CHARTERED ACCOUNTANTS IRELAND FAE LAUNCH Management Accounting Revision & Update title goes here
Management Accounting Main Topics • Role of Management Accounting • Cost Behaviour • Traditional & Absorption Costing • CVP Analysis & Pricing • Decision Making • Process Costing • Budgeting & Variance Analysis • Performance Management & Transfer Pricing Related to Sessions 3 & 4 Related to Sessions 5 & 6
Role of the Management Accountant • Planner e.g. budgeting • Information provider e.g. operating statements • Controller e.g. budgetary control • Motivator e.g. providing budgets • Decision maker e.g. relevant costing
Management Accountant Vs Financial Accountant • Audience – Internal Vs External • Format of Reporting – Free format Vs prescribed • Regularity of Reporting – Monthly Vs Annually • Perspective – Prospective Vs Retrospective
Cost Behaviour How costs behave as the level of activity/volume changes. Types • Variable e.g. petrol, direct materials • Fixed e.g. car tax, factory rental • Semi-variable (Hybrid) e.g. phone bill. Cost separation is the process of separating the fixed and variable elements of a semi variable cost. • Methods • High – Low Method • Regression Analysis
Cost Separation Why an understanding of cost behaviour is important ? • Unit Costing • Pricing • Decision Making • Budgeting • Break-even analysis
Absorption Costing Steps In Absorption Costing • Allocation of overheads relating to one dept/cost centre only • Apportionment of shared overheads using: Phase 1 – Apportion shared overheads to all departments including service departments Phase 2 – Apportion overheads of service departments using simultaneous equations or the repeated distribution method • Absorption of overhead into units using predetermined overhead absorption rates
Absorption Costing Absorption Costing - Technical Issues • Absorption Costing (AC) differs from Marginal Costing (MC) in that it includes fixed overheads in unit costs • The predetermined nature of AC may lead to the under/over absorption of overhead at period end • Absorption rates may be calculated on a departmental or factory wide basis • Students may have to select: a) the basis on which shared overheads are apportioned b) the absorption rate bases
Activity Based Costing Activity Based Costing – Steps • Identify overhead activities • Decide on prime driver of each overhead activity • Record overhead activity cost in cost pools and the number of prime drivers for each overhead activity for the period • Determine the prime driver rates • Charge overheads to units based on their proportionate consumption of the driver of each separate overhead activity.
Activity Based Costing • Activity Based Costing (ABC) differs from Absorption Costing (AC) in the manner in which overheads are charged to units. • ABC charges overheads to units based on their proportionate consumption of the driver of each separate overhead activity Key Terms • Cost Pool • Cost Driver & Prime Driver • Prime Driver Rates Note: Students may have to decide on the prime driver for a particular overhead activity.
Activity Based Costing Activity Based Costing – Arguments For • Provides a more accurate assessment of unit costs • Underpins the competitive pricing of units on a cost plus basis • Provides an improved insight into the drivers which may lead to cost reduction opportunities • Highlights the cost of overhead activities for benchmarking against best practice/industry averages etc • Helps management assess the value added proposition of internal overhead activities
Activity Based Costing Activity Based Costing – Arguments Against • Consumes increased resources to identify and record cost pools and cost driver activity • There are many factors which influence the cost of an overhead activity in addition to the prime driver • The selection of the prime driver of each activity is subjective • It is considered as simply an extension of Absorption Costing (AC)
Break-Even/CVP Analysis Technical Issues • Requires a full understanding of cost behaviours • May require the ability to separate costs into fixed and variable • Critical to understand the concept of contribution • Can calculate using break-even formulae • Can present in a graphical form
Break-Even/CVP Analysis Underlying Assumptions • Fixed Costs remain constant throughout all relevant levels of activity • Variable Cost per unit remains constant throughout all relevant levels of activity • Selling Price per unit remains constant throughout all relevant levels of activity Note: The relevant range of activity is the range within the above linear assumptions are considered to be valid.
Break-Even/CVP Analysis Break Even Arithmetic Contribution Sales Ratio = Contribution Per Unit Selling Price Per Unit Break Even Point in Units = Total Fixed Costs Contribution Per Unit Break Even Point in Revenues = Total Fixed Costs C/S ratio Margin Of Safety = Actual/Budgeted Sales (Units or Volume) – BEP Sales (Units or Volume) * 100 Actual/Budgeted Sales (Units or Volume)
Break-Even/CVP Analysis Preparation of Break Even Chart - Steps • Determine scaling requirements • Plot fixed cost line • Plot total cost line • Plot sales revenue line • Label graph indicating: • Break Even Point (Units and Revenues) • Profit & Loss Zones • Margin of safety
Break-Even/CVP Analysis Limitations • can only be applied to a single product or single mix of products • the linear assumptions relating to fixed costs, variable costs and selling prices does not represent reality • assumes that sales and production are equal i.e. there is no change in inventory levels
Pricing Decisions Approaches to pricing. 1. Cost – Plus Approach Full cost + mark-up. Used for recurrent business. Marginal cost + mark up. Used as a guideline for one off/incremental pricing. 2. Target costing. Used in a competitive marketplace.
Pricing Decisions Other Factors to Consider : • Economic conditions and confidence. • Importance of customer/client. The potential for repeat/additional business. • State of competition e.g. price skimming • Competitor prices • Stage in Product Life Cycle e.g. penetration pricing • Desired brand image e.g. prestige/premium pricing
Budgeting Budget “A Plan expressed in monetary terms” Objectives of Budgeting • Compels Planning • Communication of objectives throughout hierarchy • Co-ordination of effort throughout the organisation • Delegation and responsibility accounting • Control of performance (budgetary control) • Motivation
Budgeting Role Of Budget Committee • Oversee budget setting process • Allocate responsibility to budget holders • Determining budget reporting timetable • Agreeing final budgets • Regular monitoring budgetary performance • Taking appropriate control action • Ensuring appropriate training, support and censure of budget holders
Budgeting Budget Setting Methodologies • Incremental Budgeting • Zero Based Budgeting (ZBB) • Activity Based Budgeting (ABB)
Budgeting Criticisms of Traditional Budgeting • Dealing with inherent uncertainty in a fast changing environment • Retrospective rather than prospective • Rigidity stifles innovation and creativity • Consumes significant resources • A low value added activity
Budgeting Behavioural Aspects of Budgeting • Aspiration level must be realistic but challenging to motivate • Budget holders must participate in the budget setting process (Hertzberg's Hygiene & Motivating Factors) • Must isolate uncontrollable factors when reporting budget performance. • Budget holders must be sufficiently trained and supported.
Budgeting Steps in preparation of budgets • Identify the principal budget factor i.e. any other limiting factor other than sales demand • Prepare functional budgets in accordance with the hierarchy • Prepare and reconcile master budgets
Budgeting Functional Budget Hierarchy • Sales Budget • Finished Goods Stock Budget • Production Budget • Raw Material Stock Budget • Purchases Budget • Labour Budget • Overhead Budget/s Master Budgets • Income Statement/s • Balance Sheet/s • Cash Flow
Budgeting – Preparing Cash Forecasts Guiding Principles • Typically prepared for a quarter/year profiled monthly/quarterly. • Three key concerns; receipts, payments and when • The cumulative cash balance is tracked throughout • Typically asked to comment on findings and provide advice on cash planning for the budgeted period
Budgeting Dealing With Uncertainty Flexible Budgets Types of Budget • Fixed: Prepared for a single level of activity only • Flexible: Adapted to change/flex to reflect the actual level of activity. Preparation of a Flexible Budget Flex the budget elements for each potential level of activity particularly: • Variable costs • Sales revenues • Summarise and assess results
Decision Making Types of decision include: • Pricing • Make or buy • To further process • Launch/Withdrawal of products/services • Acceptance of one-off proposals • Extra shift proposals • Closedown proposals • Use of limiting factors
Decision Making Steps in the decision making process • Accountant carries out the quantitative analysis based on relevant costing principles. • Accountant presents the quantitative analysis (future incremental cashflows) • Accountant contributes to the wider debate considering the qualitative factors i.e. the decision’s potential impact on the various stakeholder groups • The ultimate decision is made and implemented
Decision Making Quantitative Analysis - Relevant Costing – Detailed Rules • Sunk costs are irrelevant • Committed costs are irrelevant • Fixed costs are generally irrelevant unless the decision involves the stepping up/down of fixed costs • Variable costs are generally relevant as incremental • Limiting Factors – The relevant cost is the income forgone by passing up the next best opportunity i.e. the opportunity cost • Stock . The specific Rules are: • If needs to be replaced the relevant cost is the replacement cost • If will not be replaced the relevant cost is the higher of the net realisable value or he value in the next best use (if any).
Decision Making Qualitative Analysis – Stakeholder groups to consider • Customers • Suppliers • Employees • Local Community • Government • Public Relations • Corporate Social Responsibility
Performance Measurement Management Accounting Related Control Systems • Budgetary Control • Standard Costing • Target Costing • Benchmarking • Balanced Scorecard Reporting
Performance Measurement Reasons for Controls • Monitor progress towards strategic achievement • Prevent Fraud • Early warning system • Correction of adverse developments • Accentuate favourable developments • Ensure goal congruency throughout divisionalised structure
Divisional Performance Measurement Reasons for Divisionalisation • Customer Focus • Expertise • Motivational • Sheer Size • Fiscal • Geographical Types of Division • Revenue Centre • Cost Centre • Profit Centre • Investment Centre
Divisional Performance Measurement Traditional Measures of Divisional Performance • Profit • Cash Flow • Return on Investment/Return on Capital Employed Limitations of traditional measures of divisional performance • Encourage Short Termism • Manipulation of Results • Encourages complacent management • May encourage dysfunctional decision making
Performance Measurement Contingency Theory • No one management accounting system suitable. Depends on contingent factors that may impact on an organisation • Depends on internal structure of organisation and changes thereto • Depends on the type and pace of environmental change, including technological developments • Contingency theory would advocate constant micro and macro environmental scanning and adapting reporting and control systems to reflect same.
Performance Measurement Balanced Scorecard Background: • Robert Kaplan & David Norton • 1990s • Short Term view of performance adopted • Previous over-concentration on Financial Performance • Ignoring strategic development of organisation
Performance Measurement Balanced Scorecard Approach: 4 Perspectives on Performance • Customer • Shareholder • Innovation & Growth • Internal Business Processes
Performance Measurement Balanced Scorecard Approach: Benefits • Strategic Alignment • Long Term Focus Adopted • Customer Focused • Simplicity of Concept and Process • Accountability
Performance Measurement Balanced Scorecard Approach: Criticisms • No substantive improvement over operational control systems • Expensive and over elaborate measurement systems • Controllability of performance measures questioned • Too many performance measures used
Performance Measurement Benchmarking - Types • Internal – Internal Comparison • Functional – Vs Best Industrial Practice • Competitive – Vs Best Competitor Benchmarking - Benefits • Provides a position audit • Spurs Improvement • Avoids Complacency • Participation in Process
Performance Measurement Benchmarking - Dangers • Promotes a ‘one only way’ mentality • Essentially only achieves catching up • May stifle inspiration/creativity • Is reliable information available ? • Is comparison valid?