Paper background. The aim of ACCA Paper F2, Management accounting/FIA Diploma in. Accounting and Business, Management accounting, is to develop. STEP 3. F2 Management Accounting – a guide to using the examiner's reports. Part of getting started is getting to know your exam and we recommend that you. ACCA All rights reserved. 1. Management Accounting. (F2/FMA). September to August This syllabus and study guide are designed to.
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ACCA Paper F2 Management accounting Essential text. British library cataloguinginpublication data A catalogue record for this book is available from the British. Publishing F2 Study Text Management Accounting ACCA Publishing ACCA Distance Learning Courses Learn quickly and efficiently Using a blended learning. How the BPP ACCA-approved Study Text can help you pass .. The Paper F2 – Management Accounting syllabus assumes that you have some knowledge of.
A cost accounting system records data about the costs of operations and activities within the entity. The fashion magazines unit has three main functions: Similarly, the manager of a retail store in a company that operates a chain of stores might be responsible for the revenues earned by the store. Closing inventory, work in progress Equals: It is a smaller amount: Anybody please help. Describe the situations where the use of job or batch costing would be appropriate.
I wanted to convert f2 notes from pdf to word document but the pdf converter say that this file is password protected. Hi admin, i was able to download the notes but cannot print it out. Thx admin, i tried to download the Dec sylabus but i failed is there any other way i can view it. Hello admin, Is the syllabus for June the same as tht of Dec ? I want to start reading for Dec exams using the June notes, will they be helpful to me. Thx a bunch for the help you give to us.
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You must be logged in to post a comment. Click here to download. Donate here. Log in to Reply. No it is not the same. Need notes on flex budget and fixed budget. Functional budgeting. I need F1 F2 F3 pilot paper for june where to be found? On the acca website! They are there. The notes contain links to the specimen papers on the ACCA website. I need a discount factor table! I am not able to find any lecture on perpetuity?
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Anybody please help. Cost behaviour and cost estimation The variable cost per unit is often the same amount for each additional unit of output or unit of activity. This means that total variable costs increase in direct proportion to the total volume of output or activity. Here are some examples of variable cost items. Fixed costs Fixed costs are items of cost that remain the same in total during a time period, no matter how many units are produced, and regardless of the volume or scale of activity.
Fixed costs are also called period costs, because they are fixed for a given period of time. Total fixed costs therefore increase with time. Here are some examples of fixed cost items. The rental cost is fixed for a given period: Cost behaviour graphs: Graphs can be drawn for the total cost of an item or for the cost per unit of the item. Cost behaviour graphs for fixed costs and variable costs are shown in the following diagram.
Management Accounting 1. A cost behaviour graph showing the total costs for an item of mixed cost is shown below. An item of cost that is a mixed cost is an item with a fixed minimum cost per period plus a variable cost for every unit of activity or output. Example A company uses a photocopier machine under a rental agreement. Mixed costs are important in cost and management accounting. It is often assumed that the total costs of an activity are mixed costs, consisting partly of fixed costs and partly of variable costs.
Cost behaviour and cost estimation For example, it might be assumed that the total selling and distribution costs for a company each month are mixed costs. If this assumption is used, the total mixed costs can be divided into two separate parts, fixed costs and variable costs. If costs can be analysed as a fixed amount of cost per period plus a variable cost per unit, estimating what future costs should be, or what actual costs should have been, becomes fairly simple.
The expected output next month is , units of Product Y. Expected total costs are therefore: Costs in total might have a cost behaviour pattern that is very close to being a mixed cost. However there are many cost items that have a more unusual cost behaviour pattern. Unusual cost behaviour patterns can be shown on a cost behaviour graph.
On a cost behaviour graph, step fixed costs look like steps rising from left to right. When production is less than 3, hours each month, only one supervisor is needed: When output is over 7, hours each month, three supervisors are needed. These supervision costs are therefore fixed costs within a certain range of output, but go up or down in steps as the output level rises above or falls below certain levels. Cost behaviour and cost estimation A cost behaviour graph for the supervision costs can be drawn as follows.
Several are shown below. Changes in total variable costs a b Total variable costs Total variable costs Volume of activity Volume of activity In a , the variable cost per unit is a particular amount up to a certain level of activity or output, and is a lower amount for all units above that level of activity.
In b , the variable cost per unit is a particular amount up to a certain level of activity or output, and above that level of activity the variable cost per unit is a lower amount for all units not just for the units above that level of activity. Minimum and maximum charges The cost behaviour pattern in the graph below illustrates a cost during a period when there is a charge per unit, subject to a minimum charge and a maximum charge per period. Management Accounting Total cost Volume of activity Other patterns In your examination, you might be given another unusual cost behaviour pattern, and asked to identify the type of cost to which the cost behaviour pattern relates.
Here is just one example. Example Study the following cost behaviour graph and identify which of the following cost items is shown in the graph. Total electricity charges for a factory, where the electricity supplier charges: This means that there must be a fixed cost element in the annual charge.
Total costs then rise in a straight-line fashion up to a certain level of consumption so variable costs are a constant amount per unit and above that level total costs continue to rise but the rate of increase is less steep so variable costs are a new but lower constant amount per unit. The cost item shown in the graph must therefore be D. Cost behaviour and cost estimation Cost estimation: For example, it is often necessary to estimate the total annual costs of an activity or a responsibility centre, or the total annual costs of production overheads or marketing overheads.
Unless there are reasons for a different approach, it is usual to make a cost estimate on the assumption that total costs for a large number of different cost items together are a mixture of fixed costs and variable costs.
In order to estimate costs, it is therefore necessary to make an estimate of: In the same way, individual items of mixed cost can be divided into fixed and variable cost elements. Two cost estimation techniques are: The linear regression method will be explained in a later chapter. Graph of linear cost function On a cost behaviour graph, total costs would be shown as a straight line, rising with the total volume of activity. It is a cost behaviour graph for a mixed cost.
The difference between the total cost at the high level of output and the total cost at the low level of output is entirely variable cost. This is because fixed costs are the same in total at both levels of output. Step 1 Take the activity level and cost for: Step 2 The difference between the total cost of the highest activity level and the total cost of the lowest activity level consists entirely of variable costs. This is because the fixed costs are the same at all levels of activity.
Total cost of Low: Total cost of Difference: Step 3 Having calculated the variable cost per unit, apply this value to the cost of either the highest or the lowest activity level. It does not matter whether you use the high level or the low level of activity.
Your calculation of fixed costs will be the same. Calculate the total variable costs at this activity level. Step 4 The difference between the total cost at this activity level and the total variable cost at this activity level is the fixed cost. Management Accounting Example A company has recorded the following costs in the past four months: Answer 1 Steps 1 and 2: Calculate the variable cost per hour Take the highest level of activity and the lowest level of activity, and the total costs of each.
Ignore the other data for levels of activity in between the highest and the lowest. Cost behaviour and cost estimation 3. The method of analysis to use depends on whether the step increase in the fixed cost is stated as a money amount of cost, or whether it is stated as a percentage increase. You can then calculate the fixed costs at the other level of activity by adding or subtracting the step change in fixed costs, as appropriate. Example A company has the following costs at two activity levels.
Management Accounting 1 Steps 1 and 2: Total cost Low: Adjusted total cost: Total fixed costs will be the same for: Total fixed costs at the third activity level above or below the step change in fixed costs can then be calculated making a suitable adjustment for the percentage change.
Cost behaviour and cost estimation Example A company has the following costs at three activity levels. Required Estimate the expected total cost when the activity level is 7, units. Answer There is an increase in fixed costs above 7, units of activity, which means that total fixed costs and the variable cost per unit are the same for 8, units and 11, units of activity. These activity levels should be used to estimate the variable cost per unit and total fixed costs.
Fixed costs below 7, units are therefore: Management Accounting Note: Make sure that you understand the adjustment here. The same approach is needed as for a step change in fixed costs, as described above.
Example A company has the following costs at three activity levels. Total cost Difference: The variable cost per unit at the third activity level can then be calculated making a suitable adjustment for the percentage change. This reduction applies to all units of activity, not just the additional units above 24, Required Estimate the expected total cost when the activity level is 22, units.
Answer The variable cost per unit is the same for both 25, units and 30, units. What is the expected total cost when the activity level is 70, units?
This reduction applies to all units. What is the expected total cost when the activity level is 14, units? Management accounting Dealing with uncertainty: Mathematical techniques might be helpful with providing more reliable management information.
Computer modelling with spreadsheets make it possible to use some mathematical models that might otherwise be impracticable because of their complexity. Unfortunately, it is often impossible to predict with reasonable certainty what costs, revenues or profits will be. This is because there is considerable uncertainty about what might happen in the future.
The outcome of a decision might be favourable or unfavourable, depending on events and circumstances in the future. Several different possible outcomes might result from the decision, and managers take a risk hoping that the outcome will be favourable.
Decisions are therefore often made under conditions of uncertainty or risk. There are some mathematical techniques that can be used to analyse risk or uncertainty in business decisions. At this stage of your studies, you do not need to know all of them and you do not need to know any technique in great detail. The main technique you need to understand is the use of expected values.
One way of analysing costs and revenues when there is risk or uncertainty is to: Business mathematics and computer spreadsheets 1. Sometimes, probabilities can be estimated more reliably, using past experience as a guide to what is likely to happen in the future. For instance, probabilities for different possible outcomes in the future might be based on an analysis of historical records. An example might be an estimate of the rate of defective output from a manufacturing process: This historical record might be used to asses the probability that output will be defective in the future is 0.
Expected value EV An expected value EV is a weighted average value of different possible outcomes, where the probability of each different possible outcome can be estimated.
An EV can be calculated using the following formula. The total of the probabilities of all possible outcomes is 1. For each outcome and its associated probability, multiply x by p. This gives you the expected value of the future outcome — i. There is some uncertainty about the costs of the labour for the job.
These will not be confirmed until after the building work begins. One way of estimating the expected cost of building the house is to calculate the expected value of cost. This EV is a weighted average probability of the profit.
Example The chief accountant in a company is concerned about the very high level of input errors that the cost accountants are making when they enter transaction data into the cost accounting system. During a normal month, there are 10, entries into the system.
What would be the estimate of the total number of errors in transaction entries each month? Answer The estimate can be made by calculating an expected number of errors per transaction entry. This is simply a weighted average of the number of errors per entry. This is an expected value.
Expected values are used to make forecasts or estimates, and to help management with decision-making. Expected values and decision-making A decision is choice between two or more alternatives. Companies are often faced with making decisions when the outcome is uncertain. There are two types of decision where EVs might be used.
For example, should we invest in this new equipment? The choice is between investing and not investing. For example, when a company has decided that it needs to replace an item of equipment, there might be a choice between buying a smaller model or a larger model. The following rules apply to the use of expected values for decision-making, when there is risk or uncertainty and probabilities of different possible outcomes are estimated.
If there are two or more options and each has a positive expected value of profit, the option with the highest expected value of profit should be chosen in preference to the others. Management accounting The EV of annual profit from the product is: If the company makes its decisions on the basis of expected value, it will go ahead and try to sell the new product.
Example A company is considering investing in one of two projects, A and B. It cannot invest in both of them. The profits and associated probabilities of each project are as follows. Using expected values, the option with the higher expected value of profit should be chosen. If the expected value for both options shows a loss, neither project should be undertaken.
Business mathematics and computer spreadsheets If EV is used to make the decision, Project B should be undertaken because it has a higher EV of profit. Note that the expected value is not equal to any of the possible monthly profit figures. The EV is a weighted average value, not a value that is actually expected to occur. Required Calculate the expected profit or loss for next year.
Required a Calculate the expected value of he sales price. Limitations of the expected value method for decision-making There are a number of limitations associated with using the expected value technique in decision-making situations. If these estimated probabilities are not reliable, then the expected values calculated from the probabilities will also be unreliable. For example if there is a 0. This will obviously vary from person to person. Example A company is considering investing in one of two projects, X and Y.
Probability 0. Workings are not shown but you should be able to calculate these expected values yourself. Applying the normal rule, both projects would be worth undertaking. However, since only one project can be selected, Project Y should be preferred because it has a higher EV of profit. The limitations of expected values should be apparent. It is important to remember that an expected value is a weighted average of the different expected results.
Linear regression analysis can be used to estimate fixed costs and the variable cost per unit from historical data for mixed costs. For example, there might be historical data for the total monthly costs of operating a workshop. It might be assumed that total costs each month vary with the number of direct labour hours worked. Regression analysis is an alternative technique to high-low analysis, which was described in the previous chapter.
It can be used for all the same purposes in cost and management accounting that high-low analysis is used for. Regression analysis and high-low analysis compared Regression analysis and the high-low analysis are used for the same purposes.
Regression analysis is therefore an alternative technique to high-low analysis, which was described in the previous chapter, but there are important differences between them. Regression analysis uses as many sets of data for x and y as are available. This is done by calculating a correlation co-efficient, which is explained later.
You might be required to apply the formulae to data provided in an examination question. Linear regression analysis is used to calculate values for a and b in the linear cost equation: The linear regression formulae for calculating a and b are shown below. The number of pairs of data that are used in the calculation is n. The regression analysis formulae are as follows. They will be given to you in your examination: Understanding the formulae These formulae might seem very complicated, and in your examination you might be given a question that requires you to show your understanding of what the different items in the formulae mean.
Business mathematics and computer spreadsheets 2. For each pair of data for x and y, multiply the value of x by the value of y, and enter the answer in the xy column. Example The total costs and output volumes of a manufacturing company in the first six months of the year have been as follows. Management accounting Answer The starting point is to draw a table showing the values of x output and y total cost.
For each value of x and y, you should calculate the value of: For reasons to be explained later, the value of y2 will also be calculated here. There are six pairs of data, so there should be six different values for x, y, x2, xy and y2. Add the figures in each column to obtain totals for: You will therefore not be required to use the full technique in your examination.
However, you might be required to: However, the activity level might be any of the following: You could even use linear regression analysis to calculate a line of best fit between total weekly costs and the air temperature on the factory floor at midday, if you decided that total costs vary with the air temperature.
This might seem a ridiculous idea, but the point that you should try to understand is that linear regression analysis can be used to calculate a line of best fit for any two variables, given pairs of data, even when there is no actual connection between them.
Since a line of best fit can be calculated between any two variables using regression analysis, important questions are: The answer to both questions is that the reliability of the regression formula can be assessed using a statistic called the coefficient of correlation.
Correlation is a measure of the strength of the relationship between two variables. Variables are said to be correlated if a change in one variable results in a change in the other variable. Business mathematics and computer spreadsheets If you plot a graph of the data relating to two variables, you should be able to see if any visible relationship exists between them such a graph is known as a scattergraph or scatterchart.
Perfect positive correlation y x x x x x x x x Perfect correlation is seen to exist when all the data points plotted lie in an exact straight line and a linear relationship exists between the two variables. Perfect positive correlation means that high values of are variable are associated with high values of another variable. Alternatively, low values of one variable may be associated with low values of another variable. Management accounting Perfect negative correlation is seen to exist when all the data points plotted lie in an exact straight line and that high values of one variable are associated with low values of another variable.
Alternatively, low values of one variable may be associated with high value of another variable. Positive correlation but not perfect correlation y x x x x x x x x x Positive correlation means that there appears to be some correlation between the values of y and x, and in general the value of y increases as the value of x increases.
However, the correlation is not perfect because all the data does not lie exactly on a straight line on the scattergraph.
Business mathematics and computer spreadsheets Negative correlation y x x x x x x x x Negative correlation means that a relationship exists between two variables, and the value of y declines as the value of x increases.
However, the correlation is not perfect. As an alternative to drawing a scattergraph to see whether a visible relationship exists between the two variables x and y, the correlation between them can be measured by calculating a correlation coefficient.
The formula for the correlation coefficient r will be given to you in the examination. In the example, there is a separate column for y2. Calculate the square of each value of y in the y column and enter it in the same row in the y2. The value of the correlation coefficient, r, in the example in paragraph 2.
Remember that most of the values for the formula have been calculated in paragraph 2. Perfect negative correlation means that all the values for x and y, plotted on a graph, would lie on a straight downward-sloping line.
Perfect positive correlation means that all the values for x and y, plotted on a graph, would lie on a straight upward-sloping line. The value of r2 shows how much the variations in the value of y, in the data used to calculate the regression analysis formula, can be explained by variations in the value of x. Since r is negative, this means that y falls in value as the value of x increases.
Business mathematics and computer spreadsheets total cost can be explained by variations in the volume of output. This would suggest that the formula obtained for total costs is likely to be fairly reliable for estimating future costs for any given budgeted volume of production.
The coefficient of correlation and the coefficient of determination can therefore be used to give a statistical measurement to the reliability of estimates of y from a given value for x, using a line of best fit that has been calculated by linear regression analysis. As you might imagine, this can be a very useful item of management information for the purpose of forecasting or planning.
A spreadsheet program is a type of computer software. A spreadsheet is a table of rows and columns. Like any table, the rows and columns can contain words, figures or other symbols.
A spreadsheet program is used to create spreadsheets. A spreadsheet created by a spreadsheet program enables the user to prepare one or more tables of figures. Any table of figures, no matter how complex, can be prepared in a spreadsheet. A blank spreadsheet is simply a huge table of rows and columns, with each row and having a unique identity number and each column having a unique letter code A, B, C …AA, AB, etc.
The table therefore consists of boxes or cells, and each cell can be identified by a unique combination of column letters and row number, such as B5, T28, AA4 and so on. A description of the features of a spreadsheet system is given in an Appendix at the end of this text. If you are not familiar with spreadsheets, you should read the Appendix before continuing to read this chapter.
Figures are entered in the appropriate cells if their values are known. Otherwise a formula can be entered into a cell, and the spreadsheet model will convert the formula into a numerical value. The use of formulae in spreadsheets is the reason why they can be used to produce tables of figures so quickly.
Example The example below is a very simple illustration of how spreadsheets are used to construct accounting calculations. The left hand column for G shows the data as it has been entered into the spreadsheet as formulae. The left hand column for G shows the data that is displayed on the screen and in printouts. The figures in the spreadsheet can be changed quickly simply by amending some of the data in the cells.
Example Here is another example of a simple accounting calculation entered as text, numbers and formulae in a spreadsheet. All that is required is an alteration to the number in cells D4, E4, D7 or F Management accounting 4. Examples of applications of spreadsheets in management accounting include: Each table or set of related tables in a spreadsheet is held in a single file and accountants often carry a number of spreadsheet files on their lap top computer.
There are cost and management applications for which spreadsheets are not suitable. These include any application involving the recording and filing of large amounts of data. For these applications, involving the maintenance of records and large files, other types of software are more suitable, such as: Graphical reproduction of spreadsheet data Spreadsheets can be printed out and included in management reports.
It is very common in practice to find tables of figures produced in a spreadsheet to be included as appendices in management reports. In addition, the figures in a spreadsheet can be converted by the spreadsheet program into graphical display format, and shown as graphs, bar charts or pie charts.
This facility can also be very useful for the preparation of management reports. For example, if a spreadsheet is used for linear regression analysis, it can be used to show the line of best fit as a graph.
Similarly, if a spreadsheet is used to prepare an estimate of costs, the percentage of total costs made up by different items of cost direct materials, direct labour, production overheads etc can be shown as a pie chart or a bar chart. Business mathematics and computer spreadsheets Applications of spreadsheets in management accounting include: Some examples of spreadsheets are illustrated below.
Cost-volume-profit analysis will be explained in a later chapter. Example Cost-volume-profit analysis is a technique in cost accounting that might be used to prepare profit forecasts or to estimate what the profit might be at different selling prices per unit or at different sales volumes. In this example, numbers might have been entered in cells C7, D7, F7 and G7.
All the other cells, except for the text cells, will contain formulae. The estimates for selling price, variable costs, budgeted sales units and fixed costs can be amended simply by changing the numbers in C7, D7, F7 and G7. However, in this example, the text cells A8 — A12 might also need changing. Management accounting Graphical reproduction of spreadsheet data Spreadsheets can be printed out and included in management reports. In the Microsoft Excel spreadsheet program, the facility to produce graphical displays is provided by the Chart Wizard facility.
A Chart Wizard icon is on the menu bar and appears as follows: Business mathematics and computer spreadsheets 4.
Sensitivity analysis is a method of risk and uncertainty analysis. It analyses what the outcome will be if some factors are more favourable or more adverse than expected. By changing some key assumptions and seeing what happens to the profit, sensitivity analysis provides management with information about the sensitivity of the budget to changes in different assumptions about unit costs, sales volumes or selling prices.
The ability to carry out sensitivity analysis is improved enormously by using spreadsheets. Each analysis of the sensitivity of the outcome to changes in a key variable can be made quickly, by amending one or two items in the spreadsheet.
A task that could take hours if done by hand can be finished in seconds or possibly as much as a few minutes using a spreadsheet. Practice multiple choice questions 1 2 A company is assessing the expected profitability from a proposed business venture. It has been estimated that there is a 0. What is the expected value of the profit from the venture? A i only B i and ii only C ii and iii only D i and iii only 2 marks 3 Regression analysis is being used to estimate a line of best fit from five pairs of data.
The following values have been calculated from the data. A i and ii only B i and iii only C ii and iii only D i , ii and iii 2 marks 86 Go to www. Management Accounting Materials: There are several reasons for this. Any purchase of materials from a supplier should be properly authorised and approved at the appropriate management level. Documentation of the purchasing process provides evidence that approval has been obtained. The receipt of materials from a supplier should also be documented, to make sure that the goods that were ordered have actually been delivered.
There should be an invoice from the supplier for the goods that have been delivered. In rare cases when goods are bought for cash, there should be a receipt from the supplier.
The amount payable for the materials provides documentary evidence about their cost. When materials are received from a supplier, they might be held in a store or warehouse until needed. When they are issued from the store, there should be a documentary record of who has taken the materials and how many were taken.
This is needed to provide a record of the cost of materials used by different departments or cost centres. Documentation of materials is therefore needed: The procedures and documents The detailed procedures for purchasing materials and the documents used might differ according to the size and nature of the business.
However the basic requirements should be the same for all types of business where material purchases are made. Accounting for materials and labour Purchasing procedures and documents In a large company with a purchasing department a buying department and a stores department, the procedures for purchasing materials might be as follows. It produces a request to the purchasing department to buy a quantity of the materials.
This request is called a purchase requisition. It should be properly authorised by a manager with the authority to approve any such requisition.
The delivery note is a statement of the identity and quantity of the items delivered, and it provides confirmation that the items have been delivered. One copy is kept with the stores department, and another copy is retained by the supplier the driver of the delivery vehicle , as evidence of the delivery. This should include the inventory identity code for the item, as well as the quantity received.
The accounts department checks the invoice details with the details on the purchase order and goods received note, to confirm that the correct items have been delivered in the correct quantities. Data for recording costs of purchases for each item of inventory is obtained from the goods received note quantity and inventory code and purchase invoice cost. Management Accounting The purchase process Inventory records An entity should keep an up-to-date record of the materials that it is holding in inventory.
The stores department should keep a record of the quantity of each item of material currently held in inventory. This card is used to keep an up-to-date record of the number of units of the material currently in the stores department, with records of each receipt and issue of the inventory item.
This process of continuous record-keeping is known as perpetual inventory. The inventory record should be updated every time materials are delivered into store from a supplier, and every time that materials are issued to an operating department. The inventory ledger record is a record of the quantity of the materials currently held in inventory, the quantities received into store from suppliers and the quantities issued to operational departments.
In addition the inventory ledger record also records the cost of the materials currently held in inventory, the cost of new materials purchased and the cost of the materials issued to each operating department cost centre. Issues and returns of materials A cost accounting system also needs to record the quantities and cost of items of materials that are issued to the user departments, and the quantities and cost of any items that are subsequently returned to store unused.
Accounting for materials and labour The documentation for the issue and returns of materials are: A materials requisition note is used to record: The inventory records are updated from the requisitions notes and returns notes to record all issues and returns of materials.
Additions to inventory Withdrawals from inventory A simplified version of an inventory record for a perpetual inventory system is shown below, to demonstrate that inventory records can be used to record receipts and issues and returns of materials, and their cost or value.
The record needs to identify the cost centres that have issued or returned materials, and will probably also record the number of the materials requisition note or materials returns note although this data is not shown in the example below.
Mistakes might be made in recording transactions for materials received from the supplier, materials issued from store and returns to store. For example, an issue of material item from inventory might be recorded as an issue of item This would result in inaccurate inventory records for both item and item Similarly, some purchases, issues and returns to store might not be recorded, due to mistakes.
Some inventory might be stolen or might get lost, and the theft or loss might not be noticed or recorded. Stores items might deteriorate in quality when they are stored, particularly if they are stored in poor conditions.
Damaged items might be thrown away, but the write-off might not be recorded. Management should try to minimise these discrepancies between inventory records in a perpetual inventory system and physical inventory in the store. All movements of materials should be properly recorded in a document, and the data from the document should be transferred accurately into the inventory records.
Even so, good record keeping and goods stores management will not prevent some discrepancies between inventory records and physical inventory in store. This discrepancy should be checked from time to time.
The records should then be adjusted to the correct quantities. Minimising discrepancies and losses When physical inventory is checked against the inventory records, there will often be some differences. When the differences are big, there could be a serious problem with either: Some losses through theft, deterioration and breakages should be expected, but the losses should not be large.
If the inventory records are inaccurate, the information prepared for management from inventory records will be unreliable. Whichever failing is the reason for big discrepancies between physical inventory and inventory records, management should take measures to deal with the problem. TV cameras can be used to monitor activity in the warehouse. Entries and balances in a materials inventory account In a system of cost accounting, a separate record is kept for each inventory item.
This record — an inventory account — is used to maintain a record of all movements in the materials, in terms of both quantities and cost. The main contents of an inventory record are shown in the previous example. An inventory record in the cost accounts provides a continual record of the following: The inventory records are combined into a total record for all inventory, which is used for reporting purposes such as the preparation of a costing statement or an income statement of the profit or loss made in a period.
The system for recording inventory and materials costs might also be a part of a bigger cost accounting system. These accounting aspects of recording materials costs are explained in a later chapter.
Management Accounting Material purchase quantities: Economic Order Quantity 2. Total materials costs, for any item of materials, consist of: In most cases, the most significant cost is the purchase cost of the materials. However, ordering costs and holding costs might also be substantial.
Holding costs for inventory include costs such as: Inventory has to be paid for, and when an organisation holds a quantity of inventory it must therefore obtain finance to pay for it. This inventory must be financed, and it is usual to assume for simplicity that it is financed by borrowing that has an interest cost. Accounting for materials and labour There are other inventory holding costs too, such as the costs of operating a stores department — the rental cost of the stores, the wages or salaries of stores staff and other running costs.
Ordering costs are the costs of making an order to purchase a quantity of a material item from a supplier. They include costs such as: Economic order quantity EOQ If the price of materials is the same, no matter what the size of the purchase order, the purchase order quantity that minimises total costs is the quantity at which ordering costs plus the costs of holding inventory are minimised.
This order quantity or purchase quantity that minimises the total annual cost of ordering the item plus holding it in store is called the economic order quantity or EOQ. For example, if annual demand is 4, units of the item each year, the item is consumed at a constant rate throughout the year. The minimum quantity held in store is therefore 0 units and this always occurs just before a new purchase order quantity is received. The maximum quantity is Q units. The economic order quantity EOQ is the order size that will minimise the total of these costs during a period normally one year , given the assumptions stated above.
A note on ordering costs and inventory holding costs. For the purpose of the EOQ formula, the costs that should be used in the formula are only those costs that are incurred as a direct consequence of ordering inventory or holding inventory. Costs that would be incurred anyway — such as the salary costs of the buyer or the costs of renting warehouse space — should not be used in the formula because they are not relevant costs for deciding the EOQ size.
Relevant costs are explained in more detail in a later chapter. Examination hint: The demand should be annual demand and the holding cost should be an annual holding cost per unit. You might be given an examination in which demand is stated as a quantity for each three-month period but the holding cost is given as an annual cost.
You would therefore need to convert the threemonthly demand into an annual demand for using in the EOQ formula. What is the order quantity for Material X that will minimise annual costs? Accounting for materials and labour EOQ: In the example above: Total annual ordering costs and annual holding costs are always the same whenever the purchase quantity for materials is the EOQ and the assumptions on which the EOQ is based described earlier apply.
In each three-month period, 5, units of the item are used. What is the economic order quantity for this item, to the nearest whole unit? An examination question might test your ability to assess the consequences of a change in the value of any variable in the formula.
For example, what would be the consequences of: A change in any of these variables will affect: Example A company uses the economic order quantity formula to decide the purchase quantities for its major items of material purchases. An increase in the EOQ will result in a reduction in ordering costs.
If the order quantity is EOQ, total annual ordering costs and total annual holding costs are the same.
If total annual ordering costs fall, it follows that total annual holding costs will fall too. Required What will be the effect of the increase in order cost on: An increase in the order cost means an increase in CO. Given no change in the annual holding cost per unit, total holding costs must therefore increase. If total annual holding costs increase, it follows that total annual ordering costs will also rise. In some cases, however, a supplier might offer a discount on the purchase price for orders above a certain quantity.
When this situation arises, the order quantity that minimises total costs will be either: To identify the order quantity that minimises costs, you need to calculate the total costs each year of purchases, ordering costs and holding costs, for both order quantities the EOQ and the minimum order quantity to obtain the discount.
If a supplier offers a discount for order quantities above a certain amount and an larger discount orders above an even larger quantity, you need to compare total costs for the EOQ and for each minimum quantity at which a different purchase discount applies. What is the order quantity that will minimise total costs?
Answer The economic order quantity, ignoring discounts, is 4, units see earlier example. The order quantity that will minimise costs is therefore one of the following: The inventory level therefore ranges between 0 units and Q units. The economic order quantity is used when materials are purchased from external suppliers. A similar situation arises when an entity manufactures items itself in batches and holds them as inventory until they are sold or used for further processing.
For example, a company might produce finished goods in batches, and on completion of production, the materials are transferred to finished goods inventory until they are sold.
However, when it takes some time to produce a batch of items the items might be delivered into store gradually, whilst production is still in progress. The first units are therefore received into store before production of the batch is complete.
This is because by the time that the full batch has been delivered into store, some of the units have already been used. It is used to calculate the order quantity that minimises total annual costs. If it is assumed that the cost per unit produced is the same regardless of the batch size, the economic batch size is the quantity that minimises the total annual costs of: Set-up costs. Set-up costs occur in production when items are manufactured in batches. These are the costs incurred in cleaning up the machinery and equipment from the previous batch and getting the machinery ready for making the new batch.
As stated earlier, it is assumed that inventory is replenished as soon as it reaches 0. However, the replenishment of inventory continues throughout the time that the batch of units is still being manufactured. New units are produced continually throughout the batch production process.
For example, suppose that a factory has the capacity to make 8, units of an item each year, but it only needs 4, units a year. It therefore produces the units in batches.
Suppose the batch size is 2, units. This is a quarter of the factory capacity, so it would take at least three months to complete one batch. As the units are produced, they are transferred to inventory. There is no need to wait until the end of the batch production run before transferring any of the units to inventory. This means that the maximum inventory level is not Q. It is a smaller amount: If this is the maximum inventory level, average inventory is units.
Give an annual holding cost per unit of CH: Management Accounting inventory quantity — due to the gradual replenishment of inventory during the batch production process. Example A company uses 9, units of product A23 each year, in batches. The annual production rate at which Product A23 could be made is 30, units each year. What is the batch quantity size for Product A23 that will minimise annual costs? This is the same situation that applies to the EOQ for total holding costs and total ordering costs.
You might be tested in your examination on the effect on the EBQ, annual holding costs and annual set-up costs of a change in any variable in the EBQ formula. The approach to analysis should be the same as for changes invariables in the EOQ formula explained earlier , but the EBQ formula is bit more complex and you should be careful when analysing the effect of any change. Accounting for materials and labour Example A company uses the economic batch quantity formula to decide the batch production quantities for an item of material.
Due to improvements in efficiency in the factory, the production capacity speed of production is increased. Given no change in the set-up cost per batch, total set-up costs must therefore be higher. If the order quantity is the EBQ, total annual set-up costs and total annual holding costs are the same. If total annual set-up costs increase, it follows that total annual holding costs will also rise. In practice, however, there is likely to be some uncertainty about when to make a new order for materials in order to avoid the risk of running out of inventory before the new order arrives from the supplier.
There are two reasons for this. This is the period of time between placing a new order with a supplier and receiving the delivery of the purchased items. The length of this supply lead time might be uncertain and might be several days, weeks or even months. During the supply lead time, the actual usage of the material may be more than or less than the average usage. However, the examination syllabus specifies that you will only be examined about situations where the demand during the lead time is constant; therefore only the length of the supply lead time might be uncertain.
Running out of an item of inventory or stock is called a stock-out. When there is a stock-out of a key item of materials, there might be a hold-up in production and a disruption to the production schedules.
This in turn may lead to a loss of sales and profits.
Management responsible for inventory control might to know: In an inventory control system, there may be warning levels for inventory, warning management that: It is assumed that it is management policy to avoid running out of any item of inventory. In other words, it is assumed that there will be no stock-out of any material item.
Accounting for materials and labour 4. If the item is not reordered at this point there will be some risk of a stock-out during the supply lead time, before the new purchase quantity is received. For example the supplier might have delivered a new order quantity much sooner than usual and much sooner than expected or demand for the item must be below even the expected minimum.
The stores manager might need to check with the supplier about why there is a delay in the delivery, and how soon a new delivery of the material item can be expected. Reorder level A new quantity of materials should be ordered when current inventory reaches the reorder level for that material.
The reorder level should be: This is more than the average usage during the supply lead time. As a result, more inventory is held that is needed on average. The size of the safety inventory is calculated as follows: Management Accounting 4. If it does, something unusual has happened to either the supply lead time or demand during the supply lead time. When demand during the supply lead time is constant, the maximum inventory level is: The supply lead time is short; therefore there are still some units of inventory when the new delivery is received.
When inventory falls below this amount, management should check that a new supply will be delivered before all the inventory is used up, so that there will be no stock-out. When demand during the supply lead time is constant, the minimum warning level for inventory is: The reorder quantity for this material is 12, units. Weekly usage of the item is 1, units per week, but there is some uncertainty about the length of the lead time between ordering more materials and receiving delivery from the supplier.
Supply lead time weeks Average Maximum Minimum 2. Management Accounting Labour costs: Direct and indirect labour costs In an earlier chapter, it was explained that a distinction is made in cost accounting between direct labour employees and indirect labour employees.
Direct labour employees are those who work directly on the goods or services produced by the entity. The general rule is that direct labour costs are the costs of direct labour employees and indirect labour costs are the costs of indirect labour employees.
However, there are some exceptions to this general rule, and some costs of direct labour employees are treated as indirect labour costs. Two exceptions are: Idle time Idle time is time when employees are paid and are available to work, but are not doing any active work The cause of idle time could be a breakdown in production equipment or a delay in the delivery of materials from a supplier. Idle time might also occur when there are no orders from customers, and there will be no more work until the next order arrives.
Idle time should be treated as an indirect labour cost. However, in order to treat idle time as an indirect cost, the cost accounting system must be able to identify the amount of time that is lost as idle time. To do this, idle time must be recorded on labour time sheets which are often used to document the use of labour time, for the purpose of cost accounting. In costing systems, it is usual to separate the labour cost at the basic rate per hour from the cost of the overtime premium.
This is because overtime premium costs are usually treated as an indirect labour cost an overhead cost and should be measured separately. Example During one week, Masha works 46 hours. This includes 8 hours of overtime working. Her weekly cost is calculated as follows, keeping the overtime premium separate from the basic pay for the hours worked.
The main rules about whether production labour costs should be treated as a direct labour cost or as an indirect labour cost can be summarised as follows. Management Accounting Direct labour costs Indirect labour employees 5. This includes: All labour costs of indirect labour employees Recording labour costs In a cost accounting system, there must be a system for relating the cost of labour to work that is done.
There are various ways in which labour time might be recorded, but the main methods are: Time sheets or similar time recording systems can be used within a cost centre to record the time spent by each employee on different activities or tasks or as idle time. Time sheets are not necessary if an employee does the same work all the time. For example, it is not necessary to prepare time sheets for a machine worker if the employee spends all his time working at the same machine producing the same items of output.
However, time sheets are needed if employees spend time on more than one cost item, so that their labour cost has to be allocated to the different cost items. For example, a manufacturing centre might product two products, Product A and Product B, and a direct labour employee might spend time working on both products. Time sheets can be used to record the time spent on each product, so that the labour cost can be allocated to each product according to the amount of time spent on each.
Similarly time sheets are needed to work out the labour cost of specific jobs or contracts: Accounting for labour costs Within a cost accounting system, indirect and direct labour costs are recorded and charged to the appropriate cost centres and cost units.
The records of labour costs Go to www. Accounting for materials and labour are included within the double-entry cost accounting system where such a costing system is used. Labour costs are allocated between different jobs or activities on the basis of the time spent working on each job or activity.
Many employees are paid a fixed salary each month. Their costs are allocated to the departments they work in and to the activities they perform on a time basis. For example, if an employee spends half his time on one type of activity and half of his time on another activity, the cost of his labour will be divided Some employees are paid by the hour, and a few are paid a piecework rate.