T7 Key notes

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Chapter 1: Accounting for management

Functions of management

Planning – setting objectives, selecting strategiesControlling – measure and act, need to have performance measurement systemOrganizing – establish sequences of tasksMotivating – influence others’ behaviorDecision-making – making choices between alternatives

Objective of management accounting information is to help managers in planning, control, decision making and performance measurement.

Role of management accountant is to provide the manager with assistance in planning, controlling, organizing, motivating and decision-making.

Useful management information is ACCURATE:AccurateCompleteCost-beneficialUser-targetedRelevantAuthoritativeTimelyEasy to use

Limitations of management informationFail to:

(i) Meet requirements of good information(ii) Determine relevant costs and revenues(iii) Account for non-financial information(iv) Account for external information

Cost accounting systems can be maintained and improved by making sure that it is:(i) Forward looking(ii) Take into account internal and external information(iii) Account for quantitative and qualitative matters(iv) Analysed(detailed)

Chapter 2: Absorption Costing

Application of AC AC is an overhead recovery system which involves 4 steps:

(i) Allocation – Assign costs which are not shared to departments(ii) Apportionment – Sharing of cost on an equitable basis(iii) Reapportionment – Transfer of service department cost to production

department(iv) Absorption – calculate overhead absorption rate(OAR) and charge cost to

products according to full production costOAR=Budgeted overhead/Budgeted level of activity

AC can be applied to job costing, batch costing, contract costing (long-term of job costing), service costing and process costing. The cost per unit will be charged on full production cost basis.

When our actual production units are higher than normal production, over-absorption exists and this needs to be adjusted to gross profit figure.

Preparation of management accounts and cost estimates using ACProfit Statement

RevenueLess: Full Production costsOpening inventory (at full cost)Production costs (variable + absorbed fixed overhead)Less: Closing inventory (at full cost)=Gross profit+over-absorption/ (under-absorption)=Adjusted gross profitLess: Other cost=Net profit

Evaluation of ACAdvantages:

(i) An acceptable system of recovering inevitable fixed overheads(ii) Complies with matching concept(iii) Complies with financial statement need to include fixed overhead in

inventory(iv) Provides a practical way of job costing for estimating prices and profit

analysisDisadvantages:

(i) Overhead allocations and apportionment are arbitrary and can be misleading

(ii) Increase or decrease of inventory can distort income statements(iii) Under/Over absorption obscures true reasons for inefficiencies, making

overheads difficult to control(iv) Unit costs are distorted by absorption rates(v) Cannot be used for decision-making because fixed cost is irrelevant

Chapter 3: Marginal Costing

Use of marginal costing in an organization is for short-term decision-making.

MC is applicable to costing situations just as AC, but the cost per unit is charged on marginal (variable) production cost basis.

Cost behavior is manner in which a cost will react to changes in the level of activity. Costs may be viewed as variable, fixed, stepped or mixed (semi-variable).

Preparation of management accounts and cost estimates using MCProfit Statement

RevenueLess: Variable Production costsOpening inventory (at variable cost)Production costs (variable overhead)Less: Closing inventory (at variable cost)Less: other variable cost=ContributionLess: fixed cost=Net profit

Reconcile marginal costing and absorption costing profitsAt marginal costing, closing inventories are valued at marginal production cost.At absorption costing, closing inventories are valued at full production cost.If inventory level increases, absorption costing reports higher profit because fixed overheads included in closing inventory.If inventory level decreases, marginal costing reports higher profit.

ReconciliationAbsorption costing profit+ (Closing inventory-opening inventory) x fixed OAR per unit=Marginal costing profit

Evaluation of MCAdvantages:

(i) Appropriate for decision-making as it highlights those costs and revenues which will change as a result of the decision.

(ii) Fixed costs are all treated as period costs and charged into income statement which avoids distortion in reported profit. Profit will be more realistic.

Disadvantages:(i) Cost behaviour must be known(ii) In longer term, all cost must be covered by revenue of the organisation if it

is to make a profit(iii) Pricing decisions based on marginal costing principles may be harmful to

the business in longer term.

Use of absorption and marginal costingAbsorption costing is used for inventory valuation and financial reporting.Marginal costing is used for short-term decision making and CVP analysis.

Chapter 4: Activity Based Costing

Reason for development of ABC is because modern manufacturing environment:(i) More automated than labour intensive(ii) Fixed costs become a larger proportion of total costs(iii) Overhead is a lot higher than direct costs

Select appropriate cost pools and cost drivers and calculate product costs using ABC.Cost drivers are any factors which causes a change in activity cost (cost pools). It might be better to think of it as the “cost causer”.Steps involve in calculating cost are:

1. Identify a cost2. Identify cost drivers3. Calculate cost driver rates (cost pool/cost driver)4. Trace the cost into the units produced

Example: Cost of goods inwards department totalled $10000. Cost driver for goods inwards activity is number of deliveries. During 20X0 there were 1000 deliveries. 200 of these deliveries related to product X. 2000 units of product X were produced.Answer: Cost driver rate = $10000/1000deliveries = $10 per deliveriesTotal cost of product X = $10 x 200 deliveries=$2000Cost per unit of product X = $2000/2000units=$1

Application of ABCAlternative to AC and MC in a job, batch, contract, service or process costing system.ABC is also useful in costing of services.

Evaluation of ABCAdvantages:

(i) Unit costs should more accurately reflect the activities performed(ii) Effectively used in identifying unprofitable customers and unprofitable

products and company can concentrate on profitable(iii) Identify those activities that add more to value (iv) Better understanding of how product is derived(v) Avoid arbitrary cost apportionment

Disadvantages:(i) Unknown technique and not widely accepted(ii) More complex and costly technique to set up and operate(iii) Unlikely to relate all overheads to specific activities(iv) Cost drivers might be difficult to identify

Use of AC, MC and ABCAbsorption costing is used for inventory valuation and financial reporting.Marginal costing is used for short-term decision making and CVP analysis.Activity based costing is used for inventory valuation, financial reporting, long-term decision making, produce budgets (activity based budget) and aid in planning and control.

Chapter 5: Collection of Information

Sources of information include internal and external. Internal sources may be obtained from data recorded from standard costing, budgeting and performance measurement control system. Main sources of external information are government sources, suppliers and customers, trade associations and trade journals, financial and business press and other media.

Sources of information from suppliers and customersCustomers can provide information such as:

(i) Product that they want(ii) Quality required(iii) Delivery periods required(iv) Preference of packaging and distribution methods

Suppliers may be able to provide information on:(i) Quantity discounts and volume rebates which may help decision on order

size(ii) Availability of products and services(iii) Alternative products or services which may be available (iv) Technical specifications of their product

Sources of information from government, trade associations and financial pressGovernment publishes statistical data covering many aspects of the nation’s economy.Trade associations publish their trade journals which will contain useful news and other information.Financial press provides statistics and financial reviews as well as business and economic news and commentary.

Sampling techniques and when they are appropriate to usePurpose of sampling is to gain as much information as possible about the population by observing only a small proportion of that population i.e. by observing a sample.

In random sampling, sample is taken in such a way that every item of the population has equal chance of being selected. It is useful if population is known and not big.

Systematic sampling involves selecting every nth item after a random starts, only first item is selected randomly. For example, if the population contains 50000 items and a sample size of 500 is required, then 1 in every 100 items is selected. The first item is determined by choosing randomly a number between 1 and 100, eg. 67, then the second item will be 167th, the third will be 267th up to 49967th item. This method is useful if population is logically same type but will introduce bias if population has a repetitive pattern.

Stratified sampling involves selecting random samples from well defined groups (strata), eg. men and women, smokers and non-smokers. The method is often used by auditors to choose a sample to confirm receivables balances. This method requires prior knowledge of each population item.

Multistage sampling involves dividing population into sub-populations and small random sample is selected from sub-populations. It is useful if the population is large.

Cluster sampling involves diving population into sub-populations and small random sample is selected from sub-populations, then every items in the random sample are investigated. It is useful if the population is large.

In quota sampling, investigators are told to interview all the people they meet up to a certain quota. This may be very biased because they choose how to fill the quota.

Benchmarking is a process where organisations gather information outside the organisation to use as comparisons and for setting targets.

Types of benchmarkingInternal benchmarking refers to comparisons being made between different departments or functions within an organisation.

Functional benchmarking (also known as operational or generic benchmarking) involves comparisons with the performance of external practitioners of similar functions. These practitioners need not be in the same industry.

Competitive benchmarking involves comparisons with the performance of a direct competitor.

Strategic benchmarking takes place at the highest levels of performance measurement (such as company-wide return on capital employed, market share etc) and is aimed at prompting strategic change. Strategic benchmarking seeks to compare the strategies of the originator with those of competitors, in order to more closely identify where competitive threats and opportunities may lie in the longer term.

Advantage of benchmarking(i) Flexibility so can be used in private and public sectors(ii) Identifies processes to improve(iii) Aids cost reduction(iv) Focus on planning(v) Improves effectiveness of operations

Disadvantage of benchmarking(i) It can be complex and needs a lot of work(ii) Benchmarking reveals the standards attained by competitors but does not

consider the circumstances under which the competitors attained such standards

Chapter 6: Presentation of information and use of indices

Prepare written reports representing management information in suitable formats according to purposeTypical report structure will include:To:From:Subject:Date:IntroductionAnalysis (use an underlined heading for each sub section)ConclusionAppendices (show calculations in detail)

Present information using tables, charts and graphs (bar charts, histograms, frequency polygons) and interpretPurpose is to summarise the information and present it in a more understandable way.TableEg. Alpha Products Plc

Changes in labour force (20X0-20X1)20X0 20X1

Depart A

Depart B

Total Depart A

Depart B

Total

Wages bill ($) 218000 295000 513000 224000

313000 537000

Number employed 30 42 72 25 43 68

When interpreting, write down what you see. For example, in 20X1, total wages are $537000 which is higher than in 20X0. ChartsThere are three types of charts:Simple bar chart – Only one variable is being illustrated.Component bar chart – Gives breakdown of each total into its components.Compound/Multiple bar chart – Two or more separate bars are used to present sub divisions of information.HistogramIt is similar to bar chart but used to represent the frequencies in a grouped frequency distribution. Area of the bar represents the frequency rather than height of the bar. Therefore if the class intervals are unequal then the height relationships of the bars will differ. The bars touch each other, there are no gaps.Frequency polygonsIf the midpoints of the tops of the rectangles in a histogram are joined by straight lines, we get our frequency polygon.

Calculate price and quantity indices on Laspeyres' and Paasche basesLaspeyre price index-weighted by base year quantitiesPaasche price index-weighted by current year quantitiesLaspeyre quantity index-weighted by base year pricePaasche quantity index-weighted by current year price

Eg. Laspeyre price indexItem 20X2

Price Quant.20X3

Price Quant.20X2 price X 20X2 quantity

20X3 price X 20X2 quantity

Product A $6.50 10 $6.90 5 $6.50x10=$65 $6.90x10=$69Product B $2.20 30 $2.50 40 $2.20x30=$66 $2.50x30=$75

Total $131 $144Laspeyre price index= (sum of current price X base quantity)/(sum of base price X base quantity) X 100=$144/$131 X 100=110

Discuss advantages and disadvantages of Laspeyres' and Paasche indicesAdvantages:

(i) Ease of calculation. Laspeyres price index is based upon the baseline quantities, only the current year’s prices are required for the calculation of the index. For the Paasche price index then the current year quantities and prices are required. Laspeyres price index is slightly easier to calculate and can be obtained in situations where the current year’s quantities are unknown.

(ii) Relevance. Paasche price index uses current quantities so more relevant and topical, especially where the quantities may have changed dramatically.

Disadvantages:(i) Long series of data. Paasche price index has to be recalculated each period new data comes along as the current period will have changed. When quantity changes then the previously calculated Paasche price indices may take substantially different values from the newly calculated ones based upon the new current year quantities. Laspeyres price index does not need to be recalculated as the base period remains the same.

Adjust raw data using appropriate indicesIndex can be used to adjust past costs and revenues data into current values. For example, 2010 price index is 140, 2009 price index is 125 and revenue is $1250, when we need to adjust 2009’s revenue value using 2010 price, we can simply take 2010 price index divided by 2009 price index and multiply 2009 revenue:140/125 X $1250=$1400$1400 is the revenue for 2009 if it was 2010’s price level.

Chapter 7: Forecasting

Use the high-low method to estimate the fixed and variable elements of a costStep 1: Calculate difference between cost of highest and lowest level and then divide it with units of highest and lowest level to get variable cost per unit.Step 2: Calculate fixed cost by fixed cost= total cost – (variable cost per unit x units)Step 3: Summarise the relationship by making an equation, eg. Fixed cost=$600, variable cost per unit=$0.2, equation will be y=a+ bx, so y=600+ 0.2x.

Advantages and disadvantages of the high-low methodAdvantages:(i)A simple, non-technical method(ii)Can be used with a minimum of dataDisadvantages:(i)Uses past data to attempt to forecast future costs(ii)Uses only two points(iii)Assumes the cost relationship is linear

Construct scatter diagrams and lines of best fitStep 1: Collect data of past volumes of output costs.Step 2: Plot cost and output data on a graph.Step 3: Draw a “line of best fit” through the middle of the plotted points.Step 4: Fixed costs=intercept on vertical axis.Step 5: Variable cost per unit= [total cost (read from graph)-fixed cost]/activity level

Use of linear regression analysis in the analysis of cost dataA more mathematical technique to improve the accuracy of the line of best fit. It is based on working out an equation for the line of best fit (not required in T7). General equation for a straight line can be expressed as: y=a + bx.

Use linear regression coefficients to make forecasts of costs and revenuesThe value of a and b will be given in exam, eg. a=27.49 and b=14.18, equation will be y=27.49+14.18x, but this equation can mean different thing according to different types of question, for example, if y is the annual maintenance cost and x is the years of machine and required to estimate the maintenance cost of a machine that is 10 years old, then the forecast of cost will be 27.49 X (14.18 X 10).

Adjust historical and forecast data for price movementsThe method of adjustment will be the same as previous at chapter 6 last part, using our forecast price index to adjust for past sales value.

Advantages and disadvantages of linear regression analysisAdvantage:(i)Provides a more reliable approach as it arrives at the equation of the regression line from the use of mathematical principles known as least squares method.(ii)A large number of observations can be built into regression line and this is likely to make the relationship derived more accurate.

Disadvantage:(i) Only valid where the relationships involved are linear.(ii)Uses past data(iii) More complex technique to apply.

Principles of time series analysisTrend is the general direction in which a graph of sales goes.Seasonal variation is short-term fluctuations.Random variation is irregular fluctuations that cannot be identified or eliminated.

Calculate moving averagesWhen the time series is not approximately linear, we can use a technique known as moving averages. However it requires a lot of time and will not required in T7.

Determination of trend, including the use of regression analysisWe can determine the trend by using linear regression formula, for example S=110+10T where T=1 denotes for first quarter, Quarter 1 of 2000, T=2 denotes for Q2 of 2000 and so on, then our trend value for Q2 of 2001 will be 110+10X6.We can also determine the trend by extending the trend line on the graph and reading off the relevant figures. This is also known as “extrapolation”.

Use trend and seasonal variation (additive and multiplicative) to make budget forecastsAdditive model: Forecast sales (A) = Trend (T) + Seasonal variation (S)Multiplicative model: A = T X S Eg. Additive model: Seasonal variations are Quarter (Q) 1=(52), Q2=24, Q3=116, Q4=(88), after we determined our trend value for next year, we can forecast our sales, let say our trend values for next year are Q1=215, Q2=218, Q3=222, Q4=227, our forecast sales for Q1 next year will be 215 – 52.Multiplicative model: Seasonal variations are Q1= (40%), Q2= 20%, Q3= 30%, Q4= (10%), trend values for next year are as above, then our forecast sales for Q1 next year will be 215 X 60%.

Advantages and disadvantages of time series analysisAdvantage:(i)Able to make accurate forecast of sales(ii)Simple to useDisadvantage:(i)Assumes past trends will continue indefinitely but competitors may influence the sales of products which cause the trends to change.

Concept of the product lifecycle and its implications for sales forecastingThe product lifecycle model shows how sales of a product can be expected to vary over time. If an organisation knows where a product is in its lifecycle, they can plan the marketing of that product more effectively and derive an approximate forecast of its sales from knowledge of the current position of a product in its lifecycle.Standard lifecycle model for a product has 4 stages: introduction (sales are at low level), growth (sales increase rapidly), maturity (growth in sales will probably stop) and finally decline (sales will fall).

Chapter 8: Budgetary planning

Planning and control cycle in an organisationThis involves 7 steps:Step 1: Identify objectivesStep 2: Identify alternative courses of action (strategies)Step 3: Gather data about alternativesStep 4: Select course of actionStep 5: Implement the long-term plan in the form of annual budgetStep 6: Monitor actual resultsStep 7: Respond to differences from plan, go back to step 2 if needed or control and go to step 5 again.

Explain how the design of the planning and control system will be affected by organisational structure, business objectives, the organisation's administrative procedures and the nature of the product/service marketDifferent organisation structure definitely influenced the way managers are going to design the planning and control system as it is the pattern which all managers follow. The business objectives are the first step of planning and control cycle, so when it is changed, every steps below will also change. The design of planning and control system will also be affected by the procedures of the administration because the implementation of budget strongly depends on it. Different products will affect the way managers chose to get profit from it.

Compare short-term and long-term business plans and explain how they are relatedShort-term plan is 1 year or than 1 year plan. Long-term plan could be 2-5 years plan. Short-term plan is there to assist the success of long-term plan.

Describe principal budgetary factor and its importance in constructing budgetPrincipal budgetary factor is also known as limiting factor, it is a factor that places limit of the activity of the business. It is the first thing to consider before constructing the budget, it may be labour hour, machine hour or material that restrict us from achieving the demand, therefore we start our budgeting by identifying principal budgetary factor first, then construct budgets.

We need to be able to identify principal budget factor in specific situations. For example company A has maximum demand of 150000 units but it can only produce maximum of 100000 units, the company’s principal budget factor would be materials or labour hours.

Describe the order of budget construction relating to a specific limiting factorIf the limiting factor is sales, our order of budget construction will be as follow:Step 1: Sales budgetStep 2: Production budgetStep 3: Cost of goods sold budget (raw material, labour and factory overhead budget)Step 4: Non-production overhead budget (eg. selling and distribution budget)Step 5: Budgeted income statement-Master budgetStep 6: Cash budget-Master budgetStep 7: Budgeted balance sheet-Master budget

Budget preparation timetable is a timetable that described the preparation process of budget. Budgetary process involves the following stages:1. Communicating details of budget policy and budget guidelines2. Determining limiting factor3. Preparation of sales budget4. Initial preparation of other budgets5. Negotiation of budgets with superiors6. Coordination of budgets7. Final acceptance of budgets8. Budget review

Describe relevant documentation produced and the management accountant’s role in its productionDocument produced will be the budget manual which is a collection of instructions governing the responsibilities of persons and the procedures, forms and records relating to the preparation and use of budgeting data. Management accountant will act as an budget officer, who is secretary to the budget committee and is responsible for seeing that the timetables are followed and provide necessary specialists assistance to functional managers in drawing up their budgets and analysing results.

Describe the involvement of staff at all levels in the organisation in the budget preparation process and the effect on employee motivation of the approach adoptedThe staff involves would be chief executive, the management accountant and functional heads (head of departments). This can improve employees’ motivation as they have a target to achieve.

Sources of information required for budget preparation and their likely limitationsInformation required would be previous year’s actual results, other internal sources, statistical data and external sources. But there are limitations, external information may not be accurate which can cause wrong decision made. Uncertain economic climate may cause the information collected from internal sources and past data to be not useful.

Management might plan for variations in capacity levels by increasing advertising, incur promotion expenditure, makes improvements to the product and more.

Prepare budgets under varying capacity levelsThe way of using limiting factor analysis will be finding out contribution per limiting factor for each products and then rank each products, the highest contribution per limiting factor means the highest return, produce the product which is ranked no.1 first.

Prepare sales budgetsTake the budgeted sales units multiply by the selling price per unit.

Prepare functional budgets (production, raw materials usage and purchases, labour, fixed overheads)Production budget = sales units + closing inventory – opening inventoryRaw material usage budget = production units x material usage per unitMaterial purchases budget = material usage + closing inventory (material) – opening inventory (material)Labour budget – production units X labour hour per unit=total labour hour, total labour hour X labour cost per hour= total labour costFixed overheads budget – if the production overhead is absorbed based on labour hour, fixed production overhead/total labour hour=fixed OAR

Discuss the preparation of discretionary expense budgetsSome possible approaches such as:(i)Based this year’s budget figure on last year’s budget, adjust for inflation.(ii)Based this year’s budget figure on last year’s actual expenses, adjust for inflation.(iii) Managers using their knowledge and experience to set a budget.(iv)Output based budgeting-based on the output of management accounting department.

Prepare capital budgets and cash budgetsNot really required in T7, it will be covered in T10.

Prepare master budgets (profit and loss account and balance sheet)Especially budgeted income statement, using AC or MC, the method will be the same like chapter 2 and 3.

Main features of zero-based budgetingZBB involves preparing a budget for each cost centre from a zero base. Every item of expenditure has to be justified first before included in budget.

Advantages and limitations of zero-based budgetsAdvantage:(i)Identifies and removes inefficient and obsolete operations.(ii)Encourages innovation(iii)Removes budgetary slack(iv)Takes changes in the business environment into accountLimitation:(i)Involves time and effort and is costly(ii)Information systems may not be able to provide suitable information

Compare the use of incremental and zero-based budgeting systemsIncremental budgeting involves adding a certain percentage to last year’s budget to allow for growth/inflation. But it has disadvantages such as out of date, budgetary slack and so on. ZBB would be useful in preparing budget but it has certain limitations.

Describe when zero-based budgets are commonly usedZBB is useful in service industries, support expenses, non-profit-making organizations and discretionary costs.

Main features of a rolling budgetRolling budget is a continuously updated budget by adding a future accounting period when the earliest accounting period has expired. It takes into account the latest information.

Role of spreadsheet models in budget constructionSpreadsheets are of great use in budgeting and decision making as it can manipulate a large amount of data very quickly.

Prepare simple spreadsheet formulae for budget constructionIn spreadsheet, the intersection of each row and column is referred to as cell. Columns are referenced alphabetically and rows numerically with the result that a cell reference is a combination of these. For example, A1*A5 means column A row 1 multiply by column A row 5. A1=cell.

Describe financial modeling softwareIt is software that allows organization to build up an overall financial plan including a detailed set of budgets.

Describe “what if” analysis and scenario planning“What if” analysis is a form of sensitivity analysis, which allows the effects of changing one or more data values to be quickly recalculated. It is useful to test uncertain situation and it can be assisted by using spreadsheet.Scenario planning is strategic planning method that some organizations use to make flexible long-term plans. Scenarios are descriptions of vividly different, contrasting and relevant future environment in which the business may have to operate.

Chapter 9: Budgetary control

The importance of flexible budgets in controlVariance report based on a flexible budget compares actual costs with the budgeted costs which is based on actual activity level achieved. Variances can be calculated in a more meaningful way.

Disadvantages of fixed budgets in controlFixed budgets are based on estimated cost per unit and estimated activity level. Therefore, when actual is compared with fixed budgets, we can’t find anything other than knowing the differences with actual result, it will not show the price or activity variances.

Identify situations where fixed or flexible budgetary control would be appropriateFixed budgets are generally used for planning and define the broad objectives of the organization. It is a starting point for the on-going budgeting process.Flexible budgets can be drawn up to show the effect of the actual volumes of output and sales differing from budgeted volumes at the planning stage. At the end of a period, actual results can be compared to flexed budget as a control procedure.

Flex a budget to a given level of volume and prepare formulae appropriate for flexing a budgetTake budgeted cost per unit (original budgeted cost/budgeted volume) x actual volume to get flexed value. Fixed costs will remain the same. Semi-variable costs need to be split into their fixed and variable components using high-low method.

Prepare flexed budgets at various output levels and estimate profit at various output levelsEg. Budgeted revenue is $1500000 and budgeted sales are 50000 units. Actual units sold were 37500 units and actual revenue is $1075000, find the flexed revenue budget.Solution: flexed revenue= (1500000/50000) x 37500= $1125000, actual is $50000 less than flexed, therefore it is an adverse variances because actual revenue is lower.

Calculate sales price and sales margin volume variancesCover later in Chapter 10: Standard Costing.

Explain the meaning of budget variancesA variance is the difference between actual result and an expected result. Price variances simply mean the differences of budgeted price and actual price. Activity/Production volume variances mean differences of budgeted activity level and actual activity level.

Analyse the potential causes of budget variancesPotential causes of budget variances may be due to incorrect records of actual costs, random events, poor budgeting, machines breakdown and so on.

Prepare control reports suitable for presentation to management and discuss the relative significance of variancesReport will have to be understandable to the person who read it, it should be prepared based on the format covered in chapter 6 and in the analysis part, discuss the significance of variances, telling the management whether the variances are important or not, a big variances will be significant.

Potential actions to eliminate variances and advantages and disadvantages of particular actionsThese actions may be done by management to get desired performance so it might include manipulation. But the disadvantages are much exceeds advantages, they cannot understand the problems and control is not taken which will cause long-term problems.

Discuss the use of spreadsheets in flexing budgets and prepare spreadsheet formulae for budget flexingSpreadsheet is useful as it can manipulate the activity level of fixed budget very quickly and make it flexed. The thing that needs to be changed could be just one cell in the spreadsheet formulae which already exists.

Define the concept of responsibility accountingResponsibility accounting is a system of accounting that separates revenue and costs into areas of personal responsibility in order to monitor and assess the performance of each part of an organisation.

Explain its significance in controlWe are able to know about the performance of each responsibility centre and therefore be able to control each centre more effectively.

Evaluate the responsibility of managers in a given situationManager of cost centre will be responsible to costs only, manager of revenue centre will be responsible to revenue only, manager of profit centre will be responsible to revenue and cost, manager of investment centre will be responsible to return on investment.

Explain the problem of joint responsibilityIn joint responsibility, manager’s responsibility increases and this may cause de-motivation as there is pressure in following the responsibility.

Design reports appropriate to a given responsibility structureAgain the report should follow the format covered in chapter 6.

Identify costs to be collected for a given responsibility structureFor example, production department’s costs would be overtime pay.

Explain the concepts of controllable and uncontrollable costsControllable cost is a cost that can be controlled, typically by a cost, profit or investment centre manager. A cost which is not controllable by a junior manager might be controllable by a senior manager. A cost which is not controllable by a manager in one department may be controllable by a manager in another department.

Distinguish between controllable and uncontrollable costs in a given situationNon-controllable costs could be increases in expenditure items due to inflation. Some costs are controllable but only in long term (eg production costs may be reduced if new machinery is purchased).

Define cost centres, revenue centres, profit centres and investment centresCost centre is a collection place for certain costs before they are analysed further.Revenue centre is similar to cost and profit centre but accountable for revenues only.Profit centre is any unit of an organisation to which both revenues and costs are assigned.Investment centre is a profit centre which particularly deals with investment returns.

Discuss performance measures appropriate to each type of responsibility centreCost centre – variances analysis, efficiency measuresRevenue centre- comparison of budget with actual revenueProfit centre- profitInvestment centre- return of capital employed (ROCE) and residual income

Calculate controllable profit, traceable profit, return on investment and residual income in a specific situationROCE=profit before interest and tax/capital employed Residual income=profit before tax – notional interest charged on investment

Distinguish between managerial performance and business unit performanceManagerial performance will be the performance of the manager. Business unit performance is the performance of one department and it is actually depended on manager’s performance.

Define motivationMotivation is what makes people behave in the way that they do.

The importance of motivation in performance managementIndividuals will be motivated by personal desires and interests. These may be in line with organisation’s objective and that’s why motivation improves the performance.

Identify factors in a budgetary planning and control system that influence motivationFactors include the level at which budgets and performance targets are set, manager and employee reward systems and the extent to which employees participate in the budget setting process.

The impact of targets upon motivationIf a budget target is set too easy, then actual performance will be a little better than the budget but it will not be optimised. If a budget is set too difficult, managers become discouraged as it is unattainable standard and may be de-motivated.

Evaluate managerial incentive schemesA good incentive schemes is fair, motivational, understandable, consistently applied and objective (not bias).

Discuss the advantages and disadvantages of a participative approach to budgetingParticipative budgeting is a budgeting system which all budget holders have chance to participate in setting their own budgets.Advantage:(i)More realistic budgets(ii)Motivation improved(iii)Knowledge is pulled togetherDisadvantage:(i)Consume more time(ii)Does not suit some employees(iii)Managers may set easy budgets to ensure that they are achievable

Explain top down, bottom up, and budget challenging approaches to budgetingTop down budgeting is an imposed style of budgeting, only top management will prepare budget. Bottom up budgeting is participative approach to budgeting.Budget challenging/Negotiated budget is a budget which are set largely on the basis of negotiations between budget holders and their superiors.

Define goal congruence and dysfunctional decision makingGoal congruence is the state which leads individuals or groups to take actions that are in their self-interest and also the best interest of the organisation.Dysfunctional decision making is a situation where managers take decisions that promote their self-interest but not organisation’s interest.

The importance of goal congruent behaviourWith goal congruent behaviour, organisation can continue to grow and sustain.

Discuss causes of dysfunctional decision-makingFormal reward and performance evaluation systems can cause this problem.

Identify dysfunctional behaviour in a specific situationIt can be identified in a situation where manager/employee obtained his goal but organisation is not improving.

Amend budgeting procedures to encourage goal congruent behaviourA well-designed control system which encourage continuous feedback and have good performance evaluation system can ensure goal congruence.

Describe ideal, attainable, current and basic standardsIdeal standard is based on perfect operating conditions.Attainable standard is based on the hope that a standard amount of work will be carried out efficiently, some allowance made for wastage and inefficiencies.Current standard is based on current working conditions.Basic standard is kept unchanged over a long period of time, may be out of date.

Chapter 10: Standard costing

Explain the operation of a standard costing systemStandard costing is a control technique which compares standard costs (planned unit costs) and revenues with actual results to obtain variances which are used to stimulate improved performance. At the very beginning, it will involve setting the standards for material price and usage, labour rate and efficiency, overheads and selling price and margin. It can be used in many situations such as to value inventory and cost production and to act as a control device using variance analysis.

Discuss the advantages of standard costing and variance analysis, evaluate the appropriateness of standard costing in a specific situation and discuss the value of standard costing in a modern manufacturing and service environmentThe greatest benefit from its use can be gained if there is a degree of repetition in the production process. It is therefore most suited to mass production and repetitive assembly work. However, a standard cost can be calculated per task if there is a similarity of tasks. In this way standard costing can be used by some service organizations. Setting standards for cost control involves dealing with people. A standard costing system will only be effective if it is designed with full understanding of its potential behavioural effects.

Define standard absorption and standard marginal costingStandard absorption costing is a system of cost ascertainment and control which is based on full production cost whereas standard marginal costing is based on marginal production cost.

Discuss the advantages and limitations of standard marginal and standard absorption costingStandard marginal costing is helpful in decision making but not pricing. Standard absorption costing is helpful in pricing but not decision making.

Prepare standard cost cards (product specification) for standard marginal and standard absorption costing

Standard cost card (MC)Direct materialsDirect labourVariable production overheads=Standard marginal cost of production

Standard cost card (AC)Direct materialsDirect labourVariable production overheadsFixed production overheads=Standard full cost of production

Calculate material price and usage variances (price variances to be based upon usage or purchases)Material price variances – standard cost (cost per kg x actual material used) compare with actual cost (similar to flexed budget compare with actual).Material usage variances – standard usage compare with actual usage (in kg), if in $, multiply another standard cost per kg.Material cost variance = material price variance + material usage variance

Calculate labour rate and efficiency variancesLabour rate variances – standard cost compare with actual cost.Labour efficiency variances – standard hours compare with actual hours (in hour), if in $, multiply another standard cost per hour.Labour total variance = labour rate variance + labour efficiency variance

Calculate fixed overhead expenditure, volume, capacity and efficiency variancesFixed overhead expenditure variances – budgeted fixed overhead expenditure compare with actual fixed overhead expenditure.Fixed overhead volume variance – budgeted cost compare with standard cost.Fixed overhead capacity variances – budgeted hours compare with actual hours (in hours), if in $, multiply another standard cost per hour.Fixed overhead efficiency variances – standard hours compare with actual hours (in hour), if in $, multiply another standard cost per hour.Fixed overhead total variance – fixed overhead absorbed compare with actual fixed overhead incurred.

Calculate variable overhead expenditure and efficiency variancesVariable overhead expenditure variances – standard cost compare with actual costs.Variable overhead efficiency variances – standard hour compare with actual hour (in hour), if in $, multiply another standard cost per hour.

Calculate sales margin volume and sales price variancesSales margin volume variances/Sales volume profit variance – standard sales profits compare with budgeted sales profits. Sales price variances – standard revenue compare with actual sales revenue.

My tips on variances calculationIt may seem like there are a lot of formula to memorize, but no. I would say there are only a few things to remember and you will be success in these areas. Standard cost means budgeted cost per unit x actual unit. Whenever you see price variance, think of flexed (standard price per unit x actual units) compare with actual price. When you see capacity variance, it is about budgeted hour compare with actual hour. When you see efficiency variance, it is about standard hour (budgeted hour per unit x actual units) compare with actual hour. When you see volume variance, it is about standard cost compares with budgeted cost. Understand rather than memorize, make it common sense.

Undertake entries in a standard cost bookkeeping situationAdverse variances are debited in the relevant variance account; favourable variances are credited in the relevant variance account.

Prepare a reconciliation of standard to actual cost for an absorption costing systemIn AC system, cost reconciliation statement reconciles the standard full cost of production in a period with the actual costs.

Cost reconciliation statement (AC)$

Standard full costs of production (units produced x standard full cost/unit)Cost variances F ($) A ($)Direct material priceDirect material usageDirect labour rate etc

Less total cost variances=Actual total cost

Prepare a reconciliation of standard to actual cost for a marginal costing systemSimilar to AC, except that the statement reconciles standard variable costs to actual variable costs. The cost variances will only include variable cost variances. If needed to show actual total cost, less another actual fixed overhead (budgeted fixed overhead compare with fixed overhead expenditure variance).

Prepare a reconciliation of budgeted to actual profit for an absorption costing systemSimilar to cost reconciliation statement, except that they also include sales price and sales margin volume variances. If in marginal costing profit reconciliation statement, it will includes fixed overhead expenditure variance after the actual variable cost.

Standard costing operating statement (AC)$

Budgeted profitSales variances – price -volumeStandard profit from actual salesCost variances F ($) A ($)Direct material price Direct material usageDirect labour rate etc

Less total cost variances=Actual profit

Prepare a reconciliation of budgeted to actual profit for a marginal costing systemSimilar to AC, but it will start from budgeted contribution and after adjusting with sales variances, you will get standard contribution from actual sales. After adjusting standard contribution with variable cost variances, you will get actual contribution, then less the actual fixed cost (budgeted fixed overhead compare with fixed overhead expenditure variance) to get actual profit.

Prepare control reports suitable for presentation to managementReports to an individual manager should only include figures relating to his own area of responsibility. Top management is likely to be concerned only with significant variance, a form of exception reporting can be used, only specifying significant variances. The reports should be presented according to the format in chapter 6.

Subdivide variances to reflect responsibility structuresBefore we prepare the variance report, we need to consider the responsibility of the manager and subdivide variances and include only relevant variances figure. For example, purchasing manager is responsible for material price variance, so material price variance should be sent to purchasing manager.

Calculate idle time variancesIdle time variance = standard cost per hour x idle hours (always adverse)

Analyse variances into controllable and non-controllable elementsFor example, material price variance is non-controllable for production manager but is controllable for purchasing manager.

Discuss the causes of variances in generalIn general, it includes poor budgeting, incorrect record of actual costs, random events, unrealistic standards and inefficient operation.

Identify potential causes of variances in a specific situation Variances Possible causesFavourable material price – unforeseen discounts, material standard changedAdverse material price – price increase, careless purchasingFavourable material usage – higher quality material, effective use of materialAdverse material usage – defective material, excessive wastageFavourable labour rate – lower rate paid, overtime/bonus different from planAdverse labour rate – wage rate increases, unexpected pay awardFavourable labour efficiency – motivated staff, change in working proceduresAdverse labour efficiency – lack of training, unexpected idle timeFavourable variable and fixed overhead – cost savings, favourable labour efficiencyAdverse variable and fixed overhead – excessive use, adverse labour efficiencyFavourable sales price – price increases due to improved qualityAdverse sales price – price cuts to increase salesFavourable sales volume – price cuttingAdverse sales volume – poor product qualityIdle time (always adverse) – machine breakdown, illness/injury

Explain the potential interrelationships between variancesAn adverse variance might be offset by a favourable variance, for example cutting of selling price (adverse sales price variance) for increase sales (favourable sales volume variance) or favourable material price from buying lower grade material might cause adverse material usage due to more wastage.

Discuss the meaning and significance of variancesFor example, favourable sales price variance means price of sales was higher than expected and this variances help management to understand that sales manager is doing a good job.

Explain the significance of cost of investigation, cost of correction, benefit of correction, and probability of successful correction in variance investigationIf the cost of correcting the problem is likely to be higher than the benefit, then there is little point in investigating further. If a cost or revenue is outside the manager’s control then there is little point in investigating its cause.

Calculate the expected benefit of variance investigationTake expected benefit of correction less cost of correction, if it is positive, we can investigate the variance.

Discuss the role of control charts in variance investigationControl charts provide a visual representation of the variation of actual costs around standard. Management can set control limits in the control charts and only variances outside these limits will be reported. Control charts also give clear picture of trends in variances.

Explain potential courses of action to correct a variance and evaluate courses of action to correct a variance in specific circumstancesThe exact nature of the control actions taken will depend on the cause of the variance and the most suitable actions for dealing with them. For example, a significant adverse material price variance would be dealt by looking for cheaper price or take advantage of bulk purchase discount.

TipsStandard costing has 4 parts, calculation of variances, cost and profit reconciliation, causes of variances and control of variances. The one that need to be emphasized on is the calculation of variances as you can see there are different types of variances to calculate, but it is not difficult once you know the pattern of it, try some past year questions on it. For cost and profit reconciliation, it is straightforward, you just need to calculate or sometime given and put into the format. For causes of variances, it is common sense, don’t try to memorize anything, write in your own words about why this variance is favourable or adverse. For control, you do not need to do much thing but to understand when to control by taking into account of the cost, you may also see from the control chart whether it has reached control limit or not.

Chapter 11: Performance measurement

D iscuss the purpose of mission statements and their role in performance measurement The mission statement shows the vision of top management, what they are trying to achieve, and how they wish to achieve it. It is an important part of the process of controlling the whole organisation.

Discuss the purpose of strategic and operational and tactical objectives and their role in performance measurementStrategic objectives are senior management responsibility and measured by indicators that reflect the overall organizational performance.Operational objectives are middle management responsibility and measures are used to summarize departmental or divisional performance.Tactical objectives are concerned with day-to-day organizational running and are often physically measured.

D iscuss the impact of economic, market conditions and government regulation on performance measurementExternal factors may be an important influence on an organisation’s ability to achieve objectives. Market conditions and government policy will be outside of the control of organisation’s management and will need to be carefully monitored to ensure forecasts remain accurate.

Discuss and calculate measures of financial performance – profitability, liquidity and gearingProfitability ratio (measuring ability to generate profit)Profit margin=profit before interest and tax (PBIT)/sales x 100%Gross profit margin=gross profit/sales x 100%Asset turnover=Sales/capital employedReturn on capital employed/Return on Investment=PBIT/capital employed x 100%Operating margin=various expenses/sales x 100%Liquidity ratio (measuring the company’s ability to pay liability, liquidity position)Current ratio=current assets/current liabilitiesQuick (or acid test) ratio= (current assets – inventory)/current liabilitiesInventory period=average inventory/cost of sales x 365daysReceivables period=average receivables/credit sales x 365daysPayables period=average payables/credit purchases x 365daysGearing ratio (measuring risks)Gearing ratio=non-current liabilities/capital employedInterest cover=PBIT/interest payable

Discuss the importance of non-financial performance measuresNon-financial performance measures can be seen as drivers of profit. They can encourage managers to take a long-term view rather than focus on short-term financial targets. They are also leading indicators of financial performance.

Discuss the relationship between short-term and long-term performanceEffort to reduce costs in order to generate higher profit in short-term may affect the long-term profitability. For example, cutting the training cost can earn more profit in short-term, but staff may leave or become less efficient in long-term.

Discuss the measurement of performance in service industry situationsService industries do not produce a physical product, they provide services. The performance measures could be resource utilisation measures, quantitative and qualitative measures.

Discuss the measurement of performance in non-profit seeking and public sector organisationsThey lack of profit measure and competitors, they also have multiple objectives and it is difficult to define the objectives. The measurement could be judgement in terms of inputs, judgement by experts, comparisons and judgement in terms of ‘value for money’ (discuss later).

Discuss measures that may be used to assess managerial performance and the practical problems involvedMeasures which reflect the performance of the units that manager managed may not reflect the performance of the manager. Some possible management performance measures include judgement of outsiders, upward appraisal and accounting measures.

Discuss the role of benchmarking in performance measurementThrough benchmarking, organisations can learn about their own business practices and the best practice of others.

Produce reports highlighting key areas for management attention and recommendations for improveCalculations of performance measures are best presented in an appendix at the end of the report. Remember to follow the format of report as in chapter 6.

Discuss the advantages and limitations of the balanced scorecardBalance scorecard is a device for planning that enables managers to set a range of targets linked with appropriate objectives and performance measures. The framework looks at the strategy and performance of organisation from four points of view, known in the model as four perspectives: financial (focus on satisfying shareholder value), customer (measure customer satisfaction), process efficiency (measure organisation’s output in terms of technical excellence and consumer needs) and growth (focus on the need for continual improvement of existing products).Advantage:(i)Managers are unlikely to be able to distort the performance measure.(ii)Bad performance is more difficult to hide.(iii)It looks at performance from four perspectives, not just from the narrow view of the shareholders as traditional analysis would.Disadvantage:(i)It can involve large number of calculations which may make performance measurement time-consuming and costly to operate.(ii)The selection of performance indicators under each of the four perspectives is subjective.

Describe performance indicators for financial success, customer satisfaction, process efficiency and growthFinancial – Return on capital employed (ROCE), sales marginCustomer – Customer loyalty, delivery speed, customers support cost as % of salesProcess efficiency/internal business processes – Total quality measurement, unit costs, training cost as % of total production costLearning and growth – sales of new product as % of total sales

Discuss critical success factors and key performance indicators and their link to objectives and mission statements and establish critical success factors and key performance indicators in a specific situationCritical success factors (CSFs) are the factors which contribute to success of business.Key performance indicators are indicators which are used to indicate CSFs. If the organisation fails to perform well on a range of non-financial CSFs, it is unlikely to be performing satisfactorily in financial terms. Some examples are as follow: CSFs KPICompetitiveness – sales growth by product or service, relative market share positionCustomer satisfaction – speed of response to customer needsInnovation – % of new products and services to old ones Quality of output – returns from customers, reject rates, reworking costsFlexibility – product/service introduction flexibility, delivery flexibility

Explain the concepts of economy, efficiency and effectivenessValue for money (VFM) concept has been developed as a useful means of assessing financial performance in an organisation which is not seeking profit. VFM concept revolves around 3E: Economy measures the relationship between money spent and the inputs.Efficiency is the usual relationship between inputs and outputs. Effectiveness looks at outputs compare with objectives of the organisation.Ultimately VFM relates money spent to objectives achieved.

Describe performance indicators for economy, efficiency and effectivenessEconomy – use budgets and variancesEfficiency – difficult to measure because output can seldom be measured accuratelyEffectiveness – measured by comparison of outputs with targets

Establish performance indicators for economy, efficiency and effectiveness in a specific situationFor example, hospital:Economy – money spent for different types of doctors (input)Efficiency – patients’ satisfaction (output) with the doctors (input)Effectiveness – Customer satisfaction (target) will be compared with patients’ satisfaction (output)

Discuss the meaning of each of the efficiency, capacity and activity ratiosThese are related to measuring performance using standard hour.Efficiency ratio is related to speed.Capacity ratio is related to ability.Activity ratio is related to volume.

Calculate the efficiency, capacity and activity ratios in a specific situationEfficiency ratio=standard hour/actual hour x 100%Capacity ratio=actual hour/budgeted hour x 100%Activity/volume ratio=standard hour/budgeted hour x 100%Note that the above is a bit related to variance calculation that I had noted in the tips (chapter 10), now you can see why efficiency variance is standard hour compare with actual hour and so on.

Describe performance measures which would be suitable in job, batch, contract and process costing environmentsJob costing – cost per printed page, ratio of chargeable time to total timeBatch costing – quantity of material loss, level of inventories heldContract costing – levels of idle time, material wastage rate, inventory levelsProcess costing – levels of abnormal loss, production time

Describe measures of performance utilisation in service and manufacturing environments and establish measures of resource utilisation in a specific situationMeasures of performance utilisation in manufacturing environments include wastage rate, rate and efficiency variance of labour and machine hours.For service industries, 3E is useful and also the service quality.

Calculate return on investment and residual incomeReturn on investment (ROI)/ROCE=PBIT/capital employed x 100%, capital employed=equity + non-current liabilitiesResidual income (RI) =Profit before tax – notional interest charged on investment

Advantages and limitations of return on investment and residual incomeAdvantage:(i)Major measure of efficiency of profit-making organisations(ii)ROI is a relative measure so can compare centresLimitation:(i)RI uses an estimated cost of capital(ii)Increase as assets get older(iii)RI is an absolute measure so can’t compare centres(iv)Depreciation rates and inventory valuation policy affect ROI

Distinguish performance measurement issues in service and manufacturing industries, describe performance measures appropriate for service industries and establish performance measures for a service business in a specific situationMost are discussed above, just refer back. Because it is difficult to trace many common costs to different units of output and because of high level of stepped fixed costs, detailed financial ratio analysis is of limited use for service industries.

Discuss the importance of quality in organisations and establish measures of quality in a specific situationOne feature of modern business environment is the switch in emphasis from quantity to quality. The measures of quality can include staff efficiency, equipment faults, customer’s complaint and so on.

Chapter 12: Pricing and demand

Describe the factors which may influence an organisation’s pricing policyThe 4Cs as the main factors to consider in pricing:Cost – primary factor which accountants will consider.Customers – the higher the price, the smaller the quantity demanded by customers.Company – when launching new product, company may adopt market skimming approach (charge high prices when product launched) or market penetration approach (low prices when product launched) to pricing.Competition – if a monopoly (one seller who dominates many buyers), it may be able to use the lack of competition to charge higher prices. If on the other hand, the company is facing perfect competition (many buyers and sellers, one product), these competitive measures may mean the company has to charge a lower price.Other factors include suppliers, inflation, quality, incomes and product life cycle.

Prepare and justify cost based approaches to pricing using absorption costing, marginal costing and opportunity costing approachesWhen using AC based pricing (full cost plus pricing), a share of fixed cost is added to arrive at a full production cost then a mark-up is added. When using MC based pricing (marginal cost plus pricing), prices are set using variable costing by determining the target contribution per unit. Opportunity cost (benefit foregone) based pricing is based on the opportunity costs of the resources consumed added to full cost and then mark-up. ABC based pricing uses a full cost based on ABC rather than AC and mark-up. The method to calculate cost is covered in earlier chapter, you will just need to add a mark-up or margin on the cost and you can get the price.

Discuss the merits and limitations of cost based approaches to pricingMerit:(i)Simple system, using available internal data(ii)Once cost plus policy is set, it can be delegated(iii)Price increases can be justified in terms of cost increaseLimitation:(i)Ignores customer and the market demand influences on prices(ii)Ignore competitive state of the market

Describe the procedure for preparing cost estimates for fixed price quotations and tendersUnder market uncertainty it is sometimes possible to reverse the normal process of offering goods for sale. The goods may instead be advertised as being for sale and interested buyers are asked to tender (make an offer and indicate the price they are willing to pay). An open auction is a market where those wishing to tender are brought together so that they can do so in open competition with each other. At the other extreme to the open auction, a buyer may ask for sealed bids in which tenders are invited but kept secret (not disclosed to seller) until a particular day and time when they are opened and decisions made as to which tender is to be accepted. The process may be administered by a trusted third party.Alternatively, the price may be quoted (offered) by the sellers themselves. This will involve cost analysis for relevant cost then mark-up or margin to get a minimum price. This minimum price will then be quoted to the buyers.

Chapter 13: Cost management

Explain in general terms the costs of quality (prevention, appraisal, internal failure and external failure)Total quality management (TQM) is the process of applying a zero defect philosophy to the management of all resources and relationships within the firm as a means of developing and sustaining a culture of continuous improvement which focuses on meeting customers’ expectations. Two basic principles of TQM are getting things right first time and continuous improvement. Quality management becomes TQM when it is applied to everything a business does.Prevention costs – costs of any action taken to investigate, prevent or reduce defects and failures.Appraisal costs – costs of monitoring and inspecting products in terms of specified standards before products are released.Internal failure costs – costs arising within the organisation of failing to achieve the required level of quality.External failure costs – costs arising outside the organisation (after product is delivered to customer) of failing to achieve the required level of quality.

Establish measures of the cost of quality in specific situationsMeasures that might be used to control and improve quality of performance include:(i)Quality assurance (supplier guarantees quality)(ii)Inspection of output (iii)Monitoring customer reaction (involves monitoring complaints in the form of letters, returned goods, requests for servicing and so on)

Calculation of the costs and benefits of quality initiativesYou might just need to know the theory in TQM, but here I discuss some of the issues about costs and benefits of controlling quality. If the prevention and appraisal costs are not sufficiently incurred, there may be failure costs which will cause the company to incurred replacement cost, new marketing cost and so on. Therefore, arriving a good quality product will bring benefits to the organisation.

Compare cost control and cost reductionCost control is concerned with regulating the costs of operating a business and keeping costs within acceptable limits. Cost control techniques include budgeting, standard costing and responsibility accounting.Cost reduction is a planned and positive approach to reducing expenditure.Cost control aims to reduce costs to budget or standard level, cost reduction aims to reduce costs to below budget or standard level.

Describe and evaluate cost reduction methodsReducing material costs – eg. reduce costs of wastage, obtain lower prices for purchases, improve stores control and use alternative materials.Standardisation of product – a range of products may be basically standardised but with minor differences between models.Other techniques include value analysis, work study and Organisation and methods (O&M). The real aim of work study and O&M is to decide the most efficient methods of getting work done. More efficient methods and tighter standards will improve efficiency and productivity, and so reduce costs.

Describe and evaluate value analysisValue analysis is a planned, scientific approach to cost reduction, which reviews the material composition of a product and the product’s design so that improvements can be made which do not reduce the value of the product to the customer. The aim is to get rid of all unnecessary costs (costs that do not add value). Benefit:(i)Many customers will be impressed by the interest shown in their requirements and this will lead to increased sales.(ii)Firms which adopt this approach are likely to attract better staff(iii)Economic and financial benefits arising from the elimination of unnecessary complexity and the better use of resources.

Describe life cycle costingLife cycle costing is the accumulation of costs over a product’s entire life. (4 stages described in chapter 7)

Discuss the benefits of life cycle costing in a specific situation The manager is able to have full understanding of individual product profitability, able to get more accurate feedback information and more opportunities for cost reduction.

Describe target costingTarget costing involves setting a target cost by deducting a desired profit margin from a competitive market price. (Target price – desired profit margin = target cost)

Discuss the link between target costing and pricingTarget costing is a top down approach where it starts with a target price and derives a cost from that price. The essential idea behind target costing is that where the price of a product is determined by the market place, costs have to be reduced (target cost) to enable the product to be sold at that price. Value analysis and value engineering is used to help business achieve that target cost.

Discuss the role of value engineering in target costingValue engineering attempts to design the best possible value at the lowest possible cost into a new product which can then be used in a target costing system. Various techniques for value engineering can be employed such as using standard components wherever possible, training staff in more efficient techniques, acquiring more efficient technology, using cheaper staff, cutting out non-value-added activities and so on.

ConclusionThe syllabus of T7 is quite big with full of technical terms, learn them as you will see them again in further performance management papers. I confirm that this note had covered the full syllabus of T7, but you may not understand all the notes without reading some from textbook. I wish you good luck in T7 success.