takes time and so start and finish normally in different accounting periods have to find way to allocate contract revenue and costs to the accounting period when the work is done. Study Guide pg 51 Accounting Separate records are kept for each contract and the results of each contract are calc’d separately. Account is opened for each contract – all costs debited to this account and all goods or writing back of costs is cr. At end of contract account is cr with amount of the contract price. If contract is incomplete the cost price of the work completed plus profit on the contract (or loss) is cr to contract account at year-end. If only direct costs (materials and labour) then it is a gross profit, but want net profit so have to include actual or total cost so have to calc the overheads / indirect costs. Costs to be accumulated against construction contracts : costs that directly relate to contract (direct contract costs) e.g. : materials issued – either purchased from suppliers or issued from entity’s stores. Dr contract accounts 21 returns of materials – excess materials returned to stores. Cr Contract account and dr Store account. If materials transferred from one contract to another must cr contract supplying the materials and dr the contract receiving the materials sale of material – CONTRACT COSTS ARE REDUCED BY INCOME FROM SALE OF EXCESS MATERIAL (INCIDENTAL INCOME). If part of material sold then cr contact account with SELLING price of material cost of subcontract work – if subcontract hired to do part of work (e.g. electrician to do the wiring) then subcontractor will supply his own materials and labour and then contractor must pay him directly. This influences primary cost of contract and so must dr contract account site labour costs (incl supervision) – wage book written up from wage cards showing hours worked and the contract number and direct wages for each contract must be calc’d directly and dr to contract account machinery and plant costs – cost of hiring machinery and equipment can be either : hiring equipment – normally per hour and full price will be dr to contact account depreciation of machine and equipment used – if contractors own equipment then deprec according to GAAP and then dr to contract account cr to deprec account in GL, based on period that the equipment was used on the contract (so deprec for periods not used on contract is just general expense for contractor) revaluation of equipment – machinery taken to the site is valued and total value of machinery is dr to the contract account and cr to machinery account. At end of yr the machinery is revalued and value of machines is cr to contract account and so difference in value from start to yr-end is the depreciation for that time of construction. Revalued amount is opening bal for contract account in next financial yr. at end of contract machinery is revalued and cr to contract acc and dr to machinery account or, if transferred to another contract, then dr to that contract account. If machinery or equipment is sold then that is incidential income and will be cr to contract account with FULL amount of sale price moving machinery and equipment to site – direct cost so dr to contract account indirect costs / costs relating to contract activities in general and have to be allocated to contracts – costs not directly related to one specific contract but generally associated with all contract activities must be allocated systematically and rationally and constantly applied. Either : in accordance with ratio of total cost of this contract to the total cost of all contracts. Can be done like this easily, but then calc of profit or loss on completed contracts only done at yr-end and better to know contract profit when it is completed allocate costs using the cost of labour as basis use any other ratio that suits contractor as basis for cost transport e.g. of general contract costs are : storage costs insurance design costs and cost of technical assistance not specifically for one contract cost of preparing / processing the salaries and wages for the construction staff charges that are specifically charged to customer in terms of the contract Costs that are NOT related to contract activities – or costs that can’t be allocated to specific contract are EXCLUDED from cost of contract and written off in IS as expense. e.g. : general research and developments cost head office cost general admin expenses advertising cost financing other then for specific contracts depreciation on machinery and equipment that has been standing idle (down time) Extras / variations – contract normally has specifications laid down by contractor and client and if need to change specs on client’s request then contractor needs to be paid for this extra materials. Just added directly to cost of the contract and contract will evaluate and revise the estimate of the contract income and costs as agreement is added to. Estimated cost of variations will be included in estimated total costs of contract completion and the initial contract price will increase by the amount of the extras to get a total contract profit. Retention money – certain portion of the progress payments that is withheld until all the conditions of the contract have been compiled with or all the defects have been corrected. If any other defects occur within certain period specified in contract then contractor has to repair them at his own cost. So when contract is completed the contractor doesn’t transfer full amount of profit to IS – the retention amount is either b/d as cr bal in that Contract account or is cr to Provision for Defects Account. If provision becomes a dr balance cos of very high expenses then show in IS as Loss as Result of Latent Defects. If at end of specified date there are no claims against this provision account then this is transferred to IS as additional profit. 22 Cost & Management Accounting pg 234 Contract revenue = initial amount agreed in agreement as well as changes in contract work, claims and incentive payments. Amount can increase or decrease from one period to another cos of : variation on claims that increase or decrease contract revenue in subsequent period as per agreement in contract amount of revenue in fixed price contact can increase cos of escalation clauses in the agreement amount of contract revenue can decrease cos of time penalties set on date of completion if fixed price contract involves fixed price per unit of output then contract revenue will increase as the number of units is increased Duration of project is normally from date the contract is signed until the project is substantially completed and handed over to client. Cost incurred before contract is signed normally period costs, but if cost can be identified with future contract and reasonably certain that contract will proceed then pre-contract costs are contract costs. Costs incurrent normally by construction entity are normally either : contract costs – divided into either : direct contract costs – for a specific project e.g. material bought specifically for that project or material charged out from stores to specific project site or project wages including supervision subcontract work costs of hiring plant and equipment depreciation of plant and equipment used on contract cost of moving plant and equipment to and from contract site financing costs if borrowed specifically for that project costs of design and technical assistance directly related to the contract indirect contract costs – general project activities that are allocated to individual projects using systematic and rational method. e.g. : warehouse costs insurance transport cost of design and technical assistance not for specific contract construction overheads including preparation and processing of construction personnel payroll costs specifically chargeable to the client under terms of the contract general costs – incurred by entity to function and not allocated to specific contract. e.g. : general admin costs head office costs allocated to IS as period cost and selling costs NOT contract cost, but should still be financing costs except for specific contracts taken into account when determining research and development costs price or tender cos effects entity’s depreciation of idle plant and equip not used on specific contract final profit Separate account opened in contracts ledger (supporting ledger), where account is dr with all contract costs and cr with the contract price. So each contract account becomes separate profit and loss account for that specific contract. Characteristics of contract cost accounting : contract number assignment to each contract material ordered specifically for contract is dr directly to the contract from the supplier’s invoice – materials requisition used to draw material from warehouse stores most other costs are also direct costs e.g. labour and subcontractors machinery and equipment costs charged to contact either : on rental basis normally per machine hour revalued at end of each financial year, and then difference between beginning and end of financial period is the depreciation for that period. using normal depreciation to write off cost over time specifically used for that contract Total estimated costs = most recent estimation of the total cost to complete the whole contract. Is costs incurred to date and the estimated additional cost of completing the contract. Total estimated profit = total contact prices less total estimated costs Certified work – progress payments made after supervising architect / engineer issues certificates of progress (specify the contract value of the approved work completed to the date of the certificate). Contractor then requests progress payments from his client for the certified work according to the contract agreement. Stage of completion is in terms of the contract price, NOT in terms of the contractor’s costs 23 Uncertified work – certified work is done in terms of the contract and at times agreed upon, but not normally at yearend so normally there is a portion of the contract at year-end that has been done after the last certificate was issued. This uncertified work costs must be determined at the year-end as part of work in process at year-end. Material at site – with incomplete contracts there is unused material on hand at yr-end ordered specifically for the contact. These are valued at cost price and carried over to next financial year. Study Guide pg 58 Methods of recognition of profit on construction contracts – if contract is begun and completed in one financial year then can determine total costs and total income easily. But if over more then one year then can calc profit using : completed contract method – USED ONLY IF FINAL OUTCOME OF CONTRACT (PROFIT AFTER COMPLETION) CAN’T BE ESTIMATED RELIABLY. Profits are only regarded as being realised when the contact has been completed or is almost completed (i.e. if there is only minor work left). Uses actual costs and not estimates that may be incorrect cos of unforeseen expenses or possible losses, so no risk that profit that might be showing profit that hasn’t been earned. Disadvantage is that the reported profit only refers to the result of projects competed during that year and so not accurate reflection of ALL the activities of the year percentage of completion method – USED IF FINAL OUTCOME OF CONTRACT (PROFIT AFTER COMPLETION) CAN BE ESTIMATED RELIABLY. Recognises profits on basis of stage of completion of contract work at end of each accounting period and profits are bought into account as the contract work progresses. Calc costs incurred to attain the level of completion and match them to the contract income earned to that stage and will give profit / loss of the portion of work that has been completed by that stage. So are showing the contract profit in the financial year when the work was done. Only used if : total contract profit can be determined reliably cost of completing the contact and stage of completion of the contract can be estimated reliably at BS date cost attributable to the contract can be clearly identified so that actual costs can be compared with prior estimates. Use following methods to determine the stage of completion which must be applied when calc the contract profit for the financials : proportion of cost incurred to date to the total contract cost – so contract profit is calc’d up to the end of the accounting period as contract profit = . cost to date x estimated total profit estimated total cost 1 or contract profit = actual cost to end of financial year x total contract price - total estimated cost latest estimated total cost of completing contract 1 So profit up to end of financial year is added to contract cost up to the date and that is the value of incomplete work at end of accounting period. certified surveys of work executed by professional advisors – architect / engineer will inspect the progress periodically and issue certificate which is value of completed portion relative to full contract price. (Progress payments are dr for work done on a contact even if they are not paid by client). Cos certificates won’t be dated at year-end, must also calc the COST price of work done but not yet certified and this must be added to certified work for total cost of the year. contract profit = contract value of certified work + cost price of work not certified x 100 total contract price 1 or contract profit = value of work certified contract price x estimated total profit 1 So certified work is at CONTRACT price, but estimation of work completed but not certified is at COST price. Can use different methods for different contracts – but must be used consistently. Cost & Management Accounting pg 238 Profit determination for contracts Completed contract method – no profit bought into account until project is completed no matter how long the contract takes to be done. Conservative method of profit calc and there is no doubt about the profitability of the profit since income and costs that are brought into account have all been realised, so no need to estimate or adjust figs cos f unforeseen costs or losses. Only used when can’t reliably estimate the profit at completion. 24 see example pgs 239 / 240 of text book Percentage of completion method – profits calc’d on work done and the total profit on the contract is divided over the accounting periods in relation to the work completed. So income and profits are brought into account when they are earned and so costs are incurred when the income is earned. Stage of completion is measured by either : proportion between costs incurred to date and the estimated total costs of the project – so calc proportion of costs to date at end of financial year to total estimated costs to complete the contract (using the latest calc’s). costs that have been incurred but not utilised NOT included (e.g. materials not used, advances to subcontractor for work that isn’t done yet, undepreciated value of machinery and equipment if cost of machinery and equipment have already been dr to contract account). proportion of value of work certified to the total contract price – stage of completion calc’d as proportion of work certified to end of financial yr by client’s engineer / architect to the total contract price of the project. If project ongoing for many years then should review profits already reported because of changing circumstances. May have to make adjustments to prior year profits / losses and then the current year’s reported profit will be combination of current year and adjustment for previous years. project contracted in stages – if project is completed, delivered and invoices in stages then each of these stages can be viewed as a separate project without having to make provision for expected losses in the next stages. see example pgs 241 / 243 of text book Study Guide pg 58 Reserve for contingencies Cos always risk of over estimating profit and also cos of changing circumstances best not to transfer full amount of profit to IS – normally keep portion in reserve account. Management decides policy and portion in reserve will only be transferred to IS when contract is complete. Called realised portion of the calculated profit and calc’d : by taking fairly high percentage of calc’d profit to IS and then balance to Reserve for Contingencies e.g. 33.3% or 25% by using cash received in relation to cash receivable (i.e. the amount payable by the client to date). Determined by provisions of the contract and certificates issued by client’s architect / engineer : contingency reserve = cash received x estimated profit to date cash receivable 1 or contingency reserve = progress payments received progress payments receivable x estimated profit to date 1 Provision for loss if estimates indicate that the contract cost will exceed the contract income, then TOTAL expected loss must be provided for as expense. Amount to be provided for the loss determined irrespective of : contract work has already started or not stage of completion amount of expected profit on other contracts. Loss must be provided it is probable will occur and it can be estimated see example pgs 246 / 247 of text book see examples pgs 63 to 79 of study guide Study Unit 4 (text book unit 6 – Process costing systems) Study guide pg 81 Process costing system used to accumulate, process and reflect manufacturing costs of identical products that are manufactured in bulk and the products pass through different consecutive processes during manufacture e.g. paint, chemicals and textiles. Average cost per unit must be calc’d by dividing total manufacturing cost for the process by the number of units manufactured during the period. Cost per unit = cost price of the final product which is taken into the inventory system. Must have 2 kinds of data : total manufacturing costs for each separate production process for a certain period number of units manufactured for the various processes 25 Cost & Management Accounting pg 258 Job costing = @ client’s specs and only starts after client places an order. Jobs aren’t identical and costs are per job and finalised after completion of the job. Use job card for cost for each job. Manufacturing can be over more then one financial year, so then costs after 1st year become incomplete work and accumulated costs transferred to the next period. Process costing system = products manufactured continuously according to standard specs. Products are manufactured in large quantities and are identical (so each unit needs same quantity of material, labour and manufacturing overheads). Costs are collected for fixed period. Costs are collected by departments or processes for a specific period. Number of units also determined by department or process and cos each process has a standard product then total manufacturing costs (for that specific period) average cost per unit of specific dept for specific period = no. of units manufactured (in that specific period) So 1st have to divide the manufacturing process into different departments / processes and these are cost collection points – either divided into small cost centres for single activities (smaller entity) or into large group of activities (larger entity). Responsibility for process costs is responsibility for : costs quantities Study guide pg 82 Product and cost flows Cos product has to go through various consecutive processes can have materials added during 1st process and then any of the following processes as well. So output of one process will be the input for the following process. Conversion costs (labour and overheads) occur in each process and so costs accumulate as the product moves through the processes. Process costs uses principle that unit cost for each process is separately calc’d and then all the unit costs are added together as the products move through the manufacturing process. see diagram pg 83 and example pgs 84 / 85 (showing journals) of study guide Cost & Management Accounting pg 259 After processing in first phase with materials, the product moves to the next phase and more conversion cost occur and possibly more materials. Unit costs calc’d for each department and total cost accumulates as product moves down the line. Can use production diagram to analyse and organise data for process costing. see diagrams pg 260 to 262 of text book Study guide pg 85 Process cost reports Basic process costs reports have 3 sections : quantity / production statement – summary of the number of units entering the process and what happens to them. Number of units as input should be equal to number of units as output. see example pg 86 of study guide production cost statement – summary of all production costs incurred during the period – shown in total per cost element and calc’d per unit. cost allocation statement – costs recorded in production statement linked to units indicated in the output or production part of quantity statement. Cost & Management Accounting pg 263 Process cost report shows summary of total and unit costs for each department in steps : Step 1: Quantity or production statement Shows how many units were received in department and how they were dealt with i.e. transferred to next department or if incomplete work – so is physical flow of units and also the stage of completion they are at. Units in the quantity statement are in measurements of the department’s finished product (litres / kgs) – all units must be in the same standard. If not all completed then must calc equivalent production. Step 2: Establishment of production costs Total production costs incurred by department in accounting period determined in cost statement of the report. Costs for any period can be from : incomplete units that were still in the process of being completed at beginning of financial year (i.e. units and unit costs transferred from previous period) if second department or more down the production line then costs from previous departments will be received when units are transferred to this department each process gets more labour and manufacturing overheads and sometimes materials 26 Step 3: Calculation of unit costs Units costs NOT for production as a whole, but for each separate department PLUS costs from previous departments and costs in current department Step 4: Allocation of costs Once total costs are determined then must give account of them i.e. costs from : units transferred to next department or to finished goods units still being processed by department lost units Step 5: Proof that all costs are accounted for must recon steps 2 and 4 (i.e. the full production costs that were established against the allocation of the costs) Process costing methods either : single product : single process single product : multiple processes multiple products : single / multiple processes Single product : single process Only have single process cost statement for each accounting period. Costs of material used in departments obtained from material requisitions and labour costs from salaries department / wage analysis statements. Overheads allocated by applying the appropriate rate. Production account / Work in Progress account in GL is opened for each department or process and shows the costs of material, labour and overheads and also the transfer of completed units made. see example pgs 265 / 266 of text book Jnls from cost statement : Dr Cr Production account xxxxx Material control xxxxx Production Account Labour control xxxxx Material control Finished goods Labour control Overheads control xxxxx Overheads control (production costs for the month) Dr Cr Finished goods xxxxx Production account xxxxx (trsf of completed units – xxxx units @ R … each) Single product : multiple processes If more then one department then the costs incurred in EACH department are collected and accounted for in the same way as in single process. So total costs in each department (including the costs transferred from the 2nd department onwards) will be divided by the production of that department to get the unit cost for that department. see example pgs 267 to / 270 of text book Study guide pg 86 Equivalent Completed Units (ECU) Cost for certain period is linked to number of units manufactured during same period in a specific department. If there are partly completed units on hand at the beginning and end of a period then have to convert them into equivalent completed units. Normally stage of completion is separately determined for each cost element see example pg 88 of study guide Cost & Management Accounting pg 272 Cos there is continuous production will always be partially processed products at year-end – so have to allocate the costs for that department to both completed and incomplete units, so use equivalent completed units (ECU) of product. Done by taking the number of units entering the department and subtracting the number of units that were completed and transferred to next department, to get the units that were still being processed at period end. Now must determine how much work was done on the incomplete units by inspecting them and deciding what percentage of work has been done to those units – materials, labour and overheads. (i.e. what percentage of the total resources necessary to complete the units has been expended on the incomplete units). Then use that percentage to calc ECU = units still in process at end of period x percentage of work done on unfinished units Then the unit cost will be calc’d : total manufacturing costs (for that specific period) . 27 cost per unit = completed units + ECU (unfinished units x % of work done) Use of resources Resources used 2 ways in production : continuously during the process (then assume that use occurs evenly) in lots at specific stages in the process Normally assumed that labour and overheads are used continuously and evenly during the production process and that materials are used at the stage that they enter the process. How resources are used effects the calc’s of the unit costs : if resources are used continuously and evenly then equivalent production deemed to be directly in proportion to completeness of product (in %) if resources are added to production line at certain stages then equivalent completed units (ECU) are the ones that have already passed the stage at which the resource was used. e.g. if know that labour and overheads are used continuously and evenly and material is added at the beginning of the production and that units are 70% complete at the end of the period then calc of equivalent production. Cos we know that the units have moved past the stage when the material was added (cos at start and already 70% complete), then material equivalent completed units is 100% while the labour and overhead charges are only 70% Closing inventory of incomplete work on 20 000 units : direct materials = 20 000 x 100% = 20 000 units labour and overheads = 20 000 x 70% = 14 000 units see example pgs 274 / 275 of text book labour costs + overheads = conversion costs Incomplete units in closing inventory If production department gets products from previous department as input and then processes it further then there are 3 types of costs to be taken into consideration : costs from the previous process (don’t have to be broken into materials, labour and overheads – just use it as total cost of process) direct material added to this process conversation costs incurred in the process see example of complete process cost report with opening inventory pgs 275 to 277 of text book Incomplete units in the cost allocation section ALL THREE of the cost groups are brought into account at the equivalent unit costs – cos if not then the Cost Statement and Cost Allocation sections won’t reconcile. Study guide pg 89 Incomplete units in opening stock Cos of rising costs of materials can have problem when unit costs of products manufactured in different periods differ. Then what happens with value of stock if manufacturing began in 1 period and is completed in the next? Which period’s costs are used to value the product when it is finished? When costing stock normally use : weighted average method FIFO method When there are incomplete units on hand in closing stock then portion of the cost gets allocated to the incomplete units (on basis of equivalent completeness). If use weighted average or FIFO method doesn’t make any difference to value of the closing stock at the end of the period. Difference between weighted average or FIFO stock values only apparent at beginning of following period when closing stock at year-end becomes opening stock in new financial year. Weighted average method – cost incurred during previous period for partially completed units is added to cost incurred during the current period to give the total cost. This is then divided by total number of equivalent units to get the weighted average cost per unit. Incomplete units at end of previous financial year plus the equivalent units completed during the current period give the total equivalent units. FIFO method – cost of the partially completed units in opening stock is recorded separately from the cost of the units started in the current period. Then cost incurred in the current year for completing the opening stock is added and a separate unit cost is calculated for opening stock. Cost & Management Accounting pg 278 Incomplete units in opening inventory Weighted average method – cost of the opening inventory is added to the cost of the current period so that all the units that are completed have the same unit cost. 28 Units in the opening inventory are treated same way as the units which are started and completed in the current year. Previous year’s costs allocated to incomplete work at the start + Current period manufacturing costs on all units in process Total cost for the period = Valuation of completed products / (divided by) and Equivalent production for period = Average cost per unit used for : Valuation of incomplete units at yr-end FIFO – costs of the units in opening inventory which are finished in following year are kept separate from the costs of the units which are begun and completed in the current period. Costs of goods which are completed and transferred are made up of cost of the units which were : completed which were in the opening inventory and started and completed in the current period. Closing inventory of incomplete work is valued at unit cost of current production (determined by dividing the production costs incurred in current period only by the equivalent units manufactured during the current year). ECU calc (weighted average method) So total costs evenly attributed to 2 production groups (competed units and incomplete units at end of period) Step 1: units completed and transferred PLUS Step 2: units completed and on hand @ 100% see example pg 280 of text book & weighted average example pgs 280 / 281 of text book PLUS Step 3: incomplete units in closing inventory @ % of completion PLUS Step 4: units lost @ % of completion at time the loss is ascertained ECU calc (FIFO method) Step 1: units completed and transferred @ 100% PLUS Step 2: units completed and on hand @ 100% PLUS Step 3: incomplete units in closing inventory @ % of completion So total costs evenly attributed to 3 production groups : Group 1 - units in opening inventory Group 2 - units that were started and completed during the period Group 3 - units which were still incomplete at the end of the period PLUS Step 4: units lost @ % of completion at time the loss is establishedsee example pg 280 of text book & FIFO method example pgs 284 / 285 of text MINUS book Step 5: opening inventory @ % of completion Previous years costs allocated to opening incomplete work COST GROUPS + Costs incurred in the current period = Total costs Portion of current period costs attributable to completion of opening incomplete work Portion of current period costs attributable to units begun and completed in the period Portion of current period costs attributable to incomplete units at the end of the period Group 1 – cost of units in opening inventory completed during the period Group 2 – cost of units in begun and completed during the period Group 3 – cost of incomplete units on hand in process at end of period In Quantity Statement - opening stock plus units added during the month are used to calc the equivalent production and the average cost per unit. 29 In Cost Allocation Statement the total is equal to the cost of the incomplete work at the beginning of the month plus all the costs that have incurred during the month. Also cos the total costs are from different cost groups (materials, process and conversion costs), must now calc the average unit costs for EACH of these so can calc the value of the incomplete units at the end of the period. So in FIFO Group 1 will be the costs for the units in opening inventory plus the costs incurred in the current period to complete the units. Groups 2 & 3 will be the other costs incurred during the period i.e. cost input of units received during the month from the previous department (complete and incomplete units), but equivalent unit costs are ONLY for costs incurred in the current period. Study guide pg 91 If product is manufactured in 2 consecutive processes then must do Quantity Statement, Production Statement and Cost Allocation Statement for both processes separately. see example pgs 91 to 98 of study guide Cost & Management Accounting pg 293 Increase in costs due to addition of material – when material is added to process then the unit cost will increase. If material is added evenly during the course of the process then the degree of completeness for the equivalent production for material will be the same as the conversion costs. But sometimes when material is added it increases the number of units in the process as well. Then cos materials have been mixed and can’t be distinguished from each other, the total cost must be divided by the increased units. In weighted average cost method and equivalent production basis then the cost of the increased units is carried by all the units that were processed during the period. In the Cost Allocation Statement the cost is divided between the completed goods and work in progress in the closing inventory. see example weighted average cost method pgs 294 to 296 of text book In FIFO method the cost of the work in process of opening stock isn’t used in calc of current period’s equivalent unit costs. In both methods the addition of material means that the number of units will increase, and because normally the material will be added at the beginning of the department’s process then the increase in the number of units will be on new products ONLY. see example FIFO method pgs 297 / 298 of text book If the increase in units takes place cos the material is added continuously throughout the process then the increase in the number of units will effect the new production and the opening inventory. In FIFO DON’T add the value of the opening work in process like in weighted average method. In Cost Allocation section of Process Cost Report must remember : cos the opening stock is only part processed must use more cost elements to opening work in progress so that opening stock can be completed in FIFO method the completed goods that are transferred are groups 1 and 2 (opening inventory that has now been processed and units from the current years production that are completed) closing inventory of work in process has 3 cost elements and must use equivalent production to allocate them at the applicable unit cost. Summary - adding material and labour from previous process increases the unit costs – if material added evenly during the process then will determine the equivalent production according to conversion costs calc If weighted average cost method (on equivalent production basis) then cost of the units is carried by the units that were processed during the period. In Cost Allocation statement the cost is divided between the completed goods and work in process in the closing inventory. In FIFO method – the cost of work in process of opening inventory isn’t brought into account in calc of current period’s equivalent unit costs. Cost & Management Accounting pg 300 Spoilt units Cos in process costing there is mass production of standardised product, there is no job-related wastage so in process costing system all waste is either normal wastage (to do with the process (e.g. evaporation) or abnormal wastage. In job costing system the expected cost of normal wastage is included in overheads recovery rate, but in process costing cost of normal wastage is calc’d at end of accounting period and allocated to work in process and completed units (depending on how much is completed when the wastage is detected). Cost of normal wastage allocated ONLY to completed units that have already past the inspection point or wastage point. Wastage normally detected at fixed inspection points in the process, but can occur at beginning, any stage during or at end of process. if at beginning or during process then the cost of normal wastage is absorbed by : units manufactured and transferred to the next process or to finished goods work in process (closing) 30 abnormal losses. If wastage occurs during or at the end of the process and there is incomplete work in process which hasn’t reached the wastage point – then no normal wastage cost is allocated to incomplete work. Then normal wastage is absorbed by : compete units and abnormal losses Study guide pg 99 Some losses in manufacturing process can’t be avoided – called normal / unavoidable losses and take place as part of the manufacturing process (e.g. waste materials in textile industry). These losses are absorbed by the completed units that do meet quality requirements. But also losses that can be avoided – called abnormal / controllable losses e.g. using inferior raw materials. Cost of wastage that exceeds normal losses have to be separately calc’d and show in the IS. Wastage is identified at inspection points and MUST know if the products being inspected have already moved past the point or not. Losses at the BEGINNING of the process (opening and closing work in process has already passed through the wastage point) : Beginning of the production process Wastage point Opening work in process Closing work in process End of production process If closing work in process has already passed the wastage point then the cost of the normal loss is ABSORBED by : units manufactured and transferred to the following process or to finished products work in process at the end of the process abnormal losses Losses DURING the process (opening work in progress still has to pass the wastage point, but the closing work in progress has already passed this point) : Beginning of the production process Opening work in process Wastage point Closing work in process If closing work in process has already passed the wastage point then the cost of the normal loss is ABSORBED by : units manufactured and transferred to the following process or to finished products work in process at the end of the process abnormal losses End of production process Losses DURING the process (opening work in progress passes the wastage point but closing work in progress has NOT yet reached the wastage point) : Beginning of the production process Opening work in process Closing work in process Wastage point End of production process If closing work in process has not yet reached the wastage point and where losses take place at the end of the process then the cost of the normal loss is ALLOCATED to : units completed and transferred to the following process or transferred to the finished products abnormal losses 31 Losses at END of the process (both opening work in progress and closing work in progress still have to pass the wastage point) : Beginning of the production process If closing work in process has not yet reached the wastage point and where losses take place at the end of the process then the cost of the normal loss is ALLOCATED to : units completed and transferred to the following process or transferred to the finished products abnormal losses Opening work in process Closing work in process Wastage point End of production process Inspection during manufacturing process : Inspection point for wastage Opening stock / work in progress Normal loss Completed & transferred units PRODUCTION LINE Input during the period Abnormal loss Incomplete units Cost of the normal loss is absorbed by the completed units, incomplete units and abnormal loss. Inspection at end of manufacturing process : Opening stock / work in progress Cost of the normal loss is absorbed by the completed units, incomplete units and abnormal loss Inspection point for wastage Normal loss Input during the period Incomplete units Completed & transferred units Abnormal loss Cost & Management Accounting pg 302 Accounting for wastage using the weighted average method see example of normal wastage at the beginning of process pgs 302 / 303 of text book If normal wastage at the beginning of process then : normal wastage DOESN’T influence on the total production cost normal wastage DOES influence unit cost cos the normal wastage is absorbed by the approved units cos normal wastage is inherent in manufacturing process the number of wasted units is left out of the calc of the equivalent units BUT cos actual wastage is never equal to estimated normal wastage normally have abnormal wastage. see example of normal wastage and abnormal wastage at the beginning of process pgs 303 / 304 of text book see example of wastage at the beginning of process & incomplete work at the end of the process pgs 304 to 306 of text book see example of wastage during the process pgs 306 to 310 of text book Calculation of equivalent completed units for the spoilt units is based on the state of completeness that the products have received when the wastage occurs. Cos this is at the end of the process the full applicable amount of material and conversion costs are allocated to the spoilt units. Cos using weighted average costing method the cost (in Cost Statement) of opening inventory of work in process is added to the costs incurred in the current period, and divided by the equivalent units of the relevant cost components to obtain and average cost per unit. Journal will then be : Dr Cr 32 losses in respect of abnormal wastage finished goods production account xxxxxx xxxxxx xxxxxx Study guide pg 105 see example of wastage at end of the process pgs 105 to 110 of study guide see example of wastage at beginning of and during the production process pgs 110 to 113 of study guide Accounting for wastage using the FIFO method Will be different to the weighted average method cos now have the opening stock in incomplete units forming a separate cost group. see example pgs 114 to 122 of study guide Cost & Management Accounting pg 310 see examples pgs 310 to 316 of text book Cost & Management Accounting pg 286 Combined Process Cost Report - can present process Cost Report as combined quantity & Production Cost Statement Combined Quantity and Production Cost Statement for ….. 2011 Quantity Incomplete work (opening) Received from previous process Production during the month : Material Conversion costs xxxxxx xxxxxx Total input xxxxxxx Value R xxxxxx xxxxxx xxxxx xxxxxx xxxxxx xxxxx xxxxx xxxxxxx xxxxx Completed and transferred : xxxxxx From opening inventory Previous period costs Costs in current period to complete those units xxxxxx Units begun and completed in current period Completed and transferred : Incomplete work (closing) : Costs from previous process Material Conversion costs xxxxxx xxxxxx xxxxx xxxxx Unit Price R xxxxx xxxxx xxxxx xxxxx xxxxxx xxxxx xxxxx xxxxxxx xxxxxxx xxxxx Study Unit 5 – Joint Products and By-Products (text book unit 6.6) Study guide pg 126 When use common raw material or joint production process then can have more then one different products from same production process. So a joint process can produce 2 different products. The products yielded by the joint processes are either : joint products – if both products are more or less equivalent in importance, quantity and value to the other products which arise from the same manufacturing process & make a material contribution to the market value of all the outputs of manufacturing process by-products – if one product is subordinate to the joint products in importance, quantity and value. By-product has a sales value but it is incidental to the manufacturing process. Some by-products don’t have a value at all. Contribute relatively small amount to the total market value of all the outputs of a process Good quality meat Ox Slaughtering process Carcass Hide Butcher buys carcass & processes it into joint products Bad quality meat Bones 33 by-product Joint costs When processing the joint products and by-products there are labour and overheads for all 3 products. In manufacturing process there will be a point when can’t identify individual products. Up to that point (when can still identify individual products) is split-off / separation point. All the costs incurred before the split-off point is reached are joint costs (so will include all materials, labour and overheads incurred to process the products up to the split-off point.) Additional processing costs If joint product is not sold directly after the splitting off point, but still processed further then the additional processing costs must be allocated directly to the respective products by job or process costing system. THESE COSTS AREN’T PART OF JOINT COSTS, BUT ARE APPORTIONED TO THE SPECIFIC PRODUCT AFTER THE SPLIT-OFF POINT. Cost & Management Accounting pg 324 Costs incurred up to split-off point are joint costs and include all material, labour and overheads to get the product to the spilt off point. Additional processing costs for each product after the split-off point are separate costs cos are allocated to that product by either job or process costing system. Product A Materials Split-off point Materials Labour Overheads – joint products are processed further so they can be sold Labour Overheads Applied joint costs and separable costs Product B Materials Labour Applied joint costs and separable costs Overheads Separable costs Total cost of products Study guide pg 128 NO joint costs are allocated to by-products – allocated only to the joint products based on one of the following : physical standard method (units produced in either quantity or weight). This will always produce the same cost per unit for each joint product. Sales values are left out of the account when allocating joint costs – so costs allocated to the product could exceed the income from that product. market value at the split-off point method (selling price / market value). So assume that higher selling prices will mean higher costs and if there is a joint product with a higher selling value then it will bear higher costs then a joint product with a lower selling value. If the products are sold at the split-off point then the products will both have the same gross profit percentage. relative market value of the final product method (all additional processing costs after split-off point, selling and distribution costs are deducted from the market value of the final product to find the estimated market value at the split-off point). Work backwards from market value of the final product to get estimated market value at the split-off point. reverse costing method – use the amounts that must be absorbed by each product. Management decides on minimum rate of return (profit) percentage and use that to calc the estimated net income for each product separately using estimated net income as basis, and then counting back the income and additional costs and also the portion of the joint costs that have to be carried (absorbed) by each product. Can use method of drafting Income Statement for products at both split-off point and after additional processing to determine which product should be sold at split-off point and which products should have further processing. see example of calcs using butcher scenario pgs 128 to 135 of study guide see examples pgs 327 to 331 of text book Study guide pg 135 Costing methods for by-products Proceeds of sale of by-product used to REDUCE the joint cost of the joint products. Shown in IS as : reduction of joint production costs 34 “other income” reduction in the cost of the goods sold see example of calcs using butcher scenario pgs 135 to 140 of study guide Cost & Management Accounting pg 332 Can calc the net market value of by-product and use it to reduce joint production costs see examples pgs 332 / 333 of text book When no joint costs are allocated to by-products then the sale of the by-products is shown directly in the income statement. see examples pgs 333 / 334 of text book Waste materials AREN’T by-products, but any sale of waste materials must be used to reduce the cost of the main product that is being produced. Study guide pg 140 NO joint costs are allocated to by-products. see examples pgs 141 to 149 of study guide Study Unit 6 – Direct and Absorption Cost (text book unit 4.3) Cost & Management Accounting pg 154 Recovery of fixed costs done either by : direct costs : marginal costing variable costing absorption costing Direct costing method – total fixed costs are written off against the income of the number of units that were sold during the period. No fixed costs allocated to the units that are still in inventory. Inventory is only valued at variable costs (direct materials, direct labour and variable manufacturing overheads). Direct costing recognises fixed manufacturing overheads as period costs. So difference between fixed and variable costs are emphasised – direct costing uses ONLY variable manufacturing costs (i.e. direct materials, direct labour and variable manufacturing overheads). Fixed costs are viewed as cost of capacity and so is not included in inventory, but rather seen as expired costs and written off in the IS. Absorption costing method – fixed costs are allocated to the number of units manufactured (units sold PLUS units in inventory). So fixed costs related to the units that are in inventory are transferred to inventory to be sold in the next financial period and are included in the opening inventory of the next period. Inventory is valued as production costs (variable costs plus fixed manufacturing costs), so absorption method recognised fixed manufacturing overheads as product costs. Different methods will mean different amounts reflected in the financials in the short term, but as all fixed costs are eventually recovered in long term, the two different methods will eventually give the same results. Absorption costs ALLOCATE all manufacturing costs to the product (i.e. direct materials, direct labour, variable overheads and fixed overheads). Fixed manufacturing overheads are allocated to the product using pre-determined fixed overhead rate and only expensed when the product is sold - i.e. they are inventory costs. Direct costing Absorption costing Inventory valuation Product costs Direct materials Direct labour Variable overheads Period costs Fixed overheads Selling expenses Admin expenses Direct materials Direct labour Variable overheads Fixed overheads Selling expenses Admin expenses 35 If all the products are manufactured and sold in the same period then there will be no difference between the net profit for each method. BUT if there is product left at the end of the reporting period then it will be valued differently using the different methods and will result in a different profit in the IS. see example pgs 156 / 157 of text book Income statement see example pgs 157 to 159 of text book Using the absorption method the closing inventory will have a higher value as it includes the fixed costs, so will result in a higher absorption cost. Fixed and variable selling and admin costs are NOT allocated to the product under either method – but are rather period costs and so NOT shown in inventory. Revenue / production / income relationship Variable costing income higher then absorption costing income if more products are sold then manufactured (cos more products flow out of finished goods inventory then the inflow). Absorption costing units from the finished goods inventory can have fixed manufacturing overheads from previous period as well as the fixed overheads of the current period as well, so the fixed manufacturing overheads in COS will be higher then the fixed manufacturing overheads moving out of inventory. Absorption costing income will be lower then variable costing income by fixed overheads that are coming out of finished goods inventory. If revenue and production are the same then there is no difference between the income using the direct costing and absorption method cos there will be no fixed manufacturing overheads coming into or going out of inventory. production GREATER then revenue production LESS then revenue production EQUAL to revenue THEN absorption net income GREATER then variable net income absorption net income LESS then variable net income absorption net income EQUAL to variable net income If production is GREATER then revenue then inventory has increased If production is LESS then revenue then inventory has decreased If production is EQUAL to revenue then opening stock is same as closing stock. see example pgs 160 to 164 of text book Reconciling direct costing profit with the absorption costing profit 1. Record the direct costing net incomes 2. Calc fixed manufacturing cost (number or production units x fixed manufacturing overheads per unit) 3. Calc fixed manufacturing part of the absorption COS (revenue units x fixed manufacturing overheads rate per unit) 4. Absorption costing net income = step 1 + step 2 - step 3 see example pg 164 of text book Study guide pg 151 In project costing, very important to allocate the total manufacturing costs incurred during a period to the total number of units manufactured during that period, so that can calculate manufacturing cost per unit. total manufacturing cost for period manufacturing cost per unit = number of units manufactured in period . Once have unit cost then can calc the allocation of manufacturing cost to units that are still in stock and to units that have been sold, in order to calc the net profit. Direct costing / variable costing / marginal costing uses only the variable cost in manufacturing cost of the product. Only variable manufacturing costs (direct materials, direct labour and variable manufacturing overheads) are used to calc the manufacturing cost per unit or in total, but when calc marginal income then ALL the variable costs are taken into account. Fixed manufacturing overheads are written off against income as a period cost during the period in which they occur. Absorption costing includes both fixed and variable costs in the total manufacturing cost of a product (so the product is “absorbing” the variable and fixed manufacturing cost). The larger the number of units that are manufactured then the lower the unit cost will be (cos same amount of fixed costs are being divided by larger number of product units). Fixed manufacturing costs are recovered on the basis of the number of units of a product that are MANUFACTURED during the period. 36 If the number of units produced and the number of units sold are the same (i.e. no stock on hand) then Income Statements for the direct or absorption costing methods will have the same net profit. If there is stock on hand then the difference in net profit can be reconciled by taking into account the difference between opening and closing stock used in the two methods. see example pgs 154 to 157 of study guide Absorption costing – Income Statement : Direct costing - Income statement : Sales xxxxx less variable costs : Direct material Direct labour Variable manufacturing overheads Other variable costs : Selling expenses Administrative expenses = marginal income less fixed costs : manufacturing cost selling cost administrative cost xxxxx xxxxx xxxxx xxxxx Sales xxxxx less manufacturing costs : Direct material Direct labour xxxxx xxxxx xxxxx xxxxx Manufacturing overheads : Variable Fixed xxxxx xxxxx xxxxxxx = gross profit xxxxxxx xxxxxx = net profit xxxxx xxxxxx xxxxx xxxxx xxxx less other costs : Selling costs (fixed & variable) Administrative costs (fixed & variable) xxxxxxx = net profit xxxxxxx xxxxx xxxxx Cost flow of manufacturing costs according to direct costing method : Direct material Direct Labour Variable manufacturing overheads Cost price of goods in stock Debited against income when goods are sold Fixed manufacturing overheads Debited against income in that period Cost flow of manufacturing costs according to absorption costing method : Direct material Direct Labour Variable manufacturing overheads Cost price of goods in stock Debited against income when goods are sold Fixed manufacturing overheads Difference in net profit between direct costing method and absorption costing method is the difference between the fixed manufacturing costs that are included in the closing stock in the absorption costing method. see example pg 159 of study guide 37 Stock either valued by FIFO or weighted average method. How the opening and closing stock is valued will mean a difference depending on which method was used. see example of weighted average valuation method pgs 160 to 163 of study guide see example of FIFO valuation method pgs 163 to 165 of study guide Direct costing – advantages easier to control different elements of cost cos variable costs are controlled per unit and fixed costs are controlled in total operating results can be presented in understandable and synoptic form operating results important to management for : effects of changes of output volume and product mix on the profitability of the entity determination and adjustment of selling prices fixing of entity’s policy cos distinction made between variable and fixed costs significance of fixed cost as percentage of total cost can be applied in conjunction with standard costing and budgetary control eliminates dangers of overcosting and undercosting of fixed overheads to certain products no allocation of fixed costs Direct costing - disadvantages relationship between fixed cost can be directly attributed to the manufacturing of some products and the marginal income from these products isn’t calc’d, or is calc’d on arbitrary basis in reality all variable costs don’t vary in direct proportion to volumes so direct costing is more complicated can be semi-variable costs that create complications SARS doesn’t recognise inventory, work in progress and finished goods valuations according to direct costing method risk that people try to compare the relative profitability of groups of products that can’t be compared e.g. products made using extensive manual labour against machine made products would have very different marginal incomes and can’t be compared shouldn’t be used if variety of products are manufactured – rather used as guideline but not basis for pricing Absorption costing – advantages recognises the importance of fixed costs prevents reporting of fictitious losses – if entity has seasonal sales and builds up production during off-season periods and the costs were shown in IS during the off-season period, but there were no sales then there would be large losses out of season and large profits in season (cos of high sales and very small fixed variable costs if the direct costing method was used) valuation of work in progress and finished goods is recognised by SARS see example pgs 168 to 172 of study guide Study Unit 7 – Activity Based Costing (text book unit 4.4) Cost & Management Accounting pg 170 Based on fact that products are created from activities and so costs are allocated to these activities. Traditionally overheads were allocated in two stages : overheads allocated to departments cost of departments overheads allocated to products If fixed costs allocated inaccurately then the cost prices will reflect inaccurate unit costs, mainly due to : incorrect application of unit-based cost drivers. Some fixed overheads aren’t related to production volume but rather other factors – called non-unit based cost drivers e.g. number of setups, material handling hours and inspection hours. So can’t use unit based cost drivers for these costs as won’t be allocated accurately. degree of product diversity – when products consume overheads in different proportions e.g. can have the same number of machine hours per unit, but one product could have a quicker set up time for the machines and could be manufactured in larger batches so should have lower costs then another product that has longer set up times. Distortion factors : allocated based on unit related measures differences in relative consumption ratios see example of traditional costing on pgs 171 / 172 of text book ABC costing reduces the distortions cos use the actual cost driver for each activity in production to allocate the costs directly to the product used. 38 4 steps to ABC system : Step 1 : Identify activities Entity must identify all activities (e.g. tasks, actions or unit of work). Activities are classified into 4 categories : unit-level activities – relating to individual units produced (i.e. unit level activities have to be performed every time a batch is produced). Directly related to production volumes e.g. direct material, direct labour, variable manufacturing overheads batch-level activities – performed each time a batch of goods are produced so related to production batches but NOT to individual products e.g. machine setups, purchasing orders and inspections. Variable cost and will depend on the number of batches manufactured, but fixed cost is allocated to the number of units in each batch e.g. cost for processing a sales order, equipment setup, cost to move batch and cost for inspection product-sustaining activities – performed to support the different products that are manufactured e.g. cost incurred to enhance a specific product written off against that product and not dependent on number of units produced e.g. new bills of materials for modified products, compiling engineering changes and developing new process or product testing procedure facility-sustaining activities – performed to sustain factory’s general manufacturing process. Benefit the whole manufacturing process and the costs must be written off against total production. Viewed as fixed costs for all products manufactured in the plant e.g. plan management, security Step 2 : Identify cost drivers for each activity Cost drivers are factors that cause different activity costs. Must be measurable and must also be able to be allocated to products (i.e. must be direct relationship between cost driver and the activities that must be performed) e.g.’s Activity Cost driver Activity classification Direct labour hours Direct labour hours Unit-level Setups Number of batches Batch-level Maintenance Maintenance hours Product-sustaining Accounting services Headcount Facility-sustaining Cost driver is the cause of the cost that occur every time an activity is performed. Step 3 : Cost pool creation Cost of each activity accumulates into cost pool. Each cost pool has related costs like departmental manufacturing overheads that are allocated to one or more cost objectives like products, services and activities. One cost driver for each cost pool. Number of cost pools determined by : activity cost must be material in size in order to justify separate treatment cost diver should be most suitable one for the cost pool Step 4 : Trace activity costs to cost objectives Activities cause costs and cost objectives. 1st allocate costs to cost pool and then to cost objectives. Rate to allocate costs calc’d : activity cost (cost centre cost) cost centre rate = cost driver volume allocated amount = cost centre rate x cost driver volume see example pgs 175 / 176 of text book and see example pgs 176 178 of study guide Cost & Management Accounting pg 178 Criteria for use of ABC system : non-unit based costs (fixed manufacturing costs) must be high part of total overheads – if aren’t then can use traditional absorption costs cos will give the same results consumption rate of unit-based and non-unit based activities must be very different. If in about the same ratio then doesn’t matter if unit-based costs are used to allocate all overhead costs or to individual products if line managers have doubts about the integrity of product costs from the management accountant when marketing department refuses to use reported product costs as basis for pricing the products if divisional profit margins are difficult to explain if product lines are diverse if certain products have suspicious profit margins if marketing department suggests that seemingly profitable product should be dropped if number of low priced products are increasing while the profits are declining due to undercosting of those products. Study Guide pg 178 39 Traditional absorption costing systems can measure volume related costs that are consumed in production to the number of production units, BUT assume that products also use non-unit related costs in the same proportion as production volumes so will have distorted product costs. Can also be distorted if high level of product diversity. ABC system 1st traces costs to activities and then to products. Have to identify the activities, identify the cost divers, create cost centres, and allocate activities costs to products. ABC system used when non-unit based overhead costs are significant and there is a high level of product diversity. Study Unit 8 – Cost-Volume-Profit Analysis (text book unit 9.1) Cost & Management Accounting pg 388 Cost-Volume-Profit analysis is technique for short-term planning and based on fact that any change in either cost, volume or eventual profit will have an influence on the other two elements. So CVP is study of relationships between : price of product volume or level of activity variable costs per unit total fixed costs sales mix estimated profit. Conventional income statement (absorption costing) doesn’t distinguish between fixed and variable costs so can’t be used for internal management purposes. Use the info we have on fixed and variable costs to draw up marginal income statement which shows the distinction between fixed and variable components for ALL expenses. Total variable costs are deducted from sales revenue to determine the marginal income. Conventional Income statement : Marginal Income Statement : Sales xxxxx Sales xxxxx less Cost of Goods sold : xxxxx less variable costs : xxxxx variable production costs variable marketing costs variable admin costs xxxxx xxxxx xxxx Gross profit xxxxx Marginal income xxxxx less operating expenses : xxxxx less fixed expenses : xxxxx Marketing Administration = net profit xxxxx xxxxx xxxxxxx fixed production costs fixed marketing costs fixed admin costs = net profit xxxxx xxxxx xxxx xxxxxxx CVP analysis used to evaluate changes in selling price, cost or volume on profits. Must calc the marginal income (balance after variable costs have been deducted from sales revenue). Then take marginal income and deduct the fixed costs to get the profit for the period (so if there isn’t enough marginal income to cover the fixed costs then there will be a loss). So basically if only on item is sold then sales less variable costs = marginal income and less fixed costs will be a loss. But if additional items are sold then eventually there will be sufficient to cover all the fixed costs and will make a profit. see example pg 390 of text book Marginal income = difference between sales value and the total variable costs (marginal costs) of those sales OR Marginal income = the increase in total costs which arise if an additional unit is manufactured OR Marginal income is the aggregate of the variable costs applied to produce or market a single product. Calc of break-even point using marginal income per unit method Break-even point = volume (number of units that must be sold) for marginal income to cover all the fixed costs (minimum quantity of product that must be sold to ensure that all fixed costs are covered and that enterprise doesn’t make a loss). total fixed costs . 40 break-even units (number of products) = marginal income per unit = number of units that must be sold Break-even value = sales value of the break-even number of units : total fixed costs marginal income ratio . break-even value = break-even quantity x selling price per unit OR = number of units that must be sold see example pg 391 of text book Instead of working out the calcs per unit, can also calc the income variable costs and marginal income as a percentage. Marginal cost ratio = percentage of variable costs to total sales Marginal income ratio (or profit / volume ratio) = percentage of the marginal income to total sales marginal income ratio = Marginal income x 100 sales 1 OR marginal income ratio =1 - variable costs sales Marginal income ratio can then be used in different calcs : break-even value = 1 - fixed costs variable cost per unit sales price per unit . OR total fixed costs marginal income ratio . break-even value = see example pg 393 of text book Also use marginal income and marginal income ratio in profit-volume graphs Expected profit or return Used to calc the sales value that will produce a specific net profit. sales volume = fixed costs + expected profit marginal income per unit . = number of units that will need to be made to make a specific expected profit . sales value = expected profit units x selling price per unit OR fixed costs + expected profit marginal income ratio = number of units that must be sold see example pg 394 of text book Margin of safety (M/S) This is the amount by which the sales value exceeds that break-even value. Can be either in Rands or units : margin of safety in Rands = total sales - break-even sales margin of safety in units = total units sold - break-even sales units see example pg 394 of text book Margin of safety ratio (as a percentage) – used to show the percentage that the volume of sales can drop before start to make a loss : margin of safety value % = M/S in Rands x 100 total sales 1 sales - break-even sales x 100 41 OR margin of safety units % = total sales 1 M/S in units x 100 total sales 1 see example pg 395 of text book Change in selling price Increase in the selling price of a product normally results in lower sales. Can use Cost-Volume-Profit analysis to show how low the sales volume can fall before the planned profit suffers. Then can use info of the price increase and the planned profit to calc how many units will need to be produced to break even or to achieve a planned profit. see example pg 395 of text book Change in variable costs Can have a change in variable costs and calc the break-even point and also the number of units that need to be produced to achieve a certain profit. see example pg 396 of text book Change in fixed costs Can have a change in fixed costs and calc the break-even point and also the number of units that need to be produced to achieve a certain profit. see example pg 397 of text book Product mix If entity has more then one product then more complicated to find break-even analysis and difficult to get accurate forecast. Each product will have its own marginal income ratio, so must establish sales mix to calc the marginal income ratio on a weighted average basis. see example pg 398 of text book Change in product mix If there is a change in the product mix then the break-even point will also change. see example pg 399 of text book Change over point Can change from one Cost-Volume-Profit ratio to another and the change over point is the quantity at which the profit will be the same. see example pg 400 of text book Break-even analysis using graphs Used to show the relationship between costs, volumes and profit at various sales volumes. Use Y-axis / vertical axis for monetary values and X-axis / horizontal axis for volume in units. 1. draw the fixed costs line (will be the same for all the volumes), so drawn parallel to the X-axis 2. draw the total costs – fixed costs + (expected sales / sales for the period x variable costs per unit) 3. draw straight line from the origin (0) to the maximum value of the sales (this is the total value of the proceeds of the sales value x units) 4. break-even point is the intersection between sales line and the total costs line. The break-even value is point BV, and BU is the break-even volume 5. the vertical distance between the sales line and the total cost line is the profit or loss amount. Using the cost line – anything below the break-even point is a loss and anything above the break-even point is profit 6. the safety margin is the distance between the break-even point and the units sold (so will be between the 500 and 1000 units) see example pg 401 of text book Break-even graph 42 Y But if want to do a R 10,000 marginal income graph then can’t be the same as R 8,000 the break-even graph as difficult to draw the R 6,000 different income and costs lines on the same graph. But cannot always have a R 4,000 cost line that is a straight line as there are changes R 2,000 in costs. Variable costs can also increase or decrease 0 500 1000 X progressively or Volume digressively in relation to the volume of business. Selling price per unit can also change and then sales is also not a straight line. see example pgs 402 to 403 of text book Use Y-axis / vertical axis for monetary values and X-axis / horizontal axis for volume in units. 1. use the same scale on each axis (e.g. 1 cm = R 1 000) 2. the break-even line will divide the Y axis into positive profit or negative loss, so the portion above the line on the Y axis is the profit portion and the portion below the line is the loss. 3. the fixed costs are marked on the graph at – R 2 000 and the profit is at + R 2 000 on the profit line (so before production even starts there is already a total loss of R 2 000.) 4. the break-even point is where the profit line cuts through the break-even line 5. the safety margin is the distance between the break-even point and the R 10 000 sale point Marginal income graph Y + R3 000 see example of marginal income graph when there is a production mix on pgs 403 and 404 of text book + R2 000 + R1 000 0 Algebraic / equation methods of calc’ing Cost-Volume-Profit analysis - R1 000 - R2 000 - R3 000 R 5 000 Value of sales less = less = S V MI F P less = less = R 10 000 X Income Statement sales variable costs marginal income fixed costs profit So : Sales = Fixed costs + Variable costs + Profit / Sales = Marginal Income + Variable costs Variable costs = Sales - Fixed costs - Profit Marginal Income = Sales - Variable costs Fixed costs = Sales - Variable costs - Profit / Fixed costs = Marginal Income - Profit 43 Profit = Sales - Fixed costs - Variable costs OR Marginal Income x 100 Marginal Income ratio = Sales 1 Sales - Variable Costs x 100 Sales 1 OR Marginal Income ratio = 1- Variable costs x 100 Sales 1 OR Fixed cost Break-even quantity = Selling price per unit - Variable cost per unit Break-even value = Fixed cost Marginal income ratio OR Fixed cost Marginal income per unit . = break-even quantity x selling price per unit OR Break-even value = 1- Fixed costs variable cost per unit sales price per unit Margin of safety = Sales - break-even value Margin of safety ratio = . OR (or variable costs) or (sales) = sales quantity - break-even quantity Sales quantity - break-even quantity sales quantity x 100 1 OR = Sales - break-even sales x 100 total sales 1 Minimum subsistence turnover in value = Fixed cost + planned profit + variable cost OR = Fixed cost + planned profit marginal income ratio Minimum subsistence turnover in quantity = Fixed cost + planned profit marginal income per unit Marginal income approach in non-manufacturing activities see example pgs 407 and 408 of text book Cost structure and operating leverage factor Cost structure is the relative relationship between fixed and variable costs in entity. Management must ensure that fixed costs are used effectively irrespective of the actual level of activity. Operating leverage used to show how profit reacts to changes in sales volume and also to evaluate extent of how fixed costs have been utilised. Operating leverage factor : Indicates how much influence a percentage change in sales Marginal income volume will have on net profit. Net profit Specific operating leverage factor is valid for a specific sales volume and will change as the sales volume changes 44 So in case where two different entities both have the same net profit, they will have completely different cost structures and operating leverage ratios. In entity which has larger marginal income and larger fixed costs, then that entity will earn more profit, however if sales fall then entity that has lower fixed costs will be better off. So profit will increase or decrease at a higher rate for entity that has a higher operating leverage. Operating leverage will be reduced in proportion to the increased gap between the sales value and the break-even point. So can calc the effect of different sales volumes on net income without having to prepare detailed statements. see examples pgs 409 and 411 of text book Evaluation of Cost-Volume-Profit analysis When using break-even analysis which has a fixed ratio of cost, volume and profit must remember that it is limited cos of assumptions that : selling price per unit will remain constant irrespective of the sale volume (so sales are shown graphically as a straight line) all costs and expenses are either variable or fixed fixed costs remain constant no matter what the volume of the business while variable costs change in direct ratio with volume (so can also be shown as straight cost lines on a break-even graph) the sales mixes are constant for different types of products no change in the variable costs effectiveness in the production factors (also relates to the linear variable costs) inventory levels don’t change materially during the period (cos more inventory there is the more fixed costs there will be in the manufacturing cost of inventory and visa versa.) Cos don’t use the fixed manufacturing costs from the production costs, CVP analysis doesn’t work out the profit at different inventory levels. Still useful tool for management for short-term decision making and profit planning. CVP can be used for short-term investigations and decisions, cos can calculate sales in order to make an expected profit level and can also be used to evaluate the effect of operating changes on profit (including changes in selling price and fixed costs). Summary Break-even graph = graphical relationship between revenue, variable costs, fixed costs and profit / losses at various activity levels Break-even point = point where no profit or loss is made Break-even quantity = lowest quantity of products that must be sold to ensure total costs are recovered and to prevent the entity from making a loss Break-even value = lowest marginal income to earnings to ensure that total costs are recovered to prevent the entity from making a loss Change-over point = level of activity at which total costs (and profits) are the same under two alternative CVP situations Cost structure = relative relationship between fixed and variable costs in specific entity CVP analysis = management technique used to examine relationships between total volume, total costs, total revenues and profits during period Marginal cost accounting approach = method where all variable costs are deducted from sales to determine the marginal income Marginal income = difference between sales and variable costs i.e. the amount available to cover fixed costs and make a profit Marginal income ratio (MIR) = marginal income divided through sales and expressed as a percentage of sales Marginal income statement = management tool to evaluate the influence of changes in the selling price, cost or volume on profits Operating leverage = degree of sensitivity of net profit to change in sales volume Safety margin (monetary) = sales value in excess of the break-even value i.e. states the sales value or sales units that sales can decrease before the entity starts to suffer a loss Safety margin (units) = sales units in excess of the break-even units i.e. states the number of sales units that can decrease before the enterprise starts to suffer a loss and also states the number of units that represent making a profit Safety margin ratio = expresses the margin of safety as a percentage of sales Sales mix = relative quantities in which entity’s products are sold Sales value = sales volume multiplied by the unit cost Sales volume = number of units sold see examples pgs 186 and 198 of study guide Study Unit 9 – Flexible / Variable Budgets (text book unit 11.1) 45 Cost & Management Accounting pg 529 Fixed budgets Budget = plan of action to achieve a stated goal (so route that must be followed from current period and situation to a future target). Must be in writing and in realistic quantitative measurable terms. Management must set out a specific goal for entity and then must spell out plans as to how to achieve the goal using budgets. Comparison between the budget and actual results used to evaluate performance and take corrective steps. Budget control = budget is the route that must be followed to achieve specific goal and budget control is used to make sure that any deviation from the route is noticed, and that the goal is achieved in good time. Done by continuously measuring the results against the budgeted target and also by determining if what was planned in the budget can be carried out in practice. Also if there is a difference between the panned and actual results then budget control can establish the cause, which can then be corrected and the problem averted. Functions of budgets and budget control : budgets = planning function Study of what must be done, what is necessary to be do it, how it must be done and what the eventual outcome must be. budget controls = controlling and coordinating function Piecing together of the underlying or subsidiary budgets (e.g. sales, production and labour budgets), and co-ordinating all the activities and production resources of the entity as a whole. Control maintained by comparing results achieved against budgeted results. Control will lead to further planning. Aims of budget control : focus on the long term aims of the business gather various ideas of all levels of management in preparation of budget co-ordinate all the activities of the organisation efficiently centralise controls for decentralised activities lay basis for future policy when unforeseen situations affect the budget plan costs and income in a way to achieve maximum profits use capital expenditure in most profitable manner use production factors in most economical way serve as standard against which actual results can be compared establish the causes for variables between actual and budgeted results and advise management how to correct deviations or take advantage of favourable situations Advantages of budgets / budget control are an aid for achieving the management’s objectives facilitate establishment of standards if standard costing system is in use expenditure of the 3 cost elements in manufacturing are planned and controlled leads to effective management principles and makes delegation of authority possible can determine the relationship between planned profits and planned employment of capital cost variations will expose the weaknesses in the entity Disadvantages of Budgets can be problems when defining responsible staff cos some duties can overlap forecasts are never 100% accurate and effectiveness of the budget depends on the accuracy of the forecast degree of willingness and co-operation of management will determine if it is successful budget programme needs additional admin work and so additional expenses cannot prevent some relaxing of the budget Important aspects for the preparation of budgets : human factor – if staff understand the purpose of the budget and are correctly guided and motivated by management to co-operate with budget programme then it will work budget period –strategic plan is long-term (identifies the desired output can be 3 to 5 years or longer) while budget is short-term (emphasises the inputs that are necessary to achieve the desired output normally for a financial year). length of budget period : seasonal entities – budget period should cover at least one cycle should cover the entire production cycle budget period should link with financial period so easier to compare actual and budgeted figures 46 budget personnel – budget committee prepares and administers the budget as well as reviewing, discussing and co-ordinating all the budget activities. Once all the budgets are reviewed they must be combined in final budget and submitted to top management for approval budget factors – any scarcity factors must be taken into account in determining the entire budget programme e.g. availability of capital, material or labour shortages etc Study Guide pg 201 Fixed / prediction budget – when sales and costs are based on estimated turnover that will be manufactured according to utilisation of estimated and available factory capacity level. Budget control = comparing the actual results obtained on continuous basis with budgeted targets set, and identifying the causes of any differences that may be found so that corrective action can be taken. In practice might be distorted picture when comparing actual and budgeted figures using fixed budget cos if the number of units that were budgeted for differs from the actual units at the end of the year, then the variances in the budgets compared to the actual results will b unrealistic. Can only get a meaningful comparison if the budget figures are based on the same activity level of units produced as the actual results. see example pg 202 of study guide Variances calculated by comparing the actual results with the fixed budget are based on number of units actually produced and not the effectiveness of production. Cannot use a fixed budget when costs are influenced by change in volume – should rather use variable / flexible budget which is adjusted to the actual level of activity of entity. Flexible budget = budget that calculates budgeted income and budgeted costs according to actual production volume and sets them off against each other to determine the budgeted net profit or loss. Must calc the variable cost per unit. The budgeted fixed cost will remain the same irrespective of the volume produced so flexible budget can be used as either : unit-based budget total budget Cost & Management Accounting pg 585 Classification of standards : Must decide at which level of business activity the budgets and standards are going to be based, and can also use more then one basis for the establishment of a standard for a single cost element e.g. machine hours or labour hours. If standard hours are basis then is the amount of work that should be completed in an hour. 4 different methods for setting standard level of business activity in entity : expected actual level of business activity – level expected for budgeted period based on the prevailing conditions basic level of business activity – level of activity that was set in the past and against which expected and actual performance will be compare, Very important for statistical purposes ideal or theoretical level of business activity – achieved only if all the conditions are ideal i.e. impractical, will never be ideal conditions normal level of business activity – level of business activity that can be achieved with efficient performance under prevailing conditions. So is average figure which aims to absorb and cover total costs taking into account economic and seasonal conditions. Especially suited for establishing standard for manufacturing overheads. Study Guide pg 203 Before budget can be drawn up must decide on the level of production or capacity on which the budget and fixed manufacturing overheads recovery rate should be based To determine normal capacity of entity must take into account the physical capacity of the plant and the realistic sales expectation. Once normal capacity established then might find that some departments are under-utilised or over-utilised. This can be corrected by using sub-contractors, purchasing additional material or selling excess machinery. Study Guide pg 201 Flow of labour costs : Wage cards are kept for each employee and a wage sheet is kept for each week showing gross earnings, deductions and net wages. 47 Once the wages are paid then the bank is credited and the Wages Due account is contra’d with a dr. Then have to divide the labour costs between direct and indirect labour costs. Must also allocate the direct labour costs to the various jobs using the wage sheet : total of the wages are dr to the wage control account the manufacturing overheads and admin costs are dr to expense accounts unfinished work allocated to each of the jobs. Study Guide pg 203 When drafting flexible budget first need to determine the normal capacity of the entity and then calculate the overheads recovery rate. Flexible budget must attempt to predict entity’s results within service of capacity levels. Costs at each capacity level divided into 3 groups : fixed costs – don’t change with an increase or decrease in sales volume or quantity of units of product manufactured e.g. factory rental. But if different number of units manufactured per month then the fixed cost is divided by those units and so will also differ per month see example pg 204 of study guide variable costs – change in proportion to an increase or decrease in quantity of units manufactured or sold e.g. direct material costs, direct labour and variable manufacturing overheads which are constant per unit see example pgs 205 / 206 of study guide semi-variable costs – has both fixed cost component and variable cost component, so change in cost per unit isn’t directly proportional to the change in the level of production. When calc’ing the semi-variable costs for flexible budget then have to use acceptable method to divide fixed and variable cost component. Can use either : high-low method least squares method regression analysis using scatter diagram see example pg 207 of study guide Drafting flexible budget Normally few budgets prepared for different production volumes or capacity levels. see example using direct costing method pgs 208 to 210 of study guide Once have info of all the expenses and have identified fixed and variable components then can draw up a budget schedule showing the info that you need to draft a flexible budget. Flexible budget drawn up using either : table method see example pg 211 of study guide 48 formula method see example pgs 211 to 213 of study guide graphical method – used mainly for curved or stepped costs (i.e. costs that vary). Budgeted info is read directly off the graph for various capacity levels. see example pgs 213 to 215 of study guide Determine the manufacturing overheads Fixed costs Variable costs Semi-variable costs Apply high-low method Fixed costs Variable costs Draw up schedule containing budget info : Capacity Budgeted allowances - based on experience - direct labour costs - theoretical - direct labour hours - practical - machine hours - expected / anticipated - direct material costs - normal - units produced Must have following info : Direct overheads Indirect overheads - fixed - fixed - variable - variable Cost of service departments Draft flexible budget (using either Table, Formula or Graphical method) Direct costing method see examples pgs 217 to 223 of study guide Absorption costing method Study Unit 10 – Standard costs (text book unit 12.1) Study Guide pg 226 Standards are used to give a measure against which actual figures can be measured so that management can identify factors for the variances, and can then take corrective action (especially if the variances are negative / unfavourable). If use standard costing system then standards are laid down using historical info as well as info from similar manufacturing entities and also technical and economic criteria. Standard cost is calculated cost of product at particular production volume under given set of conditions Before establish standards need : careful selection of raw materials systems analysis and time and motion studies to determine the most effective manufacturing methods engineering studies on the subjects of equipment design and the provision of facilities Differences in standards can be cos of policies, cost composition and resources. Must be revised regularly and MUST be adapted when change in cost component (like material, labour or overheads) Info on costs either : historical / post-calculated – price already paid pre-calculated – standard costs Relationship between standard costing and variable budgets! Cost & Management Accounting pg 583 Overheads recovery rates give a pre-determined rate based on estimated cost and a normal level of business activity. Using these rates means can value production when don’t know the actual historical costs. 49 Normal / pre-calculated rates are the EXPECTED cost of business activity and NOT the actual costs at that level of activity. Standard rates are the same as many predetermined normal overhead recovery rates – they indicate normal standards of what costs should be. Standard costs are the cost of the efficient employment of production resources under current business circumstances by reasonably competent management. Standard costing = system where comparison drawn between : what should be done at standard costs and what was done at actual costs Aims Standard costing should furnish relevant info to management in good time through cost reports. Info should show which cost centres / departments aren’t functioning efficiently so that management can concentrate on areas where there are large differences between established standards and actual info. Improves cost control by : establishing standards for each cost element determining actual costs for each cost element comparing actual costs with standard costs and determining the difference / variances analysing variances and facilitating measures to correct them where necessary Study Guide pg 227 Entity sets standards that reflect the philosophy and mission of entity and this leads to the aim of the entity. Staff must be continually aware of costs. Goal of standards will determine how strict and high the standards are – if to cut costs then would be very strict, but if to value stock and income then standards would be reasonable, and if prices being set then standards would have to be realistic. Standard costing system and a budget control system are DIFFERENT things, but one compliments another. Most important differences : Budget statement that sums up intended, estimated and desired income and costs at certain capacity level and serves as guideline for keeping the enterprise on track budget emphasises volume and cost levels that have to be maintained in order to achieve a certain result budget control = comparison of actual results to budgeted results of all parts of entity for given period budgets establish the maximum permissible costs Standards standard reflects what the costs should be when manufacturing takes place under particular production conditions, NOT what the costs may possibly be standards emphasise the cost level at which the optimum profitability will be achieved – especially when break-even analysis is carried out standard costing controls = only cost aspect of the production and distribution of products standards establish the minimum allowable costs Characteristics of good standard costing accounting system : standards must be attainable and realistic must be room for normal variances employees must be informed about the purpose and application of the system and feel motivated to achieve and maintain the standard standard not based on historical results – rather on realistic future costs, results and conditions methods followed to achieve the standards must be relevant and attainable info from standards must be useful Cost & Management Accounting pg 584 If there is a standard costing system in use then can facilitate the preparation of budgets, and a budget control system is great help in controlling costs Uses of standards and standard costs – normally in homogeneous products (the same) or if entity does piecework / jobs : cost control – standards enable management to draw periodic comparisons between actual and standard costs to measure efficiency stock valuation – if stocks valued at standard costs then can convert them to actual costs for BS purposes 50 planning for budget purposes – facilitate the preparation of the production, cost and sales budget fixing of prices – normally connection between selling price and unit cost of product. Standard unit costs enable management to achieve the best combination of prices and volumes for a given period keeping of records – when standard costing system used together with actual costs then can reduce keeping of records in detail (e.g. stock registers that show quantities). Purpose for which the standard costing system is introduced will determine its use i.e. improve control physical stock, control use of time, to determine the cost price of products more accurately etc. Classification of standards : Must decide at which level of business activity the budgets and standards are going to be based, and can also use more then one basis for the establishment of a standard for a single cost element e.g. machine hours or labour hours e.g. if standard hours are basis then is the amount of work that should be completed in an hour. 4 different methods for setting standard level of business activity in entity : expected actual level of business activity – level expected for budgeted period based on the prevailing conditions basic level of business activity – level of activity that was set in the past and against which expected and actual performance will be compare, Very important for statistical purposes ideal or theoretical level of business activity – achieved only if all the conditions are ideal i.e. impractical, will never be ideal conditions normal level of business activity – level of business activity that can be achieved with efficient performance under prevailing conditions. So is average figure which aims to absorb and cover total costs taking into account economic and seasonal conditions. Especially suited for establishing standard for manufacturing overheads. Type of industry and purpose that the standard costing system is implemented will determine the basis on which standard costs should be calculated as well as method of establishing standard production capacity. Advantages of standard costing serve as yardstick against which actual costs can be measured analysis of variations necessitates consistent control over the whole production process – so could lead to cost reduction programmes cos draws attention to aspects that might not be controlled efficiently use of standard costs reduce clerical work cos the value and quantities of the cost elements of each completed product that must be manufactured are already available on standard cost card and so production orders only need to be recorded on standard forms analysis of cost reports by management are simpler and take less time standard costing means better control over costs – object is to improve work performance and have more efficient material usages so entity is more cost conscious task of valuing raw materials, half complete and completed production is easier standards being established can serve as stimulus to further planning which leads to greater efficiency Disadvantages of standard costing if prices fluctuate in a period then standards may not be reliable can be costly to implement and modify standard costing system system only useful in manufacturing entity where mass production or batch processing take place report from system can be long and complex and won’t be understood by non-financial managers system need continual monitoring and management standards that are set too high can be negative yardstick. Cost & Management Accounting pg 586 Before implementation standard costing system must : divide production departments into cost centres for greater efficiency and responsibility classify accounts so can make provision for actual costs, standard costs and variations choose level of business activity to be used as basis for determining standard costs establish standard quantities, standard times and costs for each element In order to establish costing standards for each cost element must have a standard card for each product manufactured or service provided that shows : standard quantities and standard prices of each raw material standard labour rate and standard hours standard variable manufacturing overheads standard fixed manufacturing overheads total standard costs allowed 51 MUST take into consideration ALL possible factors that could have any influence when establishing the standards cos must make sure that they are set with the greatest accuracy possible. If there are any changes then standards must be changed accordingly (cos must be as accurate and reliable as possible) Variances of different elements : TOTAL VARIANCE Manufacturing variances Material variances Marketing & administrative cost variances Labour variances Sales variances Overheads variances Study Guide pg 227 Classifying a manufacturing entity into centres When standard costing system is implemented then must look at two levels in the organisation : info that is based on units overall info per cost element in the organisation Must classify manufacturing entity into centres so that each functional responsibility is represented : MANUFACTURING ENTITY Manufacturing Production Cost Centres Administration Sales & Distribution Research & Distribution Production departments are divided into cost centres and classified. In accounting system accounts classified and grouped according to Expense, Income, Asset or Liability accounts. In manufacturing process have to add Cost Accounts, Control Accounts and Production Accounts. If Standard Costing System is used then get Standard Costs and Standard Cost Variances. Service Standard cost card - needed for each product that is manufactured and for each service that is rendered. Card must show : standard quantities of each raw material see example of a standard cost card on standard unit price of each raw material pg 233 of the study guide standard labour rate standard labour hours standard manufacturing overheads total standard costs allowed according to the standard to manufacture a unit of a completed product Variances – difference between standard costs and the actual costs of manufacturing the product AND the difference between the standard selling price and the actual selling price Must determine the possible cause or reason for the variances and what action is necessary to eliminate similar variances in the future. Variances are favourable (positive) or unfavourable (negative). Must understand the basic principles of calc’ing the standard cost variances as needed to determine the exact origin of the variance. Standard costs and standard cost variances : direct material total variance 52 material purchase price variance material quantity variance direct labour total variance labour rate variance labour efficiency variance overheads variable manufacturing overheads variable with hours worked o total variance o overhead rate variance o overhead efficiency variance variable with production o total variance o overhead rate variance o overhead efficiency variance (always zero) variable sales and distribution overheads total variance expenditure variances volume variance (always zero) sales price variance Cost & Management Accounting pg 586 Standard specs must be prepared for establishment of standard material quantities according to size, mass or any other measure. Must include : quantities prices Total material variance rates quality grades Quantity variance Price variance and must also provide for : normal scrap losses Purchase price variance wastage OR Issue price variance breakages So when standards are established there will be : a price standard for materials (normally based on historical, current and expected future prices) quantity standard for materials (quantity specs serve as the basis for determining the standard quantities required to manufacture one unit of each completed product) Actual quantity of material used and costs that differ from the standard quantity and costs are variances. Standard costs Quantity variance Actual costs (difference in quantity @ standard price) Standard quantity x Standard price Material variances Actual quantity + Price variance (difference in price x actual quantity) x Actual price = TOTAL VARIANCE Total cost of material consumed in or purchased for the manufacturing process is : unit price paid for the material purchased quantity of material issued for consumption or application variance between standard material composition and actual material composition (if more then one type of materials used in manufacturing) 53 So total variance between standard material cost and actual material cost will be variance in one of these. Actual results are : actual units manufactured in period under review actual quantity of material used to manufacture the actual units actual price paid for material consumed for actual production Total material variance is difference between the actual quantity of material consumed at the actual price and standard quantity allowed (standard quantity allowed for units actually produced) at standard price Total actual costs less Total standard costs allowed for actual quantity manufactured difference = total variance If actual costs > standard costs = unfavourable / negative If standard costs > actual costs = favourable / positive see example pgs 236 / 237 of study guide Total material variance is either : material price variance – material purchase price variance based on actual price paid for the material purchased. Standard price is then the NORM : if actual price > standard prices then variance is unfavourable if actual price < standard price then variance is favourable Material purchase price variable is the difference between the actual quantity purchased and consumed at the actual purchase price and the actual quantity purchased and consumed at the standard price. CONSTANT FACTOR = actual quantity of material purchased and used To calc material purchase price variance need : material quantity actually purchased and used to manufacture the completed units actual price paid for the material standard price of the material purchased NOT standard quantity of material allowed for actual production cos constant factor = actual quantity of material purchased and used!!! see example pg 239 of study guide Material purchase price variance causes can be : entity not taking advantage of rebates on bulk purchases poor control over purchases, receipt of stock and timeous payments price increases cos of inflation, exchange rates or rise in petrol / transport costs faulty standards (errors / mistakes when calc’ing the standards) material quantity variances – either : volume variance efficiency variance Material quantity variance – difference between the actual quantity of material purchased and consumed at standard prices, and the standard quantity of material allowed for actual production at standard prices if actual quantity > standard quantity then variance is unfavourable if actual quantity < standard quantity then variance is favourable CONSTANT FACTOR = standard material purchase price To calc material quantity variance need : number of completed units actually manufactured quantity of material actually consumed in order to manufacture the completed units standard quantity of material allowed in order to manufacture the actual completed units standard price of material NOT actual material purchase price cos constant factor = standard material purchase price!!! see example pg 241 of study guide Cost & Management Accounting pg 590 Purchase price variance – when actual price differs from standard price. Variance = difference between actual cost of the amount purchased and the standard cost (amount purchased x standard price) 54 (AP x AQ) - (SP x AQ) (actual price x actual quantity purchased) - (standard price x actual quantity purchased) OR (AP - SP)AQ Must use “basket method” (actual price - standard price) x actual quantity purchased Cost & Management Accounting pg 591 Material quantity variance – difference between the actual amount of material used at the standard price and the standard quantity of material allowed at the standard price (standard quantity of material allowed = standard quantity allowed for the actual production) (AQ x SP) - (SQ x SP) (actual quantity of material used x standard price) - (standard quantity of material allowed for actual production x standard price) OR (AQ - SQ)SP (actual quantity - standard quantity) x standard price Total material variance (AQ x SP) - (SQ x SP) (actual quantity of material used x standard price) - (standard quantity of material allowed for actual production x standard price) OR total material variance = material price variance + material quantity variance If standard costs > actual cost then variance is favourable If standard costs < actual cost price then variance is unfavourable OR AC > SC = unfavourable AC < SC = favourable see example pgs 592 / 593 of text book Material quantity variances can be attributed to : faulty standards (errors made when calc’ing the standards) poor controls over the use of material poorer quality material resulting in poorer output inefficient working conditions, equipment, supervision and skills of staff Transactions in the GL Purchases from suppliers : cr Creditors Transfer material for manufacturing : dr Production Account cr Material Stock Account and favourable or unfavourable balance to Material Quantity Variance account Transfer of completed units from manufacturing process to completed stock : cr Creditors, dr Material Stock Account and favourable or unfavourable balance to Material Purchase Price Variance account. unfavourable favourable unfavourable favourable Material Purchase Price Variance account If material purchase price variance is unfavourable then dr If material purchase price variance is favourable then cr Material Quantity Variance account If material quantity variance is unfavourable then dr If material quantity variance is favourable then cr 55 Cost & Management Accounting pg 601 Labour standards and variances Labour rate / tariff and labour efficiency standard are drawn up. Rate standards based on established wage scales paid for that specific type of labour and time standards, Must include idle time which is unavoidable. Variances for labour are : labour rate variance Total labour variance labour efficiency variance Study Guide pg 244 Rate variance Direct labour costs have 2 basic elements : rate (or tariff) which is paid for labour per hour time required to manufacture the product Composition (mix) variance Efficiency variance Yield variance To do calc must have : actual units manufactured during a period actual labour hours worked to manufacture those actual units (normally as total direct labour hours for the period under review or actual labour hours per unit) actual labour rate paid for actual number of hours worked – expressed as R per direct labour hour. Total labour variance is the difference between the actual hours worked at the actual labour rate per hour and the standard hours allowed (for actual production) at the standard labour rate per hour. Total actual labour costs less Total standard labour costs allowed for actual production difference = total variance If actual costs > standard costs = unfavourable / negative If actual costs < standard costs = favourable / positive see example pg 245 of study guide Total labour variance is either : labour rate variance – difference between the actual hours worked at the actual rate and the actual hours worked at the standard rate. Standard price is then the NORM : if actual labour costs > allowed labour hours then variance is unfavourable if actual labour costs < allowed labour hours then variance is favourable CONSTANT FACTOR = actual labour hours worked to complete the actual units To calc material purchase price variance need : actual number of labour hours worked to manufacture the completed units labour rate paid for the actual labour hours worked standard labour rate allowed per hour NOT standard labour hours cos constant factor = actual number of hours worked to deliver the actual production!!! see example pg 247 of study guide labour efficiency variance – difference between the actual time worked (in hours) at the standard labour rate and the stand time (in hours) allowed for actual production at the standard labour rate. if actual hours worked @ standard labour rate > standard labour rate then variance is unfavourable if actual hours worked @ standard labour rate < standard labour rate then variance is favourable CONSTANT FACTOR = standard labour rate To calc labour efficiency variance need : number of completed units manufactured actual labour hours worked to manufacture the completed units standard labour hours allowed for the manufacturing of these units standard labour rate per hour NOT actual labour rate cos constant factor = standard labour rate!!! see example pgs 248 / 249 of study guide 56 total variance = labour rate variance + labour efficiency variance Cost & Management Accounting pg 602 Labour rate variance – multiply difference between the actual and standard rate by the actual hours worked. (AR x AT) - (SR x AT) (actual rate paid x actual hours worked) - (standard rate x actual hours worked) OR (AR - SR)AT (actual rate - standard rate) x actual hours worked Labour rate variances can be caused by : incorrect labour rates being used changes in wage tariffs poor scheduling of production causing overtime to be paid at higher rate use of better qualified staff with higher pay Labour efficiency variance – difference between the actual hours worked at standard rate and the standard time hours allowed for the actual production at the standard rate. (AT x SR) - (ST x SR) (actual time worked x standard rate) - (standard time allowed for actual production x standard rate) OR (AT - ST)SR (actual time worked - standard time allowed for actual production) x standard rate Labour efficiency variances can be caused by : incorrect establishment of standard hours poorly trained employees bad supervision use of poor quality material problems with machinery and equipment resulting in longer manufacturing hours then anticipated see example pgs 603 / 604 of text book Transactions in the GL see example pgs 607 / 608 of text book Study Guide pg 251 Actual wages paid : dr to Wages Payable account Actual wages to be paid : cr to Wages Payable for actual number of hours worked x actual rate, and then dr to Wage Control account for the actual number of hours worked x std rate and the difference cr or dr to the Labour Rate Variance account. Wages paid for production : cr Wage Control account with actual Number of hours worked x standard Rate and dr production account with The standard number of hours allowed x standard rate and the difference cr or dr to the Labour Efficiency Variance account. Study Guide pg 252 Manufacturing Overheads Secondary cos not always noticeable in end product, but which unfavourable favourable 57 contribute to the manufacturing of the product. Unlike direct materials and direct labour which can been seen in the product (primary costs), overheads are : indirect materials unfavourable favourable indirect labour (supervisor) services (electricity, rates, insurance, rental, telephone) cost of manufacturing machines, equipment, land and buildings. Manufacturing overheads components : fixed manufacturing overheads – costs which are fixed for the period and not influenced by the number of units that are produced. So are variable per unit variable manufacturing overheads – costs which are fixed per unit (so increase or decrease in direct proportion to increases or decreases in production) semi-variable manufacturing overheads Standard fixed manufacturing overheads rated calc’d for fixed manufacturing overheads by using normal capacity as basis. Total variable manufacturing overheads variance is either : variable manufacturing overheads variance in respect of overheads that vary with hours worked – e.g. something like electricity. The more hours worked the more electricity will be used and so the higher the variable manufacturing overheads will be. Total variable manufacturing overheads variance is calculated as the difference between the actual variable manufacturing overheads and the standard hours allowed for actual production at the standard variable manufacturing overheads rate per hour. if actual variable manufacturing overheads > standard variable manufacturing overheads then variance is unfavourable if actual variable manufacturing overheads < standard variable manufacturing overheads then variance is favourable Actual variable manufacturing overheads which vary with hours worked less Standard time allowed for actual production at standard rate per hour Standard variable manufacturing overheads rate = budgeted variable manufacturing overheads normal capacity difference = total variance If actual variable manufacturing overheads > standard variable manufacturing overheads = unfavourable If actual variable manufacturing overheads < standard variable manufacturing overheads = favourable see example pgs 254 to 256 of study guide Total variable manufacturing overheads divided into : variable manufacturing overheads rate variance – difference between the actual variable manufacturing overheads incurred and the actual hours worked at the standard variable manufacturing overheads rate CONSTANT FACTOR = actual hours worked To calc variable manufacturing overhead rate variance in relation to hours worked need : o actual labour hours worked to manufacture the completed units o actual variable manufacturing overheads incurred o standard variable manufacturing overheads rate per hour o constant factor = actual labour rate!!! see example pgs 257 / 260 of study guide variable manufacturing overheads efficiency variance that vary with hours worked – monetary value calculated by difference between the actual hours at the standard variable manufacturing overheads rate and the standard hours allowed for actual production at the standard variable manufacturing overheads rate. To calc variable manufacturing overheads efficiency rate variance in relation to hours worked : o number of competed units actually manufactured o actual hours worked to manufacture the completed units 58 o o o standard number of hours allowed to manufacture these units standard variable manufacturing overheads rate per hour NOT actual variable manufacturing overheads rate cos constant factor = standard variable manufacturing overheads rate!!! see example pgs 258 / 260 of study guide variable manufacturing overheads variance in respect of overheads that vary with production – difference between the actual variable manufacturing overheads and the variable manufacturing overheads ALLOWED for the actual production during the period. e.g. machine that has to be reset after has finished one manufacturing line and before the next line can begin, cost of setting the machines will vary according to the number products manufactured on the line. if actual variable manufacturing overheads > standard variable manufacturing overheads allowed then variance is unfavourable if actual variable manufacturing overheads < standard variable manufacturing overheads allowed then variance is favourable Total actual variable manufacturing overheads for total production = Actual variable manufacturing overheads INCURRED less Total standard variable manufacturing overheads = standard variable manufacturing overheads ALLOWED Standard variable manufacturing overheads rate = budgeted variable manufacturing overheads normal capacity difference = total variance If actual variable manufacturing overheads > standard variable manufacturing overheads = unfavourable If actual variable manufacturing overheads < standard variable manufacturing overheads = favourable see example pgs 262 / 263 of study guide variable manufacturing overheads rate variance in respect of overheads that vary with production – difference between the actual variable manufacturing overheads and the actual production at the standard variable manufacturing overheads rate. Also called variable manufacturing overheads expenditure / price / budget / spending variance To calc variable manufacturing overheads rate variance for overheads that vary with production : actual number of units manufactured variable manufacturing overheads incurred standard variable manufacturing overheads rate per unit constant factor = number of units manufactured!!! see example pg 264 of study guide variable manufacturing overheads efficiency variance in respect of overheads that vary with production – difference between the actual variable manufacturing overheads and the actual production at the standard variable manufacturing overheads rate. Also called variable manufacturing overheads expenditure / price / budget / spending variance To calc variable manufacturing overheads efficiency variance for overheads that vary with production : number of completed units actually manufactured standard variable manufacturing overheads rate per unit allowed should indicate the variance in quantities, but cos there is NO variable in the actual number of units produced THE VARIANCE IS ALWAYS ZERO!!! see example pgs 265 / 266 of study guide Study Guide pg 266 Transactions in the GL Variable Manufacturing Overheads 59 Control account is dr with the actual variable manufacturing overheads. The Variable Manufacturing Overheads Control account is cr and the Production Account is dr, and the difference is taken to the Rate Variance account. The Efficiency variances is ALWAYS ZERO!! unfavourable favourable ALWAYS ZERO!! Study Guide pg 260 Transactions in the GL Actual manufacturing overheads are dr in the Variable manufacturing Overheads Control account. Then the standard hours x standard variable manufacturing overheads rate is dr to the Production account and cr to the Variable Manufacturing Overheads Control account. The difference is credited to the Efficiency Variance and Rate Variance accounts (if favourable) or dr if unfavourable. Study Guide pg 267 Variable sales and distribution overheads variances Consist of : expenditure variance volume variance Sales and distribution overheads also include admin expenses. Total variable sales and distribution overheads variance is the difference between the actual variable sales and distribution overheads INCURRED and the standard variable sales and distribution overheads ALLOWED for the units actually sold. To calc total variable sales and distribution overheads variance need : number of units actually sold actual sales and distribution overheads incurred standard variable sales and distribution overheads rate per unit unfavourable unfavourable favourable favourable If actual variable sales and distribution overheads > standard variable sales and distribution overheads allowed then variance is unfavourable If actual variable sales and distribution overheads < standard variable sales and distribution overheads allowed then variance is favourable. see example pgs 268 / 269 of study guide The total variable sales and distribution overhead variance divided into : variable sales and distribution overheads expenditure variance - To calc variable sales and distribution overheads variance : number of units actually sold actual variable sales and distribution overheads incurred standard variable sales and distribution overheads rate per unit constant factor = number of units actually sold!!! see example pg 270 of study guide 60 variable sales and distribution overheads volume variance – variance volume is ALWAYS zero cos there is no difference in volumes. see example pg 271 of study guide Study Guide pg 272 Sales price variance When selling one type of product then variance is the sales price variance. Actual sales price for actual units sold less difference = total variance If actual sales price > standard sales price = favourable If actual sales price < standard sales price = unfavourable Standard sales price for actual units sold see example pgs 272 / 273 of study guide see case studies pgs 273 to 289 of study guide Revision / Formulas EQUVALENT ORDER QUANTITY Cost of ordering EOQ = 2 x C x U (P + i) + H Cost per unit Usage yearly Holding cost p/u of inventory Interest rate If can’t split variable and fixed costs : HIGH LOW METHOD of dividing manufacturing overheads mnft o/h highest - mnft o/h lowest = cost per unit of variable number of units total o/h - (highest volume units x variable cost p/u) = fixed costs SIMPLE REGRESSION Sum xy = a sum x + b sum x2 sum of (production volume x overheads) = a(sum of production volumes) + b(sum of production volumes)2 JOB COSTING JOURNALS 61 Raw Materials & Materials Stock o/b of raw material andDirect raw material materialstransferred to production Purchases of raw materialIndirect material used in and materialsfactory Finished Goods Stock o/b stock of finishedCost of finished goods on handgoods sold Production Account Manufacturing Overheads Indirect materials usedProduction overheads in factoryallocated to production Other overheads e.g. elect / deprec Indirect labour costs o/b of incomplete workTotal costs of goods completed Raw materials put into production process Cost of goods completed Overheads allocated to production Direct labour used in production process Cost of Goods Sold Transfer from finished goods Production Wages Total wages payableIndirect labour wages (including direct and indirect labour)Direct labour wages CONTRACT COSTING ACCOUNTING Construction Contract account Dr Materials issued Return of materials Subcontractor fees Sale of materials (@ selling price) Site labour costs Material @ site @ yr-end (@ cost) Finance costs (specifically for contract) Sale of machinery or equip (@ sale price) Machinery & plant : Hire costs (full price) Deprecation (for time on site) Value of machinery and equip @ end of contract Cr 62 If retention money – then held as cr until date of return has passed, then taken to IS as extra profit If dr then IS as Loss on Latent Defects CONTRACT PROFIT contract profit = OR contract profit = cost to date estimated total cost x estimated total profit 1 actual cost to end of financial year x total contract price - total estimated cost latest estimated total cost of completing contract 1 CERTIFIED WORK ON CONTRACT contract profit = contract value of certified work + cost price of work not certified x 100 total contract price 1 OR contract profit = value of work certified contract price x estimated total profit 1 certified work @ contract price estimate of completed work NOT CERTIFIED @ cost price PROCESS COSTING average cost p/u = total manufacturing costs number of units manufactured . EQUIVALENT COMPLETED UNITS (ECU) (percentage completed @ end of period) ECU = units in process x % of work done on them Unit cost = total manufacturing costs Completed units + ECU of incompleted units . Labour + overheads = conversation costs WEIGHTED AVERAGE Prev period costs + current period costs = total costs = weighted average cost p/u equiv units ECU calc (weighted average method) 63 Step 1: units completed and transferred PLUS Step 2: units completed and on hand @ 100% PLUS Step 3: incomplete units in closing inventory @ % of completion PLUS Step 4: units lost @ % of completion at time the loss is ascertained FIFO Costs of opening stock recorded from current unit costs. Add costs for completing opening stock units and calc separate unit cost for opening stock. ECU calc (FIFO method) Step 1: units completed and transferred @ 100% PLUS Step 2: units completed and on hand @ 100% PLUS Step 3: incomplete units in closing inventory @ % of completion PLUS Step 4: units lost @ % of completion at time the loss is established MINUS Step 5: opening inventory @ % of completion PRODUCTION STATEMENT - WEIGHTED AVERAGE Input Production xxxxxxx Opening work in progress xxxxxxx Received from prev process xxxxxxx Increase in units Material % Labour % Overheads % Completed and transferred xxxxxxx xxxxxxx 100 xxxxxxx 100 xxxxxxx 100 Closing work in progress xxxxxxx xxxxxxx 100 xxxxxxx 50 xxxxxxx 60 Normal wastage xxxxxxx - Abnormal losses xxxxxxx xxxxxxx xxxxxx xxxxxx xxxxxxx - - 100 xxxxxx xxxxxx COST STATEMENT - WEIGHTED AVERAGE Work in Process Current costs Total Cost per unit R R R R Direct material xxxxxxx xxxxxxx xxxxxxx x.xx Labour xxxxxxx xxxxxxx xxxxxxx x.xx Overheads xxxxxxx xxxxxxx xxxxxxx x.xx xxxxxx xxxxxx xxxxxxx x.xx 64 COST ALLOCATION STATEMENT - WEIGHTED AVERAGE R Units completed and transferred xxxxxxx Work in progress (opening) : xxxxxxx Material xxxxxxx Labour xxxxxxx Overheads xxxxxxx Abnormal loss : xxxxxxx Material xxxxxxx Labour xxxxxxx Overheads xxxxxxx Work in progress (closing) : Material …. units @ cost p/u Labour …. units @ cost p/u Overheads … units @ cost p/u xxxxxxx xxxxxxx xxxxxxx xxxxxxx Total xxxxxxx PRODUCTION STATEMENT – FIFO Input Production xxxxxxx Opening work in progress xxxxxxx Put into production Material % Labour % Overheads % Completed from : Opening inventory xxxxxxx xxxxxxx 100 xxxxxxx 100 xxxxxxx 60 Current production xxxxxxx xxxxxxx 100 xxxxxxx 50 xxxxxxx 100 xxxxxx xxxxx xxxxx xxxxx Wastage : xxxxxxx - - - Normal xxxxxxx - - - Abnormal xxxxxxx xxxxxxx 100 xxxxxxx 50 xxxxxxx 60 xxxxxxx xxxxxxx 100 xxxxxxx 50 xxxxxxx 50 xxxxxx xxxxxx Work in process xxxxxxx xxxxxx xxxxxx COST STATEMENT – FIFO Total Material Labour Overheads R R R R xxxxxxx xxxxxxx xxxxxxx xxxxx R x.xx xxxxx R x.xx xxxxx R x.xx Work in process xxxxxxx Current costs Costs to allocate xxxxxxx xxxxxxx Equivalent production (units) Equivalent cost p/u R x.xx 65 COST ALLOCATION STATEMENT – FIFO R Opening inventory : xxxxxxx Material xxxxxxx Labour xxxxxxx Overheads xxxxxxx Current production xxxxxxx Cost gds completed & trsf'd to fin goods xxxxxxx Abnormal wastage : xxxxxxx Material xxxxxxx Labour xxxxxxx Overheads xxxxxxx Closing inventory : xxxxxxx Material …. units @ cost p/u xxxxxxx Labour …. units @ cost p/u xxxxxxx Overheads …. units @ cost p/u Total costs allocated xxxxxxx xxxxxxx COST OF WASTAGE only to completed units that have past the inspection point : @ beginning or during process : units mnfd & trsf’d / finished goods work in process (closing balance) abnormal losses @ end or during process and if is incomplete work in progress not yet at inspection point : completed units abnormal losses Stock valued at either : DIRECT COSTING : fixed costs – w/o in IS against income of units sold variable mnfd costs – only for inventory (direct materials, direct labour, variable manufacturing o/h) ABSORPTION COSTING : fixed costs – to units manufactured (sold and inventory) So fixed costs of inventory in closing balance are in opening bal of next period. Direct costing - INCOME STATEMENT : Absorption costing - INCOME STATEMENT : Sales Sales xxxxx xxxxx 66 less variable costs : Direct material Direct labour Variable manufacturing overheads Other variable costs : Selling expenses Administrative expenses = marginal income less fixed costs : manufacturing cost selling cost administrative cost xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxxx xxxx xxxx Manufacturing overheads : Variable Fixed xxxxxxx = gross profit xxxxxxx xxxxxx = net profit less manufacturing costs : Direct material Direct labour xxxx xxxx xxxxxx xxxxx xxxx xxxx less other costs : Selling costs (fixed & variable) Administrative costs (fixed & variable) xxxxxxx = net profit xxxxxxx xxxx xxxx RECONCILIATION OF DIFFERENCES Direct costing net income R xxxxxxx add fixed manufacturing costs of production units to inventory under absorption costing (no of production units x cost per unit) xxxxxxx less fixed manufacturing overheads released from inventory under absorption costing (purchasing units x cost per unit) (xxxxx) Absorption costing net income xxxxxxx APPLIED MANUFACTURING OVERHEADS Difference between applied manufacturing o/h and actual manufacturing o/h To calc if over / under applied overheads : 1. predetermined o/h rate = budgeted manufacturing overheads budgeted units produced (Product unit basis) budgeted labiour hours (Labour hour basis) budgeted labour hours x % (labour cost basis) If “cost” basis then budgeted machine hours (machine hour basis) use % (100/1) budgeted material cost x % (material cost basis) budgeted material costs + budgeted labour costs x % (primary cost basis) 2. apply the manufacturing overheads during the period : manufactured overhead applied = predetermined overhead rate actual units 3. determine if over / under applied overheads at end of period : actual mnfd o/h > applied o/h = under applied overheads (diff to COS) actual mnfd o/h < applied o/h = over applied overheads 67 STANDARD COSTS Standard cost variances : direct material total variance material purchase price variance (AP x AQ) > (SP x AQ) = unfavourable material quantity variance (AQ x SP) > (SQ x SP) = unfavourable direct labour total variance labour rate variance (AR x Ah) > (SR x Ah) = unfavourable labour efficiency variance (Ah x SR) > (Sh x SR) = unfavourable overheads variable manufacturing overheads variable with hours worked o total variance o overhead rate variance o overhead efficiency variance variable with production o total variance o overhead rate variance o overhead efficiency variance (always zero) variable sales and distribution overheads total variance expenditure variances volume variance (always zero) sales price variance