1 Costing 2 Accounting Prof. Clive Vlieland-Boddy Academic Year 2009-2010

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Costing 2Accounting

Prof. Clive Vlieland-Boddy Academic Year2009-2010

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Activity Based Costing

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Activity Based Costing

• Costs per service or activity.• Costs are allocated to a service or activity

Examples: • Cost per sales enquiry• Costs per warranty claim• Costs per credit check

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Cost Drivers

There are two main types of cost driver: • A resource driver, which refers to the

contribution of the quantity of resources used to the cost of an activity.

• An activity driver, which refers to the costs incurred by the activities required to complete a particular task or project.

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Activity-Based Costing

• A way to allocate as many costs as possible to a product

• Focuses on activities and cost of activities• Each activity has its own cost driver• Uses a separate allocation rate for each

activity

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Other Costing Issues

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Job Costing

• Measures individual costs of production or service to each sales unit.

Example: A builder will charge to a job all the materials and labour so as to identify the results of that particular job.

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Processing Costing

• Traces all direct an indirect costs of manufacturing often on a batch process. They eventually divide these costs up to calculate a per unit cost.

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Equivalent Units

• When valuing ending inventories of WIP, there may well be many partly completed units.

• These have to be equated into completed units.

Example: At the month end a cycle manufacture has 500 half completed cycles. That would equate to 250 equivalent units.

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Cost Volume Profit Analysis (CVP)& Break Even

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The principles of variable/marginal costing

1. For any given period of time, fixed costs will be the same, for any volume of sales and production (provided that the level of activity is within the ‘relevant range’). Therefore, selling an extra item of product or service:

Revenue will increase by the sales volume of the item sold

Costs will increase by the variable cost per unit Profit will increase by the amount of contribution

earned from the extra item

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Cost-volume-profit analysis

• Systematic method of examining the relationship between changes in activity and changes in total sales revenue, expenses and net profit

• CVP analysis is subject to a number of underlying assumptions and limitations

• The objective of CVP analysis is to establish what will happen to the financial results if a specified level of activity or volume fluctuates

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CVP analysis assumptions

• All other variables remain constant• A single product or constant sales mix• Total costs and total revenue are linear functions of

output• The analysis applies to the relevant range only• Costs can be accurately divided into their fixed and

variable elements• The analysis applies only to a short-time horizon • Complexity-related fixed costs do not change

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Break Even

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CVP diagram

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Margin of safety

• The extent that the revenue exceeds total costs, is called the margin of safety.

• Indicates by how much sales may decrease before a loss occurs

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Break Even Analysis

• Remember:• A higher price or lower price does not mean that

break even will never be reached! • The break even point depends on the number of

sales needed to generate revenue to cover costs – the break even chart is NOT time related!

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Activity 18.4.1

• Use the matrix on web site to do this

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Budgets

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Budgets

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Budgets

• Estimates of the income and expenditure of a business or a part of a business over a time period

• Used extensively in planning• Helps establish efficient use of resources• Help monitor cash flow and identify

departures from plans• Maintains a focus and discipline for those

involved

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Budgets

• Flexible Budgets – budgets that take account of changing business conditions

• Static Budget – Based on pre determined level of activity

24© John Wiley & Sons, 2005

Chapter 10: Static and Flexible BudgetsEldenburg & Wolcott’s Cost Management, 1e Slide # 24

Flexible Budgets• A budget prepared for a multiple levels of

sales volume is called a flexible budget.• Flexible budgets are prepared at the

beginning of the year for planning purposes and at the end of the year for performance evaluation.

• Differences between actual results and the flexible budget are called flexible budget variances.

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Flexible Budget

• This is the budget we would have prepared HAD WE ONLY KNOWN the number of units that would be sold or produced

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What is needed to do a flexible budget

• To do a flexible budget we need to know the assumptions used to create the original budget– Units expected to be sold– Expected selling price per unit– Variable cost per unit– Fixed costs (in total)



Static Budgets• A budget prepared for a single level of

sales volume is called a static budget.• Static budgets are prepared at the

beginning of the year.• Differences between actual results and

the static budget are called static budget variances.



Performance Evaluation• A static budget variance includes effects from

output volume.• A flexible budget variance removes these output

volume effects.• Other adjustments to the year-end flexible

budget may be made for a fair performance evaluation, such as• Input price changes outside the control of the

manager under evaluation• Fixed cost increases outside the control of the

manager under evaluation

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Comparing Actual Results Comparing Actual Results to Planned Resultsto Planned Results

Budget comparisons and variances



Budget Variances• Managers compare actual results to budgeted results in order to

monitor operations, and motivate appropriate performance.• Differences between budgeted and actual results are called budget

variances.• Variances are stated in absolute value terms, and labeled as

Favorable or Unfavorable.

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Actual Vs Budget

Actual Budget Variance

Sales 540,000 520,000 20,000 F

Purchases 350,000 340,000 10,000 U

Because it is a positive variance the it is marked with a F. Unfavourable is marked with a U

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Budgets

• Variance – the difference between planned values and actual values– Positive or Favourable variance – actual figures

less than planned– Negative Unfavourable variance – actual figures

above planned



Budget Variances

Budget variances are investigated. The investigation may find:

• Inefficiencies in actual operations that can be corrected.

• Efficiencies in actual operations that can be replicated in other areas of the organization.

• Uncontrollable outside factors that require changes to the budgeting process.

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Quantity variancePrice variance

The difference betweenthe actual price and the

standard price

The difference betweenthe actual quantity andthe standard quantity

Standard variances

Revenue or Cost Variance Analysis

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Easier than formulas?• Sales volume variance

– (actual units – planned units) * planned selling price per unit

• Sales price variance– (actual unit price – budgeted unit price) * units

sold

Note: Some companies use contribution margin per unit instead of selling price to compute these variances.

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Drilling down further . . .

• Sales volume variance can be further analyzed– Are sales more or less than expected because we

sold a different mix of products than we planned?– The selling price for each product might also be

different than we planned

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Production Variances• Direct materials

– Price variance– Quantity variance

The computations are similar to what we illustrated for sales. You change one element at a time and, from the difference, determine the impact on costs (instead of sales)

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• Direct labor– Rate variance– Efficiency variance

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Maybe I can attribute the labourand materials variances to personnel

for hiring the wrong peopleand training them poorly.

Responsibility for Labour Variances

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• Variable overhead– Spending variance– Efficiency variance

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• Fixed overhead– Budget variance– Volume variance

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Performance Reports

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• Report financial performance of responsibility centers

• Cost center• Difference between actual results and budget• Changes in labour dollars or hours• Changes in purchased price vs. quantity discount

• Revenue center• Variance due to selling more or less units than expected• Variance due to price changes

• Profit center–Focus on both revenue and cost variances

Copyright (c) 2009 Prentice Hall. All rights reserved. 43

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• Management by exception–Only material variances are investigated

• Should focus on information, not blame• Some variances are uncontrollable

–Examples: increase in costs due to a natural disaster or macro economic issues

Copyright (c) 2009 Prentice Hall. All rights reserved. 44

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Question 1

Activity Based Costing requires:a. Costs to be allocated to an activityb. Enables management to evaluate its services to

customersc. Enables variances to be created on customer

focused tasks.d. All of the above

Answer:d. All of the above

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Question 2

• Job Costing is where:a. Costs are assigned to a particular jobb. Often used by Accountants & Lawyers to charge

their clientsc. Enables accurate control of each job.d. All the above are correct

Answer:d.

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Question 3

• Process costing is:a. Suitable for controlling costs in a manufacturing

environmentb. Usually allocates costs by batch then divides

them up to get a per unit costc. Both a and b are correct

Answer:c.

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Question 4

• Equivalent Units:a. Are a method of assessing ending inventoriesb. Are calculated by establishing the extent that

WIP is completed in terms of finished goods.c. A and B are correct

Answer:c.

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Question 5

• CVP enables evaluation of:a. The number of units to be sold to break evenb. The relationship that total costs have to total

revenuesc. Both a and b are correct

Answer:c

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Question 6

• Margin of Safety is:a. The extent that revenues exceed total costsb. Is the extent that profits are above Break Evenc. Represent the level of activity that can be lost

before losses are sustainedd. All above are correct

Answer:d.

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Question 7

• A flexible budget is:a. A static budget adjusted for volume activityb. Is prepared for several levels of expected

activity.c. Both A and B are correct

Answer:c.

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Question 8

• A variance is:a. The extent that actual has departed from

forecastb. Is either Favourable or Unfavourablec. Enables management by exceptiond. All above are correct

Answer:d.

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Question 9

• A Sales variance can be:a. Both because of price and quantityb. Can only be a price variancec. Can only be a quantity variance

Answer:a.

recast

Documents

1 Costing 2 Accounting Prof. Clive Vlieland-Boddy Academic Year 2009-2010