Download MANCOSA Cost and Management Accounting lecture notes and more Lecture notes Cost Management in PDF only on Docsity! BACHELOR OF COMMERCE IN ACCOUNTING COST AND MANAGEMENT ACCOUNTING (MANAGEMENT ACCOUNTING & FINANCE 2A) THE SCOPE OF THE MANAGEMENT ACCOUNTING & FINANCE 2A MODULE BUDGETS & BUDGETARY CONTROL RELEVANT COSTS FOR SHORT-TERM DECISION-MAKING ACTIVITY-BASED COSTING JOINT AND BY-PRODUCT COSTING PROCESS COSTING JOB COSTING COST-VOLUME-PROFIT ANALYSIS COST ELEMENTS: OVERHEAD COST ELEMENTS: LABOUR COST ELEMENTS: MATERIAL/INVENTORY THE CONTEXT OF COSTING COST TERMINOLOGIES & COST CLASSIFICATION The MAF2A module comprises 12 learning units RECOMMENDATIONS ON LEARNING MAF 2A MODULE: Accounting is a professional field; thus, you are REQUIRED to read a lot on your own !! The Notional learning Hour Table in the MG shows that only 20% of your learning time will take placed in a facilitator-student session. That means 80% of the learning is on your OWN. The MAF2A module should be studied using the recommended and prescribed textbooks and the relevant sections of this Module Guide. You must first read the appropriate section of Module Guide before you start reading the textbooks in detail. Ensure that you make your own notes as you work through both the textbooks and the module guide. For example, when studying CVP analysis, make your own note by drawing from the MG, Webinar presentations, prescribed textbook and recommended reading on CVP. Include all examples demonstrated during the webinars. Work through the PowerPoint presentations and Practical examples on MS WORD !!!g. PRESCRIBED LITERATURE Els, G., de Wet, S.R. and van der Walt, R. (2017). Fundamentals of Cost and Management Accounting. Eighth Edition. Durban: LexisNexis. Boyce, L., Evangelou, O., Govender, B., Koortzen, P.J. and Shaku, M.D. (2017) Cost and Management Accounting. Third Edition. Pretoria: Van Schaik Publishers. de Wet, S.R. (2022). Fundamentals of Cost and Management Accounting. 9th Edition. Durban: LexisNexis. Cloete, M. and Marimuthu, F. (2021). Basic Accounting for Non-accountants. 4th edition. Pretoria: Van Schaik Publishers. Van Rensburg, M. (Ed.) (2022) Cost and Management Accounting. 4th Edition. Pretoria: Van Schaik Publishers. Drury, C. (2020). Management & Cost Accounting. 11th Edition. Hampshire: Cengage. UNIT 1:
THE CONTEXT OF COSTING
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INTRODUCTION This module marries Management Accounting and Finance. According to Kolitz, Thindisa and Kolitz (2018:9), accounting is the systemic process of (1) identifying, (2) measuring, (3) recording (classifying) and (4) communicating financial or economic information about an entity to permit informed judgements and decisions by users of that information. CIMA defines MANAGEMENT ACCOUNTING as: “The application of the principles of accounting and financial management to create, protect, preserve and increase value for the stakeholders of enterprises in the public and private sectors” INTRODUCTION Finance is generally defined as the art and science of managing money. FINANCE focuses on how corporations, governments, and individuals raise funds and allocate resources over time, under conditions of risk and uncertainty. Financial markets and financial asset prices play a critical role in determining optimal funding and resource allocation decisions. According to Skae et al. (2017: 1), FINANCIAL MANAGEMENT as a discipline seeks to optimise the financial resources of, and returns to, an entity. This is generally accomplished by optimising two primary activities, namely: (1) financing activities, by deciding which sources of funding (debt or equity?) should be used by the entity and what the optimal proportion is for the various sources used, and (2) investing activities, by deciding which investments should be undertaken within the limitations of available funds and the identified feasible and viable investment projects. Optimising financing & investing activities increases firm value & shareholders‟ wealth is optimised over the long-term. COST ACCOUNTING Cost accounting is defined as „…the process of compiling and aggregating the costs of producing certain products, providing certain services or undertaking certain activities’ (Els et al., 2017:5). Cost accounting relates to the following: the techniques and systems that are used to establish the cost of a product, service or a process. accounting for costs classification and analysis of expenditure as will enable the total cost of any particular unit of production to be ascertained with reasonable degree of accuracy and also disclose how such total cost is constituted. A quantitative method that collects, classifies, summarises and interprets information for product costing, operation planning and control and decision-making. USER OF ACCOUNTING INFORMATION Accounting thought and practice can be classified according to the user group to whom it is directed. Internal users of accounting information work for the organization and are responsible for planning, organizing, and operating the entity. The area of accounting known as management accounting is concerned with providing useful information related to the deployment of resources and the exploitation of opportunities for management. It serves the decision-making needs of internal users. External users do not work for the organisation and include investors, creditors, labour unions, customers, & Government agencies: SARS. The CF defines primary users as an entity‟s potential and existing investors, lenders and other creditors. The area of accounting known as financial accounting is concerned with providing useful information about business entities for primary users. It serves the decision- making needs of external users. FIN ACCOUNTING & MANAGEMENT ACCOUNTING Accounting systems are often described as either: Financial accounting systems (where periodic financial statements are provided to external decision-makers, such as investors, creditors and customers). It is primarily concerned with the preparation of financial statements of an entity for use by creditors, investors and other users outside the entity. E.g., preparation of a firm‟s SOFP. Management accounting systems (including information for planning and performance reports to managers throughout the organisation; that is, internal decision- makers). It is primarily concerned with the generation of economic, financial and non-financial information, & using such information by managers to plan and control many activities of the entity and to support the management decision-making process within an entity. FINANCIAL ACCOUNTING vs MANAGEMENT ACCOUNTING Characteristics Management Accounting Financial Accounting User groups Internal user (i.e. Managers) External users: (owners; Lenders; Creditors; Investors. Nature of Reports Specific, usually with some decisions in mind. General-purpose useful for wide range of purposes. Legal Requirements Not required by law since it is for internal use only. Required by law and are also regulated in terms of content, procedure and format. GAAP Not subject to the practices and principles of GAAP. Must conform to the practices and principles of GAAP. Time Focus Future orientation while providing information on past performance. Historical orientation (i.e. financial results and position of the past period). Degree of precision of Information(data used) May be less objective and not necessarily accurate or verifiable. Relevance counts more than reliability. Objective, verifiable information is used to prepare reports. Reliability is of utmost importance. Frequency of reporting None imposed; as often as required by managers (daily, weekly, monthly basis). Annually. Some entities prepare quarterly/semi- annual reports. Breadth of Focus or concern Focuses on units/divisions of the organisation as well as whole Focuses on the performance of the business as a whole. COST ACCOUNTING SYSTEMS o A cost accounting system refers to well-established techniques and procedures that are used to capture and report the costs generated by a product or an activity. This is made possible by five main activities: Cost determination: this is the process of collecting data to establish the cost of a product o Cost recording: this entails making use of the entity‟s accounting system to capture relevant costs o Cost analysis: in order for information to serve any kind of purpose, it must be thoroughly analysed by persons who are knowledgeable in the field o Cost management: with the assistance of cost analysis the cost accountant can then take part in strategic decisions regarding how resources will be allocated in order to control costs o Cost reporting: this is the process of making relevant costing information that has been analysed available to decision-makers to enable them make optimal decisions for the entity nig
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ETHICS IN ACCOUNTING Every professional body has ethical code of conduct that its members must live by. “A distinguishing mark of the accountancy profession is its acceptance of responsibility to act in the public interest” (Section 100.1of the SAICA CoPC). The Institute of Management Accountants (IMA) has developed standards that management accountants are expected to uphold when faced with ethical challenges. IMA‟s Statement of Ethical Professional Practice, effective July 1, 2017, requires management accountants to do the following: Maintain their professional competence. Preserve the confidentiality of the information they handle. Act with integrity and credibility. L) DEVELOPING ETHICAL REASONING DECISION-MAKING ACUMEN
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ETHICAL CONDUCT FOR ACCOUNTING PRACTITIONERS The Association of Accountants and Financial Professionals in Business has a very detailed code of conduct for registered members: Professional competence: members must continually enhance their skill and knowledge in order to be able to operate at a competent level and they must act in compliance with existing laws and standards Confidentiality: members ought not disclose confidential information pertaining to clients unless obligated to do so by law, or permission has been granted by the client. Integrity: members have a duty to be straightforward and honest in all dealings. Conflicts of interest must be avoided, and it is the member‟s responsibility to avoid engaging in activities that may bring the professional body into disrepute. Credibility: members must be fair and objective in all dealings, disclose information that is material to users, and point out deficiencies in all available information, transactions or dealings. ETHICAL CONDUCT: CIMA CIMA also has a well-established and publicised code of conduct guides its registered members: Integrity: honesty and straightforwardness in all dealings Objectivity: preventing bias and conflict of interest from clouding professional judgement Professional competence and due care: constantly improving on your knowledge and skill in accordance to developments in the field, legislation and accounting techniques. Confidentiality: Avoiding the disclosure of confidential information without permission. Professional behaviour: all relevant laws and regulations are to be complied with and the member should refrain from engaging in any activity that may bring the institution into disrepute. UNIT 2:
COST TERMINOLOGIES & CLASIFICATION
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Classify costs based on their nature, timing, function, and behaviour Use high-low method to separate overheads into fixed, and variable portions Simple regression analysis to separate overheads into fixed, and variable portions Define the fundamental terms used in cost accounting Scatter graphs to separate overheads into fixed, and variable portions UNIT 2 LEVEL OUTCOMES On successful completion of unit 2 of the module, you should be able to: THE CONCEPT OF COST & BASIC COSTING TERMINOLOGIES The term cost “reflects a monetary measure of the resources sacrificed or forgone to achieve a specific objective, such as acquiring a good or service” (Drury, 2020:26). CIMA defines a cost as „…the amount of expenditure incurred on, or attributable to a specific cost object…’ Essentially, a cost is any amount of money that is spent to acquire an item, to receive a service or to undertake an activity. The term has multiple meanings & different types of cost are used in different situations. Typically, a preceding term is added to clarify a cost measurement. A large terminology has emerged to indicate more clearly different cost meanings. Examples: variable cost, fixed cost, opportunity cost and sunk cost. COST OBJECTS, COST CENTERS & COST UNITS COST: Cost is a measurement, in monetary terms, of the amount of resources used for the purpose of production of goods or rendering services. Cost means the total of all expenses. Cost is also defined as the amount of expenditure (actual or notional) incurred on or attributable to a given thing or to ascertain the cost of a given thing. Thus, it is that which is given or in sacrificed to obtain something. The cost of an article consists of actual ascertained charges incurred in its production and sale. Cost is a generic term, and it is always advisable to qualify the word cost to show exactly what it meant, e.g., prime cost, factory cost, etc. Cost is also different from value as cost is measured in terms of money whereas value in terms of usefulness or utility of an article. COST OBJECTS Cost Object: A technical name for a product/service, a project, a department or any activity to which a cost relates. The cost terms should always be linked to a cost object. A cost object is any activity for which a separate measurement of costs is desired. In other words, if the users of accounting information want to know the cost of something, this something is called a cost object. Examples of cost objects include: o a product, department, sales territory, or activity o rendering a service to a bank customer or hospital patient, o operating a particular department or sales territory, or o indeed anything for which one wants to measure the cost to which resources are devoted. COST TERMINOLOGIES: Sunk costs: These are costs that were incurred in the past and as such, cannot be affected by choosing alternative options for decision-making (Boyce, 2017:14). For example, the depreciation expense of a company‟s fixed assets is not to change because of a decision that the company makes going into the future. This is because depreciation is calculated based on a cost that was incurred when the assets were acquired in the past. Sunk costs tend to be irrelevant costs as well. Opportunity cost: Economists define opportunity costs as the value of the next best alternative sacrificed as a result of a choice made. In cost accounting, opportunity cost refers to the revenue foregone because of a choice made (Boyce et al., 2017:14). Opportunity costs are part of relevant costs. Incremental costs: this is the cost of manufacturing an additional unit of a product, or rendering an additional service (Boyce et al., 2017:14). An incremental cost would form part of relevant costs. COST CLASSIFICATION
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CLASSIFICATION OF COST The basis for cost classification is as follows (7 classes): o Classification by Nature of expense: grouping costs according to natural groups: Material, Labour, and Expenses (expenses are other than material and labour) o Classification by Relation to Cost Centre - Traceability: Whether cost is directly traceable to a cost object or not: Direct, Indirect o Classification by Functions or Activities: grouping costs according to activities or function to which the costs relates: Manufacturing, Selling, Research & Development, Administration, Distribution o Classification by Behaviour: grouping costs according to the behaviour of the costs in relations to level of activity: Fixed, Variable, and Semi-Variable COST CLASSIFICATION Costs can be assigned to cost objects in 2 ways (Boyce et al., 2017:16): Cost tracing is used when costs have a direct relationship to cost objects, and as such, can be easily traced or linked to these cost objects. Cost allocation is used when costs cannot be directly linked or traced to a cost object. In this case, the costs are considered to have an indirect relationship with the cost object. COST COLLECTION SYSTEM The cost collection system typically accounts for costs in two broad stages: 1. It accumulates costs by classifying them into certain categories such as by type of expense (e.g. direct labour, direct materials and indirect costs) or by cost behaviour (such as fixed and variable costs). 2. It then assigns these costs to cost objects to deal with the issue posed by management. 3. We shall focus on the following cost terms and concepts: ● direct and indirect costs; ● period and product costs; ● cost behaviour in relation to volume of activity; ● relevant and irrelevant costs; ● avoidable and unavoidable costs; ● sunk costs; ● opportunity costs; ● incremental and marginal costs. MANUFACTURING COSTS In a manufacturing company, costs can be classified into three categories. 1. Direct materials (DM) are the cost of raw materials that are converted into the finished product and are easily traced to the product. The cost of such materials are considered direct materials. 2. Direct labor (DL) is the cost of wages and salaries of employees who convert the raw materials into the finished product. Direct labor is also a direct cost that can be easily traced to the finished product. Direct labor would include the wages of the employees who assemble the tablets. 3. Manufacturing overhead (MOH) refers to indirect manufacturing costs that cannot be easily traced to specific products. It includes all manufacturing costs other than direct materials and direct labor. These costs are created by all of the supporting production activities, including storing materials, setting up machines, and cleaning the work areas. Examples include costs of indirect materials, manufacturing factory managers‟ salaries and other indirect labor, repair and maintenance costs, and depreciation on manufacturing buildings and equipment. Other examples include the following costs for the factory: utilities, rent, insurance, and property taxes. Manufacturing overhead is also called factory overhead or indirect manufacturing costs. Let‟s look at two of the components of manufacturing overhead more closely. It is important to be able to distinguish between direct and indirect materials and direct and indirect labor. DIRECT LABOUR COSTS Direct labour costs: Labour costs that can be specifically and exclusively identified with a particular cost object. Physical observation can be used to measure the quantity of labour used to produce a specific product or provide a service. This may involve some work measurement of repeated tasks. The direct labour cost in producing a product = the cost of converting the raw materials into a product, such as the costs of the machine operators engaged in the production process in the manufacture of calculators. The direct labour cost used to provide a service = the labour costs in providing a service that can be specifically identified with an individual client or with a specific instance of service, for example a personal trainer in a gym. The direct labour costs for a departmental store are the labour costs of the staff that can be attributed specifically to a department. OVERHEADS: INDIRECT COSTS Indirect costs cannot be identified specifically and exclusively with a cost object. The term overheads is widely used instead of indirect costs. Overheads comprises: indirect labour, indirect materials and indirect expenses. INDIRECT LABOUR: In a manufacturing org, the wages of all employees whose time cannot be identified with a specific product, represent indirect labour costs. Other examples: the labour cost of staff employed in the maintenance and repair of production equipment and staff employed in the stores department. INDIRECT MATERIALS:The cost of materials used to repair machinery cannot be identified with a specific product and thus is classified as indirect material costs. INDIRECT EXPENSES: Indirect expenses are the cost objectives, include lighting and heating expenses and property taxes. These costs cannot be specifically identified with a particular product, service or department. PERIOD AND PRODUCT COSTS Another way costs can be classified is as product or period costs. For profit measurement and inventory valuation purposes, costs are classified as either product costs or period costs. This characterization is required when preparing financial statements. PRODUCT COSTS: include the costs of purchasing or making a product (i.e., costs that are identified with goods purchased or produced for resale). In a manufacturing org, all manufacturing costs are regarded as product costs. Examples: direct materials, direct labor, and manufacturing overhead. Product costs are recorded as assets in inventory accounts on the balance sheet when they are incurred; At that time, the cost is reported as Cost of Goods Sold on the income statement. On sale, they are recorded as expenses & matched against sales for calculating profit. EXAMPLE OF COST CLASSICIFCATION Cost classification is an important aspect of cost accounting. Classify the following costs incurred by a manufacturing firm (the applicable classes are: direct materials, direct labour, factory overheads or period costs) 1. Wages paid to production workers (= Direct labour) 2. Wages paid to non-production workers (= Period costs) 3. Utilities in the office (= Period costs) 4. Depreciation on machinery (= Factory overheads) 5. Steel (= Direct materials) 6. Accountant‟s salary (= Period costs) 7. Rent on factory building (= Factory overheads) PRIME AND CONVERSION COSTS The purpose of managerial accounting is to provide useful information to managers. To make cost information more useful, manufacturing costs are sometimes combined in different ways, depending on the managers‟ needs. PRIME COSTS Prime cost consists of all direct manufacturing costs. Prime costs combine the direct costs: direct materials and direct labor. In a labor-intensive manufacturing process, the direct costs are the primary costs. In that type of environment, managers may want to concentrate on the prime costs. To be profitable, it is vital for the company to control these costs. PRIME AND CONVERSION COSTS CONVERSION COSTS Conversion costs combine direct labor with manufacturing overhead. These are the costs to convert the direct materials into the finished product. In a manufacturing process that is machine-intensive, the cost of direct labor is minimal because machines do most of the work. Employees primarily set up and oversee the machine production. Overhead costs, however, can be substantial, including the cost of utilities and depreciation on the machinery. In that type of environment, managers may want to focus on the total conversion cost rather than tracking direct labor and manufacturing overhead separately. See an illustration of the relationship between prime costs and conversion costs. Notice that direct labor is considered both a prime cost and a conversion cost. COST CLASSIFICATION Classify the following costs incurred by a step railing manufacturing company as direct materials, direct labour, factory overhead, or period costs: Wages paid to production workers = Direct labour Utilities in the office = Period Depreciation on machinery in plant = Factory overhead Steel = Direct materials Accountant‟s salary = Period Rent on factory building = Factory overhead MENTIMETER Classify each cost of a paper manufacturer as either a product cost or a period cost: a. Salaries of scientists studying ways to speed forest growth. b. Cost of computer software to track WIP Inventory. c. Cost of electricity at the paper mill. d. Salaries of the company‟s top executives. e. Cost of chemicals to treat the paper. f. Cost of TV ads. g. Depreciation on a manufacturing plant. h. Cost to purchase wood pulp. i. Life insurance on the CEO. DISTINGUISHING BETWEEN DIRECT & INDIRECT COSTS Sometimes, direct costs are treated as indirect because it is not cost effective to trace costs directly to the cost object. o For example, the nails used to manufacture a particular desk can be identified specifically with the desk, but, the expense of tracing such items does not justify the possible benefits from calculating more accurate product costs. The distinction between direct and indirect costs also depends on the cost object. A cost can be treated as direct for one cost object but indirect in respect of another. o For example, if the cost object is the cost of using different distribution channels, then the rental of warehouses and the salaries of storekeepers will be regarded as direct for each distribution channel. o If, on the other hand, the cost object- is the product, both the warehouse rental and the salaries of the storekeepers will be an indirect cost because these costs cannot be specifically identified with the product. EXAMPLE: HIGH-LOW WDX Inc. wants to estimate its costs based on past information. The total costs incurred by the company at different levels of output were as follows: WDX Inc. uses the high–low method to separate total costs into their fixed and variable elements. Required: Ignoring inflation, compute the estimated total costs for an output of 305000 units. Output (units) Total cost incurred (R) 240 000 7 260 000 277 500 7 822 500 285 000 7 935 000 HIGH-LOW METHOD A strictly linear relationship exists between the IV (out put) and the DV (Total costs). All the points lie on the straight line. 7 200 000 7 300 000 7 400 000 7 500 000 7 600 000 7 700 000 7 800 000 7 900 000 8 000 000 235 000 240 000 245 000 250 000 255 000 260 000 265 000 270 000 275 000 280 000 285 000 290 000 To ta l C os ts , R Output, Units Straightline EXAMPLE: HIGH-LOW: SOLUTION Required: Ignoring inflation, compute the estimated total costs for an output of 305 000 units. Variable cost per unit = R675000/45 000 units = R15 per unit Fixed costs = R7 935 000 – 285 000 x 15 = R3 660 000 Fixed cost = R7 260 000 – R15 x240 000 = R3 660 000 Total costs = Variable cost + Fixed costs= 15 x number of unit +3 660 000 At 305 000 units, total costs = 15 x 305 000 + 3 660 000 = R8 235 00 Output (units) Total cost incurred (R) Highest 285 000 7 935 000 Lowest 240 000 7 260 000 Difference 45 000 675 000 EXAMPLE 2: HIGH-LOW METHOD: SOLUTION First thing to notice is the expression behaviour: cost behaviour is about establishing whether a cost is FIXED, VARIABLE, or MIXED !!! Use the high-low method to identify the behaviour of the following: 2.1.2. Selling and distribution costs (2 marks) EXAMPLE 2: HIGH-LOW METHOD: SOLUTION First thing to notice is the expression “behaviour”. cost behaviour is about establishing whether a cost is FIXED, VARIABLE, or MIXED !!! Use the high-low method to identify the behaviour of the following: 2.1.3. Administration costs (2 marks) EXAMPLE: HIGH-LOW WITH STEPPED-FIXED COST WDX Inc. wants to estimate its costs based on past information. The total costs incurred by the company at different levels of output were as follows: WDX Inc. uses the high–low method to separate total costs into their fixed and variable elements. However, a cost analyst has now established that there is a stepped increase in fixed costs of R90 000 when output reaches 270 000 units. Required: Ignoring inflation, compute the estimated total costs for an output of 305000 units. Output (units) Total cost incurred (R) 240 000 7 260 000 277 500 7 822 500 285 000 7 935 000 SCATTER GRAPH: SEPARATING FIXED & VARIABLE COSTS SCATTER PLOTS: A line of best fit exists to describe the relationship REGRESSION ANALYSIS: SEPARATING FIXED & VARIABLE COSTS REGRESSION ANALYSIS: A linear regression equation can be established. Output, Units Total costs, Rand 4200 14700 4800 14500 2400 9000 3000 12000 6000 19800 5400 20000 3500 12500 REGRESSION ANALYSIS: SEPARATING FIXED & VARIABLE COSTS REGRESSION ANALYSIS: A linear regression equation can be established. Equation of a straight line: y = mx +c (OR y = bx +a) 𝑏 = 𝑛 𝑥𝑦 − 𝑥 𝑦 𝑛 𝑥2 − 𝑥 2 = 7 × 459 490 000 − 29 300 102 500 7 × 132 850 000 − 29 300 2 = 213 180 000 71 460 000 = 2.983207 𝑎 = 𝑦 − 𝑏 𝑥 𝑛 = 102 500 − (2.9832)(29 300) 7 ≈ 2206.8 𝑦 = 2.9832 × +2206.8 Output, x T. Costs, y xy x2 y2 4200 14700 61740000 17640000 216090000 4800 14500 69600000 23040000 210250000 2400 9000 21600000 5760000 81000000 3000 12000 36000000 9000000 144000000 6000 19800 118800000 36000000 392040000 5400 20000 108000000 29160000 400000000 3500 12500 43750000 12250000 156250000 Total 29300 102500 459490000 132850000 1599630000 BACHELOR OF COMMERCE IN ACCOUNTING COST AND MANAGEMENT ACCOUNTING (MANAGEMENT ACCOUNTING & FINANCE 2A) THE SCOPE OF THE MANAGEMENT ACCOUNTING & FINANCE 2A MODULE BUDGETS & BUDGETARY CONTROL RELEVANT COSTS FOR SHORT-TERM DECISION-MAKING ACTIVITY-BASED COSTING JOINT AND BY-PRODUCT COSTING PROCESS COSTING JOB COSTING COST-VOLUME-PROFIT ANALYSIS COST ELEMENTS: OVERHEAD COST ELEMENTS: LABOUR COST ELEMENTS: MATERIAL/INVENTORY THE CONTEXT OF COSTING COST TERMINOLOGIES & COST CLASSIFICATION The MAF2A module comprises 12 learning units Display an understanding of the key concepts in cost accounting Evaluate cost- volume-profit relationships for decision making Analyse cost data for decision making 1 2 3 4 5 6 MANAGEMENT ACCOUNTING & FINANCE 2A MODULE LEVEL OUTCOMES On successful completion of the module, you should be able to: Apply various costing systems including Job costing & contract costing; process costing; & joint and by- product costing systems Describe the nature and purpose of budgeting and budgetary control Use the activity-based (ABC) model to measure the costs of activities Describe the concept of inventory piling Do calculations relating to all aspects of the EOQ inventory management system Determine the value of closing inventory using the AVCO method Define the terms and principles relating to inventory holding Determine the value of closing inventory using the FIFO method UNIT 3 LEVEL OUTCOMES On successful completion of unit 3 of the module, you should be able to: INTRODUCTION Assuming you are a manufacturing company that wants to make the PRODUCT below: As the cost accountant of the company, how would you COST it? How would you PRICE it? INTRODUCTION COST the product? Costing the DIRECT MATERIALS Costing the DIRECT LABOUR Costing the OVERHEADS (INDIRECT COSTS) KEY TERMINOLOGIES RELATING TO MATERIAL COSTS Primary material (raw material): The main material that is used to manufacture the finished product. For instance, in the manufacture of leather shoes, the primary material would obviously be leather. Primary material is classified ad DIRECT MATERIAL. Secondary material: The material used in the production process which contributes to the conversion of the primary material. E.g., the glue used in the manufacture of leather shoes or sandpaper to polish furniture. Secondary material is classified as INDIRECT MATERIAL. Incomplete units: Work-in-progress units: Primary material that are still within the production process and thus are incomplete, by the end of the financial year of the firm. Incomplete units incur a portion of material cost, labour cost and manufacturing overheads Finished goods: Produced from primary materials and constitutes the completed product that is ready for sale. INVENTORY PILING The time difference between the acquisition of material and the use of the material is the main reason for inventory piling. Inventory piling leads to the following: Normal inventory: material about to enter production, is in the production process, or has just been completed. Buffer Inventory: Inventory piling used to form a buffer between production and usage in situations where there is constant production, but usage is erratic. Safety Inventory: Broader than buffer inventory. Specifically aimed at ensuring that the enterprise can continue with production as usual in case new order have not arrived. Extra inventory carried to prevent stock-out. Stock-out: This occurs when certain material is not available for production purposes or when customer demand exceeds available stock. INVENTORY PILING Strategic inventory: Inventory held for strategic reasons – at the national level strategic stock of oil is kept so that it can be offloaded to the sector incase there is some supply disruptions. Speculative Inventory: Inventory held for economic reasons – e.g., when a large price change is expected bulk purchases may be necessary. Inventory-in-transit: Inventory already purchased but has not yet arrived. It is somewhere between the supplier and the purchaser. Overstocking: This occurs when the amount of inventory held is more than required (not justified in terms of the volume of production). Understocking is the opposite. Average Inventory: Often calculated as: Average Inventory = (opening inventory + closing inventory)/2 Average Inventory = Order size/2 + safety inventory L) MATERIAL CONTROL SYSTEM
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COSTS ASSOCIATED WITH INVENTORIES FIVE main categories of costs associated with inventory piling (Boyce et al., 2017:44): Purchasing costs: Money paid for the acquisition of merchandise from suppliers. Purchase costs would be reduced in cases where discounts are received. Ordering costs: Costs associated with the preparing, issuing & making payments for purchase orders, & costs associated with receipt & inspection of supplied merchandise. Carrying (holding) costs: Costs associated with the storage of stock received from supplier. It includes rental of the storage premises, insurance of the stored merchandise, security of the storage premises, the cost of deterioration or damages to inventory, and the opportunity cost of investments that are tied up in inventory. Inventory stock-out costs: the extra costs incurred from requesting an urgent or expedited delivery of merchandise, or the lost sales from customers who will go buy a substitute product somewhere else. Quality costs: Costs of ensuring that the product meets the required quality. It includes prevention costs, appraisal costs, internal failure costs, and external failure costs. EXAMPLE: QUESTION 1 When determining optimal inventory levels, which of the following costs are relevant inventory holding costs? I. Costs of preparing, issuing and making payments for purchase orders, II. Opportunity cost of investment in inventories; III. Incremental insurance costs; IV. Costs associated with the receipt and inspection of supplied merchandise; V. Incremental warehouse and storage costs; VI. Incremental handling costs of supplied merchandise; VII.Cost of obsolescence and deterioration of inventories; A. I, II, IV, V and VII only B. II, III, V, VI and VII only C. III, IV, V, VI and VII only D. IV, V, VI and VII only