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ACCA F5
Performance Management
June2015
Sample Note
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Chapter
Chapter1: Introduction .............................................................................................................. 3
Introduction to Management Accounting ................................................................................. 4
Chapter2: cost accounting techniques ...................................................................................... 9
Chapter3:budgeting................................................................................................................. 49
Chapter4: Standard Costing System ........................................................................................ 67
Chapter5: Performance Measurement ................................................................................... 86
Chater6: Information System……………………………………………………………………………………………………120
© Lesco Group Limited, April 2016
All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any
means, electronic, mechanical, photocopying, recording or otherwise,
without the prior written permission of Lesco Group Limited.
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Chapter1: Introduction
F5:
There are 5 questions within F5 and all of them are compulsory.
Total marks=100marks. You are given 15minutes of reading time and 3hours of
writing time in the exam.
The key to pass this paper is:
1, know the basic knowledge especially for the structures (covered in the
videos)
2, practice lots of past exam questions with tutors (covered in videos + live
course)
Your examiner now tends to set very practical examinations so make sure you
have covered the past exam papers from DEC2010 to DEC2013 exams (at
least).
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Introduction to Management Accounting
Management accounting① is to provide useful information② in assisting
management in the management activities③.
Overview:
If you want to open up a high fashion clothes manufacturing company in India
so what you should do?
Information required: internal & external
-existing financial information?
-company resources-staff?
-government report/industry report
Management activities: use the above information in:
-Planning: Plan future activities, budget
-Decision making: Whether to set up company and
what further investment that
company may try to make
-Control: Variance-Compare results of operation
with expected (meet sales/
cost target?)
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①Difference between Management Accounting & Financial Accounting
Idea: Management accounting is for the use of management to make decisions
Financial accounting is used for paying taxes, borrowing money from bank
or attracting investors.
Management accounting Financial Accounting
Use Internal External
Format Adapted Strict
Content Detailed
(reflect past and future)
Summary
(reflect past)
Information Financial +Non-financial Financial
Time Depends Per year
② information
1, Difference between Information and Data
-Data + meaning=information
-If I give you data profit is $5,000 and you may think it’s good but what if
I tell you that company has a sales revenue of $50m and you may think
that $5,000 is too small so you decide not to invest in this company.
-Without given context that $5,000 is just data (raw data) and you can’t
make your decision whether to invest in this company unless you are
given information, ie, incorporate the data with specific context (give
some meaning to it.)
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2, How to assess whether this Information is good?
Accurate
They should be accurate not too vague and if you’re given information that
company has made profit this year but not told how much then it’s useless
to help you make decisions.
Cost efficient
You should weigh the benefit you get after getting this information and the
cost you have to pay.
Complete If you are told that there’s a competitor emerging then you should need to
obtain its price and skills they have mastered as well.
User-focused Eg, a shop manager may wish to have a summary of the shop’s daily takings
and a sales manager may want detailed customers details to complete their
sales target.
Relevant If you want to know the price that competitor is currently charging so any
information provided about the history about the competitor may deem to
be irrelevant.
Authoritative The information should be reliable so if you are told that inflation rate this
year is 5% so you need to check where is this information coming from, eg,
from government report?
Timely Information must be produced in advance of the time when it’s needed. Eg,
budgets need to be set in advance of a period in order to compare with
actual performance as a benchmark.
Ease of use We need to make sure Information produced can be used by users, eg, easy
language.
3, Where does information come from?
Internal wage rate; production rate; sales volumes.
External government report; industry statistics.
Inflation rate; industry report.
4, How to sample information?
If you want to launch a new product then how to determine customers
are satisfied with your product you are going to launch? Well we need to
select samples from the populations and ask them whether they are
satisfied with the new products are hoping that they represent the
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whole population.
Approaches to sample:
Random sampling: Sample items at random and make sure that
every item would have an equal chance being sampled.
Systematic sampling: random sample first and sample at interval later.
Stratified sampling: stratified group first and then random sampling later.
③Management Activities
Once we’ve looked at how to generate into information we now need to know
where do we use these information for and by.
Where:
The information should be used to management activities
Planning (budget); [regularly]
Decision making; (launch new products/enter into new market) [any time]
Control (variance analysis) [regularly]
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By:
The information should be used by different level of management within the
business.
Strategic level (directors and senior management; more than 1year)
Tactical Level (divisional/departmental manager; somewhere between
1month-1year)
Operational Level (team leader; factory supervisor; daily/weekly)
To achieve better control over the organization, companies would always divide
themselves up into different centers.
Cost Center: Break group costs into different areas like in products line;
managers; location; region; location; department;
Revenue Center: Break group revenue into different areas like in products
line; managers; location; region; location; department. Eg, Sales department.
Profit Center: senior management here will control both revenue and costs in
order to maximize profit. Usually this would be divisions within organization.
Investment Center: they are not only responsible for control over revenue
and costs but also for some capital. This would be done by quite senior persons
within business usually.
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Chapter2: cost accounting techniques
In this session we will be going through:
1, cost classification
2, costing methods:
Absorption costing method(AC)
Activity based costing method(ABC)
Target costing method
Life cycle costing method
Throughput accounting method
Environmental costing method
Marginal costing
-basic theory behind marginal costing
-relevant costs
-CVP analysis
-Linear programming
-Pricing
-Risk and uncertainty
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1, Cost classification
Since we know that cost is important to business then we should try to control
the costs incurred within business.
Cost can be classified through the following 4 categories:
By Nature
By Traceability
By Cost behavior
By production & Non production costs
By nature:
This means that it can be classified as material costs, labor costs and other
expenses.
By traceability:
This means that it can be classified as direct cost and indirect cost.
Direct cost is the cost that can be traced back to the production of product.
Indirect cost is the cost that is difficult to be traced back to the production of
product.
Typical direct cost: direct material and labor into production of product.
Typical indirect cost: electricity expenses
The sum of direct costs would be prime costs while the sum of indirect costs
would be overhead costs.
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By costs behavior:
This means costs can be classified depending on different the behavior of costs
at different volume of production or sales.
The costs can be classified either variable costs or fixed costs .
Variable cost: Are the cost which can’t be linked to the product directly.
Fixed cost: Are the cost still incurred even though business is not operating .
Within variable costs it would be step costs and semi-variable costs.
Variable costs: If the level of activity changes then cost changes.
If you produce more tables then you need more materials as
well as labors.
Eg, direct material, direct labor, variable overhead (Repair
and maintenance, Power, fuel, Indirect labor etc.)
LofA
Total cost Variable
cost/unit
LofA
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Fixed costs: If the level of activity changes then cost would not change.
Eg, rent bills; fixed salary.
Step costs: If the level of activity hits a point then fixed cost changes.
If the capacity of your factory doesn't satisfy the current production
plan then you need to open up a new factory and this
Total
costs
LofA LofA
Fixed
cost/unit
LofA
Total
costs
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Semi-variable costs: This is a cost containing both variable and fix element.
Example: phone bill(fixed connection fee and variable costs/call)
By production & non-production costs
Production cost: costs must be incurred to produce this products.
Material, labour, machine etc.
Forms cost of sales within Income Statement.
Non-production cost: costs not necessarily incur to produce products.
Tax expenses; administration expenses; finance cost etc.
Forms other expenses within Income Statement.
Income statement:
Sales revenue X
Costs of sales(production costs) (X)
Gross profit X
Other expense (non-production costs) (X)
Profit after tax X
Total
costs
LofA
Fix
element
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Example: Tonic Water
If you were to manufacture a bottle of tonic water:
Materials Labor Other
expenses
Soda water Front line production workers Electricity
Sugar Factory supervisor Insurance costs
Aluminum -sales manager Utilities
Machine -human resource manager Royalties
Factory building
Lorry
Required:
State costs which can be classified under:
(i) Nature
(ii)Traceability
Answer:
Materials Labor Other
expenses
(D)Soda water (D)Front line production workers (ID)Electricity
(D)Sugar (ID)Factory supervisor (ID)Insurance
costs
(D)Aluminum -sales manager (ID)Utilities
(ID)Machine -human resource manager (ID)Royalties
(ID)Factory building
(ID)Lorry
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High low method:
We can use high low method to separate fixed and variable cost within
semi-variable costs.
We assume a linear relationship that changes in totals cost are because of the
changes in the level of activities.
1, Total costs= total variable costs + total fixed cost
2, Total variable costs = variable costs/unit X level of activity
variable cost/unit = cost at highest level – cost at lowest level
Highest level activity-lowest level activity
3, Total fixed cost= total costs-total variable costs
4, Use formula to predict future costs given the level of activity.
Note: we must ensure that any variable cost/unit is constant and the total fixed
cost is constant as well.
Q Kenny (High low method)
Kenny manufactures bottles for tonic water and the following information is
presented as the output of the number of bottles that Kenny made and the
related costs as well.
Output 65,000 units 105,000 units
Cost $133,000 $210,000
Required:
Use the above data calculate:
(i) The fixed and variable costs for Kenny;
(ii) The total costs if the output if 200,000 units.
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Q John (consider other costs as well)
John has the following total costs at two activity levels:
Output 17,000 units 22,000 units
Cost $140,000 $170,000
Variable cost per unit is constant in this range of activity and there is a step cost
of $5,000 in the total fixed costs when activity exceeds 19,000 units.
Required:
Use the above data calculate:
(i) The fixed and variable costs for John;
(ii) The total costs if the output if 21,000 units.
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2, costing methods:
1, Absorption costing
Aim: establish the full production cost/unit.
How: Link direct and indirect cost (production overhead) to one unit.
Steps:
1, Year start:
Calculate absorption cost for the product (budgeted) to determine the selling
price.
2, during the year/Year end:
1, Allocate direct cost to one unit.
2, Apportion (Spread) indirect cost from production cost center over a fair
basis.
3, Reapportion indirect cost from production service center over a fair basis.
4, Absorb costs to unit.
3, Compare step 1 and step2 =over/under absorption
Why:
1, Valuation of closing inventory (need production cost, ie, cost of sales)
2, used to establish selling price.
3, Budgeting.
4, Variance analysis.
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Notes:
What are overheads?
Sum of indirect costs (electricity, power costs, admin costs)
Production (direct) overheads costs?-indirect costs that relating to production of
one unit directly.
Power for factory; factory supervisor costs;
Non-production overheads?
Head office rent, sales staff salary.
Production cost centers
Involved in the production of units of output
Service cost centers
Don't produce physical units but they provide support to the production cost
center, eg, machine maintenance departments (engineers in it)
Reciprocal servicing cost center:
When service cost centers each provide a service to the other service cost
center.
Q Maggie (Allocation)
Maggie wants to manufacture a table.
Direct material per unit used is 4kg and $5/kg;
Direct labor per unit involved is 3hours and $3/hour.
Indirect cost incurred per unit:
-Variable overhead is $2 per unit;
-Fixed overhead is $3 per unit.
Required:
Calculate the full production cost/unit.
Q John (Apportionment)
John has overhead expenses:
Rent and rates is $25,000.
The floor areas of production department is as follows:
Production department A Production department B
Floor areas 5,000 4,000
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Required:
Calculate overhead expenses to be apportioned over these two departments.
Q Steve (Reapportionment)-elimination method
Steve incurred the following overhead expenses used by different departments:
Production department Service
department
A B C
45,000 75,000 32,000
% usage of C 60% 40% -
Required:
Calculate the amount to be reapportioned over production department A&B.
Q Clare (Reapportionment)-repeated distribution method
Clare incurred the following overhead expenses used by different departments:
Production department Service department
A B C D
$5 $4 $3 $3
% usage of C 60% 30% - 10%
% usage of D 30% 40% 30% -
Required:
Calculate the reapportionment expenses over departments by service
department using repeated distribution method.
Q Lucy (Reapportionment)-Algebraic method
Production department Service department
A B C D
$5 $4 $3 $3
% usage of C 60% 30% - 10%
% usage of D 30% 40% 30% -
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Required:
Calculate the reapportionment expenses over departments by service
department using Algebraic method.
At the year start
Q Betty (Absorption- one rate/blanket rate)
In order to set up the selling price, Betty needs to calculate the costs incurred.
The total direct material costs +total direct labor costs +variable overhead costs
is $15/unit.
The rent of factory is $700,000 per year and the budgeted units Betty is going
to produce is 5,000units.
Required:
Calculate full (absorption) cost for Betty.
Q Betty continued (absorption - different department)
Betty now expands her business into making desks and chairs.
The direct material and direct labor into making desks and chairs are $20/desk
and $10/chair.
The rent of factory is $700,000per year splitting $300,000 in assembly
department and $400,000 in finishing department and total hours to produce
desks +chairs in assembly department is 100,000hours and 40,000hours in
finishing department.
To produce a desk in assembly department takes 3hours and 0.5hour for a chair.
To produce a desk in finishing department takes 1hour and 0.5hour for a chair.
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Required:
Calculate full (absorption) cost for Betty.
At the year end
The budgeted production was 11,000units at the year start and the actual
production is 10,000units.
The total direct material, direct labor and variable overhead is $10.
The fixed overhead per unit is $2.
(i) Actual overhead at the year-end incurred is $120,000.
(ii)Actual overhead at the year-end incurred is $140,000.
Required:
Calculate the total absorption cost at the year start and whether there’s
over/under absorption.
2, Activity based costing (ABC)
AC:
OAR = budgeted o/h /budgeted level of activities
ABC:
Overhead cost items—cost pools—cost/unit based on cost driver
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Comment:
Advantages:
1. More accurate product costing.
2. Is flexible enough to analyze costs by activity providing more useful costing
data.
Disadvantages:
1. Cost vs benefit.
2. ABC information is historic and internally.
3. Difficult to apply in practice.
4. Focuses on the allocation of cost rather than minimizing the cost incurred
Q ABC plc (ABC costing)
ABC plc manufactures product A and incurs the following overhead expenses:
Material handling costs =$100,000
Power costs= $120,000
The cost drivers identified by the business:
Material handling: quantity of material used: 1,000kg.
Power: number of power drills operations: 120.
Required
Calculate full cost for product A using ABC costing method.
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3, Target costing
Traditionally:
cost/unit $10
mark-up 40% $4
selling price $14
now:
start with selling price:
target price = $8
profit margin = $1.6
(20%of price)
Target cost/unit $6.4
Actual cost/unit $10
Cost gap $3.6 (so we need to close the cost gap)
Make process more efficient
Comment:
Key advantages:
1, Cost reduction and control
Possible elimination of non-value added elements and activities in production
process.
2, Market based costing
Selling price considers what customer might want to pay for the product.
3, Customers
Customer requirements for quality, cost, and time are incorporated into
product and process decisions. The value of product features to the
customers must be greater than the cost of providing them.
4, Design
Cost control is emphasized at the design stage so any engineering changes
must happen before production starts.
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4, lifecycle costing
Not focusing on accounting period
Lifecycle cost/unit = total lifecycle costs/expected life cycle volumes
Comment:
1, better understand overall costs relating to short life products.
2, avoids products having changing product costs during the life of the product.
Q life ltd
Life ltd wants to produce a brand new pad. The following information is
available:
R&D: $100,000
Budgeted total sales/year =10,000 units
Production costs/ year = $150,000
Life of product = 2years
Required:
Calculate the life cost/unit for the pad.
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5, Throughput accounting method
In the past most business only focuses on increasing the individual process
efficiency without considering if one process slows down then other processes
will slow down as well.
If one process slows down then the inventory will be piled up, workers are idled
but still gets paid and these will increase the overall costs to the organization.
Throughput accounting underpins the idea that inventory should be eliminated
during the process of the production. It is not just focusing on individual process
but rather focus on the factory as a whole.
As mentioned before one process slows down which will make other processes
slow down as well and this is called bottle neck.
So how to increase the overall output and profit for the organization given bottle
neck exist in the organization?
Well this introduces “throughput accounting” method.
‘throughput’ is the rate at which the system generates money through sales
So we can calculate “throughput accounting ratio (TPAR)” and say:
If TPAR=1 then the business is not making or losing money (break even);
If TPAR>1 then the business is making money and
If TPAR<1 then the business is losing money.
But how can we calculate “TPAR”?
TPAR= Return/factory hour (W1)
Cost /factory hour (W2)
W1: return/factory hour=sales price/unit-direct material cost/unit
Factory hours per unit (bottleneck hrs)
W2: cost/factory hour= Total factory costs
Total factory hours
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Note:
Throughput accounting is very similar like marginal costing because you can see
the calculation of TPAR, return/factory hour is similar to contribution/hour.
Before we move on we would like to see the difference between marginal costing
and throughput accounting.
Marginal costing Throughput accounting
Variable costs Direct material
Direct labor
Variable overhead
Direct material only
Fixed costs Costs don’t vary with activity
levels
Called “total factory cists”.
Direct labor costs +all overheads
Contribution Sales-variable costs Sales-direct material costs
Q Through ltd
Through ltd has 2 production departments: assembly and finishing department.
It makes 2 products: A&B. Through ltd operates a JIT manufacturing system.
Processing capabilities are shown below:
Processing time in hours
Assembly Finishing
Product A 0.5 0.75
Product B 0.5 1
Hours available 12,000hours 12,000hours
Factory overhead and direct labor expense for the period is $180,000.
Cost data is as follows:
Product A Product B
Unit sales price $20 $15
Direct material costs/unit $11 $9
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Required:
1, identify the bottleneck process.
2, calculate TPAR for each product.
3, interpret the TPAR and suggest how Through ltd can improve the TPAR.
Environmental management accounting
This topic in the F5 exam is just on the surface and everything here is just
business common sense.
Nowadays, business needs to take into account the environmental impact that it
has during its operation of business.
The questions is why care?
From a financial perspective:
Raw material
Transport and travel
Water consumption
Energy costs
Clean up costs
taxations
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From a non-financial perspective:
Reputation
Ethics
Stakeholders needs
Pressure on resources
Possible strategies:
1, end of pipe strategy-just pay after the pollution
2, process improvement strategy-improve process to decrease pollution
3, prevention strategy-prevent pollution happening by further improving your
process
How to account for it?
1, input/output analysis:
= + +
Analyses costs throughout the process and minimize the cost.
2, flow cost accounting:
The aim of flow cost accounting is to reduce the quantities of material which
should be beneficial to the environment and saving costs for the organizations.
It uses material flows and organizational structures to make material flows
more transparent and it divides the material flows into:
1, material-these are costs and values of materials involved in the production
processes.
2, system-these are costs and values of internal handling of materials, eg,
personal costs
3, delivery and disposal-these are costs of material flows leaving the company,
eg, transport costs or waste disposal
100%
Input
80%finish
ed goods
10%scrap
value
10%
waste
r
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3, activity based costing
There are:
1, Environmentally related costs which can be specifically attributed to an
environmental cost center, eg, sewerage plants.
2, Environmentally driven costs which do not relate to a specific cost center but
relate to environmental drivers, eg, higher staff costs due to more toxic
emission during the production process.
In order to allocate the environmentally driven costs to cost centers it’s
important to find adequate costs drivers such as volumes of water and toxicity
of emissions.
4, life cycle costing
It considers costs and revenues throughout the life of a product from initial
design stage to the end of its life to be removed from market.
This allows an early focus which can help decision making such as pricing and
the design of the product taking into account of future environmental costs such
as clean up costs.
Marginal costing based decision making techniques
1, make or buy decision
Make: marginal (variable) cost
Buy: purchase price
Idea: because fixed overhead will incur irrespective of the level of activity
changes so we ignore fixed cost when making the decision.
Example:
A B
Price 17 25
Variable cost 14 28
Fixed overheads 4 4
Total costs 18 32
Required:
Should we make or buy product A & B?
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2, discontinued decision
Whether to discontinued part of the business we should look at whether after
shutting down that business we will need to pay more?
Example:
Division A B
Sales 100 40
Variable costs (60) (30)
Fixed costs (20) (20)
Profit/losses 20 (10)
After shutting down the division B 40% of fixed costs relating to admin staff of
B will be saved and the remainder being allocated arbitrarily to the divisions
from head office.
Required:
Suggest whether to shut down division B or not.
3, limiting factor decisions
How to best use the scare resources-raw material, skilled labor, machine
capacity, finance(capital rationing in F9)
Fixed cost not change.
Steps:
1, contribution per unit of sale
2, contribution per unit of scarce resource
3, ranking which higher contribution
4, use up the resource
Example
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the hours involved in producing the brand new pad are limited to 5,000hours.
Information about the pad 1 and pad 2 are as follows:
Products(per unit) Pad 1 Pad 2
Selling price($) 40 30
Variable costs($) 16 15
Fixed costs($) 10 8
Profit($) 14 7
Machine hours 8 3
Budgeted sales(units) 600 500
Required:
1, calculate the contribution per scarce resource.
2, calculate the total contribution if best use up the resources.
3, calculate the total profit if best use up the resources.
4, further processing decision
This arises in a manufacturing company that produces a product in a process or
a sequence of processes. The output from a process might have a selling price.
However, there might also be an opportunity to further process the output to
produce a finished item with a higher selling price.
So we need to compare the additional (incremental) revenue (subsequent
selling price-original selling price) and the additional (incremental) costs.
Example:
cleaning fluids, JIN and LON. The two fluids are manufactured in a joint process.
Every Lon 8,000 liters of materials input to the joint process produces 4,000
liter of JIN and 3,200 of LON.
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$
DM 1,600
DL 200
Variable production overheads 300
Fixed production overheads 2,000
Product JIN sells for $1.10 per liter and product LON for $0.75 per liter.
Company could put product JIN through another production process, where
there is spare production capacity. The further processing would produce
another cleaning product, Killer. Every one liter of input to the further process
will produce 0.90 liters of Killer.
The costs of further processing would be:
Product JIN: 4,000litres $
Additional DM 400
DL 40
Variable overheads 80
Apportioned fixed overheads 400
Total 920
Killer would sell for $1.40 per liter.
Required:
Suggest whether company should sell Jin or further process it?
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Relevant costs
Uses:
Minimum pricing
Limiting factor decisions: how to use of the scarce resources
Investment appraisal
Discontinued decision
Further processing decision
What:
This is a incremental future cash flow.
Changes as ignore sunk costs ignore depreciation
a result of book value and other accounting
adjustment
decision
Types:
Relevant costs Non-relevant costs
Opportunity cost Sunk cost
Incremental cost Committed cost
Variable cost Fixed O/H absorbed
Depreciation (non-cash flows)
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Cost Volume Profit (CVP) analysis
Using this technique we can know when we will make no profit or loss
(breakeven) as the sales volume drops to a certain level/sales revenue drops to
a certain level.
Selling price-variable costs=contribution=fixed cost +profit
Required sales volume (revenue) = target Contribution
(breakeven) Contribution/unit (sales revenue)
Ex1: (volume)
Selling price=$35/unit
Variable cost=$15/unit
Fixed cost=$10,000
Required:
1, Calculate the sales volume breakeven point.
2, if the required profit is $16,000 then calculate the sales units.
Ex2: (sales revenue)
Selling price=$35/unit
Variable cost=$15/unit
Fixed cost=$10,000
Required:
1, Calculate the sales revenue breakeven point.
2, if the required profit is $16,000 then calculate the sales units.
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Margin of safety:
Budgeted sales units=4,000units
Breakeven sales unit=1,000units
Required:
Calculate the margin of safety both in absolute and relative figure and explain
what that means.
Chart:
Sales
Revenue & cost
Total cost(FC+VC)
Fixed cost
Level of activity
P/V chart(profit/volume) chart:
PROFIT
0
300units/
LOSS @$6/unit=$1,800
Fixed cost
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If the company is trying to sell off multiple products, then we can prepare
for a multiple product P/V chart:
Products
A B
Selling price 40 45
Variable costs 30 30
Contribution 10 15
Budgeted sales 1,000units 2,000units
Fixed cost 25,000
Required:
Draw the multi product P/V chart if the company plans to sell a constant mix of
products A+B for 1:2.
Draw the multi product P/V chart if the company plans to get to its breakeven
point quicker.
Limitations:
1, Once costs and revenues have been determined, it is usually assumed that
they will have a linear relationship.
2, Fixed costs will be constant over the relevant range
3, Selling price will remain unchanged
4, The analysis covers either a single product or a mix of products at which it is
assumed that the proportion of each product will remain the same as volume
increases or decreases.
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Linear Programming
Theory: there are multiple limiting factors within the factory so we need to take
into account of those and produce an optimal production plan.
This is based on the limiting factor analysis learnt before which only considers
the one limiting factor within the factory rather than multiple ones.
Steps: (DDDGO)
1, Define variables (products)
2, Define constraints
3, Define Objective (maximum contribution)
4, Graph
5, Optimal production plan
Shadow price (pay above the normal price: consider you have binding
resources and you determine to outsource or make labour work
overtime)
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Q JAMA
JAMA plans to manufacture two products, JAMA A and JAMA B and the unit
contribution is estimated to be $50 for JAMA A and $70 for JAMA B.
For their manufacture both products require inputs of machine processing time,
raw materials and labor.
JAMA A JAMA B
Machine processing time 3hours 10hours
Raw materials 16units 4units
Labor 6hours 6hours
Limiting factors:
Machine processing time 330hours
Raw materials 400units
Labor 240hours
The technology of the manufacturing process is such that at least 12 units of
JAMA B must be made in any given time.
Sales department of JAMA has forecast to sell 50 units of each product next
month.
Required:
1, How many units of JAMA A and JAMA B should be produced in order to
maximize contribution?
2, identify and calculate the binding and slack resources.
3, calculate shadow prices for each binding resources.
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Pricing
Before we set up a selling price, we need to consider 3C’s:
Costs
Competition
Customer reaction
Then we need to consider are there any techniques to help us set up the selling
price?
Cost plus pricing
Marketing based pricing
Demand based pricing
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1, cost-plus pricing (full absorption cost-plus approach or marginal
cost-plus approach)
full absorption cost-plus approach:
Cost card $
Direct materials 10
Direct labor 8
Variable overhead 5
Fixed overhead _ ($500,000 estimated and absorbed under 10,000units
produced budgeted)
Full cost 28
Margin(20%) 5.6
Price 33.6
Ad:
Easy to apply
“guarantee” profitability
Disad:
Ignores outside
Ignore any effect on selling price on demand
Problem of estimation the level of production (this leads to marginal cost plus
approach)
Marginal cost-plus approach
Cost card $
Direct materials 10
Direct labor 8
Variable overhead 5
marginal cost 23
Margin(40%) 9.2
Selling price 32.2
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Ad:
Easy to apply
“guarantee” profitability
Disad:
Ignores outside
Ignore any effect on selling price on demand
Problems dealing with % to make sure it’s enough to cover fixed costs in order
to generate into profit.
2, marketing based pricing
1, product (business/industry life cycle)
2, possible pricing strategy in each stage
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Market skimming
Aim at small group of people and charge them at a high price for a small amount
of goods
Low risks
1, we don't have to develop too many products which costs us that much
2, we can drop the price down as we see fit.
3, High barrier to entry, Eg, technology
Market penetration
Aim at large group of people and charge them at a low price for a large
amount of goods
High risks
1, we have to develop too many products which costs us that much
2, we can’t drop the price down easily as we see fit.
3, No barrier to entry
Average (going rate) pricing
Charge the price based on the competitor average level.
Discount pricing
Large volume purchased then enjoy a lower price
Complementary product pricing
Razor is cheap but blade is expensive.
Product line pricing
Many products in the company vary from prices
Price discrimination
Charge at a different price to different people:
Eg, film tickets-child is for free but adults are charged at full price.
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3, demand based pricing
The demand for the product by customer would change if the price charged to
them changes.
Selling
price/un
it
Demand(unit
s)
Cost/un
it
Total
revenue
s
Tota
l
cost
s
Total
profi
t
Margin
al
revenu
e
Margin
al cost
16 100 14 1600 140
0
200
15.5 200 13.9 3100 278
0
320 1500 1380
15 300 13.8 4500 414
0
350 1400 1360
14 400 13.7 5800 548
0
320 1300 1340
So we can identify that when the marginal revenue < marginal costs then we
make a smaller profit and when marginal revenue=marginal costs then we can
maximize our profit figure.
Marginal revenue can be calculated through demand curve:
P=a-bQ
b= change in price
Change in quantity
a=price when Q=0
so we need to establish the demand curve and then calculate the marginal
revenue:
Q: calculator
we sell 500units calculators at a price of $25 and 700units at a price of $20.
Total cost=15,000(fixed cost) +5(variable cost)Q
Required:
1, What is the demand curve and marginal revenue?
2, units produced in order to maximize the profit.
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How to measure the change in price will lead to a change in the demand by
customers?
We use “demand elasticity”.
Price elasticity of demand (PED) = (Q2-Q1)/Q1
(P2-P1)/P1
If the PED is greater than one, the good is price elastic. Demand is responsive to
a change in price. If for example a 15% fall in price leads to a 30% increase in
quantity demanded, the price elasticity = 2.0.
If the PED is less than one, the good is inelastic. Demand is not very responsive
to changes in price. If for example a 20% increase in price leads to a 5% fall in
quantity demanded, the price elasticity = 0.25.
If the PED is equal to one, the good has unit elasticity. The percentage change
in quantity demanded is equal to the percentage change in price. Demand
changes proportionately to a price change.
If the PED is equal to zero, the good is perfectly inelastic. A change in price will
have no influence on quantity demanded. The demand curve for such a product
will be vertical.
Q PED
The price of a car is $1.20 per unit and the annual demand is 800,000 units.
Market research indicates that an increase in price of 10 cents per unit will result
in a fall in annual demand of 75,000 units.
Required:
Calculate the price elasticity of demand?
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Decision making under risks and uncertainty
In the real world there are lots of decisions made by management associated
with different outcomes.
But which decision we are going to choose? We can plot them into the payoff
table then we can consider the choices we are going to make.
Risks-quantifiable outcome
Uncertainty- unquantifiable outcome
Q Laura
Miss Laura runs a market stall selling meat. She buys a product for $20 per case.
She can sell the product for $40 per case on her stall. The product is perishable
and it is not possible to store it, instead any cases unsold at the end of the day
can be sold off as scrap for $2 per case.
The following information has been collected by Miss Laura.
Demand/day Number of days
10 45
20 75
30 30
Required:
(a) Prepare a summary of possible net daily profit using a payoff table.
(b) Advise Miss Laura:
(i) How many cases to purchase if She uses expected values (on average-risk
neutral).
(ii) How many cases to purchase if She uses maximin (risk averse) / maximax (risk
seeker).
(iii) How many cases to purchase if She uses minimax regret.
(c) Miss Laura has been approached by marketing agent to provide her more
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reliable estimate of her future demand, advise Miss Laura what maximum price
She should pay to gain the reliable information.
Expected values:
This is a weighted average value of all the possible outcomes. It does not reflect
the degree of risk, but simply what the average outcome would be if the event
were repeated a number of times.
The decision rule is to select the course of action with the highest expected
value of profit or the lowest expected value of cost.
EV = px
P = probability of an outcome
x = value of an outcome
Comment:
Advantages of expected values
EV considers all the different possible outcomes and the probability that each
will occur.
Limitations of expected values
1. The EV shows a long term average, so that the EV will not be reached in the
short term and is therefore not very suitable for one-off decisions.
2. The accuracy of the results depends on the accuracy of the probability
distribution used.
3. EV takes no account of the risk associated with a decision but just a weighted
average figure.
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Decision making (risks)
Maximax (risk seeker)
The decision maker will select the course of action with the highest possible
payoff
(the best of the best).
Maximin decision rule (risk averse)
The decision maker will select the course of action with the highest expected
return under the worst possible conditions.
Minimax regret decision rule
The decision maker selects the course of action with the lowest possible regret.
It aims at minimising the regret from making the wrong decision.
Regret is the opportunity cost of having made the wrong decision, giving the
actual conditions that apply in the future.
Risk neutral
A risk neutral decision-maker ignores risk in making a decision.
A risk neutral decision-maker will select the course of action with the highest
expected return, regardless of risk
Value of perfect information
If company wants to obtain the best information (eliminate uncertainty) then
what is the maximum of price that company needs to pay in order to do this?
The maximum price= expected value of the perfect information-expected value of
the non-perfect information
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Decision making using decision trees
Steps:
1, draw a decision tree
2, left to right –probabilities and values
3, right to left-expected value
Q Thomas
The following information relates to Thomas who is considering whether to
develop and market a brand new PC.
Probability
Development
Being successful 0.75
Being unsuccessful 0.25
Estimated development costs would be $180,000
If successful, the product will be marketed with following probabilities:
Probability Profits / (Loss)
Being very successful 0.4 $540,000
Being moderately successful 0.3 $100,000
Being failure 0.3 ($400,000)
The above profits / losses figures include the effect of the development costs.
Required:
Draw a decision tree and recommend the best action by Thomas.
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Chapter3:budgeting
In this session we will be focusing on:
Basic Budgeting theory
Types of budget
How to set up a budget
Forecasting techniques
- Regression analysis
- Time series
- Learning curve
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1, Basic Budgeting techniques
Budget is part of a planning process.
It is a plan in numbered format.
The purpose of budgets (CRUMPET):
C: Co-ordination: co-ordinate all department, plan to sell 200units product then
production department needs to know they are going to produce 200units of
products to be sold.
R: Responsibility: by setting up the budget the sales manager for example is
responsible for the sales budget and co-ordinate activities within
department to achieve the sales target.
U: Utilization of resources, eg, set up a limit of $4,000 to purchase material so
utilize resources effectively.
M: Motivation, eg, target is set and we link this target to the bonus if so we can
motivate them.
P: Planning: by setting up the budget we can make management of the business
think about how to achieve this budget.
E: Evaluation of performance: use actual budget to compare with budget we
set.
T: Telling: it assist the communication between departments using budgets.
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Budget preparation procedures:
Budget committee (senior management within the organization)
Budget manual (objective, administration of budgeting process and provide an
approach for management to prepare budget)
Department managers (receive the budget manual and prepare budget and
then submit to budget committee for approval.)
Different types of budget:
Establish Principal budget factor ie, factors limiting company’s activities, eg,
sales demand.
1, functional budget: relates to different areas of company
1, sales budget (units to sell)
2 production budget (units to produce)
3, materials budget (resource used to produce)
4, labor resource (resource used to produce)
2, master budget: summary
Cash budget
Budgeted income statement
Budgeted statement of financial position
Advantage of budget:
Motivate staff/management
Focus attention on key areas, eg, sales growth, cost reduction
Quantifiable performance measure
Disadvantages of budget:
May demotivate staff if it’s unrealistic
May result in dysfunctional behavior
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Factors influence motivation:
Targets: must be challenging and attainable
Approach to budgeting:
1, Top down approach: senior executives set strategy and communicate
targets down
2, Bottom up approach: divisional level of management and staff encouraged
to have an input.
Functional budget:
1, sales budget:
Q Salon Ltd
Salon ltd produces 2 two products. S1 and S2.
Budgeted Sales Units Selling price
S1 2,000 $100
S2 4,000 $130
Required: prepare the sales budget for Salon Ltd.
2, production budget:
Salon ltd also has the following finished goods.
The finished stock budget is as follows:
S1 S2
Budgeted sales units 2,000 4,000
Opening stock units 500 800
Closing stock units 600 1,000
Required:
Prepare the production budget for Salon Ltd.