MA Management Accounting

A. The nature, source and purpose of management information

Management accounting provides information inside the organisation to support planning, decision making and control. Financial accounting reports to external users, follows accounting standards and looks back at what has happened. Management accounting information is for internal use, has no required format, can look forward and can be as detailed as managers need. Planning decides what to do, control checks that it is happening and corrects it, and decision making chooses between alternatives. Strategic planning is long term and set by senior managers, tactical planning turns this into medium term plans, and operational planning covers day to day activity.

Data is raw facts and figures. Information is data that has been processed so it is useful to the user. Good information is accurate, complete, cost-effective, targeted at the user, relevant, authoritative, timely and easy to use. The three main sources of data are machines and sensors, transactions (such as sales and purchases) and human or social activity (such as surveys and social media). Information can be internal or external, and primary (collected first-hand for a purpose) or secondary (collected by someone else). Published data may be out of date or not suited to the purpose, and collecting data has a cost that must be weighed against its benefit.

Costs are classified in several ways. Production costs (materials, labour and production overheads) are included in the cost of a product and in inventory values. Non-production costs (administration, selling, distribution and finance) are normally expensed in the period. A direct cost can be traced to a cost unit and an indirect cost cannot. Fixed costs do not change with activity in the short run, variable costs change in proportion to it, stepped fixed costs rise in steps, and semi-variable costs have a fixed and a variable part. A cost unit is a unit of product or service to which costs are assigned, a cost centre is a location, function or item of equipment for which costs are collected, and a cost object is anything for which costs are measured. Codes help to classify and record transactions consistently.

Managers of cost centres are responsible for costs only. Profit centre managers are responsible for revenue and costs. Investment centre managers are also responsible for the assets used. Revenue centre managers are responsible for sales. Each needs different information. Management reports should be written in a format suited to the reader, and tables, bar charts, line graphs, pie charts and scatter graphs help to show patterns. A reader of a report must also be able to interpret what the figures and charts show.

Worked figures

A cost has a fixed part of $2,000 a month and a variable part of $3 per unit. At 1,500 units the cost is $2,000 + (1,500 x $3) = $6,500.

Key terms

• Cost unit: A unit of product or service to which costs are assigned.
• Stepped fixed cost: A cost that is fixed within a range of activity but rises in steps beyond it.
• Primary data: Data collected first-hand for a specific purpose.

Study tip: For cost classification questions, decide the behaviour (fixed, variable, stepped, semi-variable) and the function (production or non-production) separately.

Practice questions for section A

B. Data analysis and statistical techniques

Sampling is used when it is too costly or slow to examine every item. Random sampling gives every item an equal chance of selection. Systematic sampling takes every nth item. Stratified sampling divides the population into groups and samples each group in proportion. Cluster sampling selects whole groups, multistage sampling samples in several steps, and quota sampling fills fixed numbers from each category and relies on the choice of the interviewer. You should be able to say which is best for a given situation.

The high-low method estimates fixed and variable costs from the highest and lowest activity levels: variable cost per unit is the change in cost divided by the change in activity, and fixed cost is the remainder. It is simple but uses only two points, which may not be typical. Scatter diagrams plot cost against activity and a line of best fit shows the pattern. Linear regression finds the line y = a + bx that fits all of the points, where a is the fixed element and b the variable rate per unit. The correlation coefficient (r) measures the strength of the linear relationship, from -1 (perfect negative) to +1 (perfect positive), and the coefficient of determination (r squared) shows the proportion of the variation in y explained by x. Forecasts using a regression line are reliable only within the range of the data, with a strong correlation and enough data points.

Time series analysis separates a series into the trend, seasonal variations, cyclical variations and random variations. Moving averages smooth out short-term variation to show the trend. Seasonal variation can be additive (a fixed amount above or below the trend) or multiplicative (a percentage of the trend), and the trend plus the seasonal variation is used to forecast. Index numbers show changes over time. A Laspeyres index weights prices by base period quantities and a Paasche index by current period quantities. Data can be adjusted for price changes by dividing by a price index. The product life cycle (introduction, growth, maturity and decline) helps to explain why trends change.

Descriptive statistics summarise data. The mean is the average, the median the middle value and the mode the most common. The variance and standard deviation measure how spread out the data is, and the coefficient of variation (standard deviation / mean) allows spread to be compared between data sets. An expected value weights each outcome by its probability. A normal distribution is symmetrical and bell shaped, with about 68 percent of values within one standard deviation of the mean and about 95 percent within two. Descriptive analysis describes the data collected, while inferential analysis draws conclusions about a wider population from a sample.

Big data is described by volume, variety, velocity, value and veracity. It can be structured (in rows and columns), semi-structured or unstructured. Data can also be categorical (nominal or ordinal) or numerical (discrete or continuous). Organisations use big data analytics to find patterns, predict demand and improve decisions. A spreadsheet holds data in rows and columns and uses formulas to analyse it, which makes it useful for budgets, cost schedules and what-if analysis.

Worked figures

High-low: 2,000 units cost $9,000 and 4,000 units cost $13,000. Variable cost = ($13,000 - $9,000) / (4,000 - 2,000) = $2 a unit. Fixed cost = $9,000 - (2,000 x $2) = $5,000.

Regression: for x = 10, 20, 30, 40, 50 and y = 25, 38, 50, 66, 76, the line is y = 12.0 + 1.30x and the correlation coefficient is 0.998.

Expected value: a 30 percent chance of $40,000, a 50 percent chance of $60,000 and a 20 percent chance of $100,000 give 0.3 x 40,000 + 0.5 x 60,000 + 0.2 x 100,000 = $62,000.

Moving average: for monthly sales of 12, 15, 18, 15 and 21, the three-month moving averages are 15, 16 and 18.

Key terms

• Correlation coefficient: A measure from -1 to +1 of the strength of the linear relationship between two variables.
• Moving average: The average of a fixed number of consecutive values, used to find the trend.
• Expected value: The sum of each outcome multiplied by its probability.

Study tip: For high-low questions, pick the highest and lowest activity levels, not the highest and lowest costs, although they are usually the same.

Practice questions for section B

C. Cost accounting techniques

Materials. The control of inventory balances ordering costs against holding costs. The economic order quantity (EOQ) minimises the total of the two: EOQ = square root of (2 x ordering cost per order x annual demand / holding cost per unit per year). The reorder level is the inventory level at which an order is placed, equal to usage in the lead time when demand is constant. Buffer inventory is held in case of variations in demand or lead time. Inventory issues are valued using FIFO, LIFO or average cost, and in a period of rising prices FIFO gives the lowest cost of sales and the highest profit. Just in time (JIT) aims to hold little or no inventory by buying and producing only as needed.

Labour. Direct labour is the cost of employees who make the product, and indirect labour supports production. Pay can be time-based, piecework (paid per unit) or an incentive scheme that rewards performance. Labour turnover is the number of leavers divided by the average number of employees, as a percentage. The efficiency ratio is standard hours produced divided by actual hours worked, the capacity ratio is actual hours worked divided by budgeted hours, and the production volume ratio is standard hours produced divided by budgeted hours.

Overheads. Overheads are allocated to a cost centre when they can be identified with it, and apportioned when they must be shared on a fair basis (for example floor area for rent). Service cost centre costs are then reapportioned to production cost centres, using the reciprocal method when the service centres serve each other. Overheads are absorbed into products using an absorption rate such as budgeted overheads divided by budgeted direct labour hours or machine hours. If the overheads absorbed are lower than those incurred, they are under-absorbed, and if higher, they are over-absorbed. The difference is adjusted in profit or loss.

Absorption and marginal costing. Marginal costing values products at variable cost only, and fixed costs are charged in the period. Absorption costing includes a share of fixed production overheads in the product cost. Contribution is selling price less variable cost. When inventories increase, absorption costing gives a higher profit than marginal costing because some fixed overhead is carried forward in inventory. When inventories decrease, it gives a lower profit. If production equals sales, the profits are equal. The difference in profit is the change in inventory units multiplied by the fixed overhead absorbed per unit.

Cost accounting methods. Job costing is for one-off orders, batch costing for groups of identical items, and process costing for continuous production in which costs are averaged over the units made. In process costing, a normal loss is expected and is not charged to the good units' cost beyond its share, an abnormal loss is an unexpected loss that is charged to profit or loss, and an abnormal gain is a favourable difference. Joint products are major products of the same process, and by-products have a low value. Joint costs are shared at the point of separation, and further processing should be done only if the extra revenue is greater than the extra cost. Service costing uses a suitable cost unit, such as cost per passenger mile or per patient day.

Alternative approaches. Activity-based costing (ABC) assigns overheads using the activities that cause them. Target costing starts with the price the market will pay and works back to the cost allowed. Life-cycle costing considers all costs from design to disposal. The syllabus asks you to explain them and to contrast them with traditional costing. No calculations are required.

Worked figures

EOQ: annual demand 10,000 units, ordering cost $50 an order, holding cost $4 a unit a year. EOQ = square root of (2 x 50 x 10,000 / 4) = 500 units.

Overhead absorption: budgeted overheads $120,000 and budgeted 40,000 machine hours give a rate of $3.00 an hour. Actual hours were 38,000, so $114,000 was absorbed. Overheads incurred were $118,000, so $4,000 is under-absorbed.

Absorption and marginal costing: production was 10,000 units and sales 8,000 units, with no opening inventory. Fixed overhead is $5 a unit. Inventory rose by 2,000 units, so absorption profit is higher by 2,000 x $5 = $10,000.

Process costing: input 1,000 units cost $9,000 with a normal loss of 10 percent. The cost of a good unit is $9,000 / 900 = $10. If output is 880 units, the abnormal loss is 20 units, valued at $200, and good output is valued at $8,800.

Key terms

• Economic order quantity: The order size that minimises the total cost of ordering and holding inventory.
• Absorption rate: The overhead charged to a product for each unit of the chosen basis, such as machine hours.
• Normal loss: The loss expected in a process under normal operating conditions.

Study tip: For overhead questions, write the absorption rate first and then multiply it by the actual activity to get the overhead absorbed.

Practice questions for section C

D. Budgeting

A budget is a financial plan for a future period. Organisations budget to plan, to coordinate activities, to communicate targets, to motivate, to control and to evaluate performance. The planning and control cycle sets objectives, makes plans, takes action, compares actual results with the plan and takes corrective action. The principal budget factor is the factor that limits activity, usually sales, and it is the starting point of the budget. Forecasts predict what is likely to happen, while a budget sets what the organisation intends to happen.

Budget preparation starts with the sales budget. The production budget is sales plus closing inventory minus opening inventory. The raw materials usage and purchases budgets, the labour budget and the overhead budgets follow from it. The cash budget shows expected receipts and payments by period, and the master budget brings the budgeted statement of profit or loss and statement of financial position together. What-if analysis and scenario planning test how results change if assumptions change. The general economic environment and sustainability should also be considered.

A fixed budget is set for one level of activity. A flexible budget is adjusted to the actual level of activity, so that actual results are compared with a budget for the same activity. To flex a budget, variable costs and revenue are changed in proportion to activity, and fixed costs stay the same. Flexible budgets are better for control when actual activity differs from the plan.

Asset budgeting and investment appraisal. Capital expenditure on assets gives benefits over several years and needs separate planning and control. Simple interest is paid only on the original sum, and compound interest is paid on the sum plus the interest earned. A nominal rate is the quoted annual rate, and the effective rate allows for compounding within the year. Discounting converts future cash flows to present values. Net present value (NPV) is the sum of discounted cash flows less the investment, and a project with a positive NPV adds value. The internal rate of return (IRR) is the discount rate at which the NPV is zero, and a project is acceptable if the IRR is above the required rate. Payback is the time taken to recover the investment, and discounted payback uses discounted cash flows. Payback is simple but ignores cash flows after the payback period. Only relevant future cash flows are used, and profit measures such as depreciation are excluded. The present value of an annuity is the annual amount multiplied by (1 - (1 + r) to the power of minus n) / r, and the present value of a perpetuity is the annual amount divided by r.

Budgetary control and reporting. Variances are differences between actual results and the flexed budget, or the fixed budget. A control report should highlight significant variances and recommend action. Responsibility accounting makes managers responsible for the costs and revenues they control, so that controllable costs are separated from uncontrollable costs.

Behavioural aspects. Budgets affect motivation. Targets that are challenging but achievable motivate, and those that are too easy or impossible do not. A participative (bottom-up) approach involves the managers who will meet the budget, which gives better information and commitment but takes longer and can lead to budget slack. A top-down approach is faster and fits the organisation's goals, but may lower commitment. Incentive schemes linked to budgets can encourage managers to act in their own interest instead of the organisation's.

Worked figures

Production budget: sales 5,000 units, closing inventory 1,000 and opening inventory 800. Production = 5,000 + 1,000 - 800 = 5,200 units.

Flexing: a budget of $96,000 variable cost for 10,000 units flexes to 12,000 units as $96,000 / 10,000 x 12,000 = $115,200. Fixed costs would be unchanged.

NPV: an investment of $100,000 returns $40,000 a year for 3 years at 10 percent. The annuity factor is 2.4869, the present value is $99,474 and the NPV is $-526. The NPV is negative, so the project is not acceptable at 10 percent. Payback is $100,000 / $40,000 = 2.5 years.

Key terms

• Principal budget factor: The factor that limits the activity of the organisation, such as sales demand.
• Flexible budget: A budget adjusted for the actual level of activity.
• Net present value: The present value of future cash flows less the initial investment.
• Budget slack: Deliberately underestimating revenue or overestimating costs to make a budget easier to achieve.

Study tip: In the cash budget, include only cash items. Depreciation is never a cash flow.

Practice questions for section D

E. Standard costing

A standard cost is a predetermined unit cost based on expected prices and quantities. Standard costing sets standards, compares actual results with them and explains the differences as variances. Under standard absorption costing the standard cost includes fixed overheads, and under standard marginal costing it includes only variable costs. A standard cost card shows the standard quantity and price for materials, the standard hours and rate for labour, and the overhead rates for one unit.

Material price variance = (standard price - actual price) x actual quantity purchased. Material usage variance = (standard quantity for actual output - actual quantity used) x standard price. Labour rate variance = (standard rate - actual rate) x actual hours paid. Labour efficiency variance = (standard hours for actual output - actual hours worked) x standard rate. Variable overhead expenditure and efficiency variances are calculated in the same way using the variable overhead rate. For fixed overheads, the expenditure variance is budgeted fixed overhead less actual fixed overhead, and the volume variance is (actual output - budgeted output) x standard fixed overhead rate per unit. Where there is idle time, labour variances can be split into idle time and efficiency variances. The sales price variance is (actual price - standard price) x actual units sold, and the sales volume variance is (actual units - budgeted units) x standard profit (or contribution) per unit. A positive result is favourable (F) and a negative result is adverse (A) in each of these formulas.

Variances are interrelated. Buying cheaper material may cause a favourable price variance but an adverse usage variance if the quality is poor. Using more skilled and better paid workers may cause an adverse rate variance but a favourable efficiency variance. Before investigating a variance, consider its size, whether it is likely to continue, how controllable it is, and the cost of investigating compared with the likely benefit. Possible causes include price changes, waste, poor quality, machine breakdowns, changes in the workforce and errors in the standard itself. Exception reporting reports only on variances that are outside agreed limits.

Reconciliation. Budgeted profit is reconciled to actual profit by listing the sales and cost variances. Under absorption costing the reconciliation starts with the budgeted profit and adds favourable and subtracts adverse variances. Under marginal costing it can start with budgeted contribution or profit. If the variances are given, actual or standard figures can be found by working backwards.

Worked figures

A unit has a standard material usage of 2 kg at $5 a kg. Actual output is 1,000 units. 2,100 kg were bought and used at $4.80 a kg. Price variance = (5 - 4.80) x 2,100 = $420 favourable. Usage variance = (2,000 - 2,100) x 5 = $500 adverse. The total variance is $80 adverse, which is the standard cost of $10,000 less the actual cost of $10,080.

Labour: standard 3 hours at $10. Actual hours worked and paid were 3,100 at $10.30 for 1,000 units. Rate variance = (10 - 10.30) x 3,100 = $930 adverse. Efficiency variance = (3,000 - 3,100) x 10 = $1,000 adverse.

Sales price: 1,000 units sold at $52 against a standard of $50. Variance = (52 - 50) x 1,000 = $2,000 favourable.

Key terms

• Standard cost: A predetermined unit cost based on expected prices and quantities.
• Adverse variance: A variance that reduces profit compared with the standard.
• Exception reporting: Reporting only the variances that are outside agreed limits.

Study tip: Use the same layout every time: standard cost of actual output on one line, actual cost on the next, and the difference is the total variance.

Practice questions for section E

F. Performance measurement

Performance measurement links activity to the organisation's aims. A mission statement says why the organisation exists. Strategic objectives are long term and set the direction, tactical objectives are medium term and operational objectives are short term and specific. Critical success factors (CSFs) are the things that must go right to achieve objectives, and key performance indicators (KPIs) measure how well each CSF is being achieved. Economic conditions, government regulation and sustainability issues all affect which measures matter.

Financial measures cover profitability (such as gross margin, operating margin and return on capital employed), liquidity (current and quick ratios), efficiency (such as inventory, receivables and payables days) and gearing. Non-financial measures cover areas such as customer satisfaction, quality, delivery times, staff turnover and innovation. They help to explain financial results and give an earlier warning.

The balanced scorecard looks at four perspectives: financial, customer, internal business process, and innovation and learning. Each has measures that are linked to the objectives. It gives a wider view than financial measures alone, but it can be complex to set up and requires choices about which measures to use. Economy, efficiency and effectiveness are another framework. Economy means spending less to obtain inputs, efficiency means getting more output from inputs, and effectiveness means achieving the aims. They are often called the three Es.

Cost control keeps costs within the budget or standard. Cost reduction lowers the standard cost permanently. Methods include value analysis (removing cost that does not add value to a product while keeping quality and function), redesign, better purchasing and removing waste. In service industries, performance is harder to measure because the output is intangible, varies with each customer and cannot be stored, so a mix of financial and non-financial measures is used. Short-term results should be balanced against long-term performance, and managers should avoid cutting spending on training or research simply to meet a short-term target.

Key terms

• Critical success factor: An area in which the organisation must perform well to achieve its objectives.
• Key performance indicator: A measure of how well a critical success factor is being achieved.
• Value analysis: A review of a product to remove cost that does not add value.

Study tip: For scorecard questions, name the perspective first and then give a sensible measure for it.

Practice questions for section F