- •Lecture Notes b.Devlin
- •Introduction
- •Management accounting
- •1 Financial accounting.
- •2 Management accounting
- •To provide information about product costing to be used in financial
- •To provide information for planning, controlling and organising.
- •To ascertain the cost of a product. This information is used to value stock which is required for external reporting .
- •To assist management in the decision-making process.
- •Marginal costing
- •Decision making
- •In the short-run all fixed costs remain unchanged and therefore treated as irrelevant.
- •Variable overhead
- •2 Shut-down decisions
- •3 Make or Buy
- •Variable overheads £2
- •Variable cost of production £7
- •Variable overhead £2
- •4 Limiting factor decisions
- •5 Profit Planning or cost profit volume analysis
- •Cost volume profit analysis
- •It is possible to ascertain these by using a break-even chart or by using formulae.
- •Budgeting
- •1. Sales Budget 19x0
- •Production budget 19x0
- •3. Materials Usage Budget 19x0 (Component usage)
- •4. The Material Purchase Budget 19x0
- •Cash summary December 19x0
- •Depreciation never appears in a cash budget as it is a non-cash expense.
- •In respect to credit transactions time lags have to be built into the cash budget
- •It is useful to have a memo column to record items which will appear in the balance sheet if required. Budgeted Profit and Loss Account for six months ending 30 June 19x1
- •Budgeted Balance Sheet as at 30 June 19x1
- •Investment appraisal methods
- •1 Payback
- •2 Accounting rate of return
- •Investment appraisal compares the cash outflows with the cash returns from the project and these cash flows take place over a lengthy period of time.
- •3 Net Present Value
- •6 Profitability Index
- •The costing
- •Overheads
- •Indirect materials used in Dept. B £35,000
- •Insurance of machinery £5,000
- •In the absorption stage an overhead recovery (absorption) rate (oar) is calculated. The formula used is:
- •30,000 Machine hrs.
- •35,000 Labour hrs.
- •In recent years there has been criticism of the traditional system of costing for overheads ( Kaplan & Cooper ). Traditional cost systems were designed when:
- •Information processing costs were high;
- •Inspection cost:
- •Standard costing
- •Variances represent the differences between standard costs and actual costs. The standard cost is what the cost is estimated to be and this is compared to what the cost is actually.
- •Variable Overhead Variance
- •Variable overhead efficiency variance
- •Responsibility accounting
- •It is a ‘ system of accounting that segregates revenues and costs into areas of personal responsibility in order to assess the performance attained by persons to whom authority has been assigned’.
- •Net Residual Income
2 Accounting rate of return
This method establishes the relationship between the capital cost of a project and the profits accruing. The accounting rate of return is calculated by the following formula.
Average annual profit
------------------------------- x 100
Average cost of investment
An average profit is calculated over the life of the project. The average cost of investment is calculated by adding the initial cost of the investment and the value at the end of its useful life divided by two.
Example:
A company has two alternative projects A and B, each involving an outlay of £500,000 and £600,000
Each project has an economic life of 5 years. Project A has a residual value of £50,000. Annual profits before depreciation is £200,000 before depreciation.
|
Project A |
Project B |
|
£ |
£ |
Initial outlay |
500,000 |
600,000 |
Annual profits (Yr. 1-5) |
1,000,000 |
1,000,000 |
Less depreciation (Yr. 1-5) |
500,000 |
550,000 |
|
---------- |
---------- |
Profits after depreciation |
500,000 |
450,000 |
|
--------- |
--------- |
Average net profit |
100,000 |
90,000 |
|
---------- |
-------- |
Accounting rate of return |
40% |
28% |
The ARR method is easy to administer and is understood by business in general because of is similarity with the return on investment (ROCE) ratio.
The main disadvantage with payback and accounting rate of return is both ignore the time value of money. Money has a value in time, namely, a rate of interest. If £1 is invested for 1 year at a rate of interest of 10% the investment grows to £1.10 at the end of year 1. If £1.10 is invested in year 2 the investment
grows to £1.21 at the end of year 2. This process is called compounding which is represented by the formula £1(1 + r)n.
The opposite of compounding is discounting. This answers the question ‘ what is £1 receivable in a year’s time worth in today’s value?’ In present value terms £1 receivable in a years time (assuming the rate of interest is 10%) is £0.909. The formula for discounting is: £1
-----------
(1 + r)n
Investment appraisal compares the cash outflows with the cash returns from the project and these cash flows take place over a lengthy period of time.
Discounting allows all the cash flows to be converted to present day values which permits meaningful comparison. The following investment appraisal methods employ the discounting of cash flows.