MGT402 Short Notes Lectures 23 ~ 45
Lec # 23
PROCESS COSTING SYSTEM
(Opening balance of work in process)
Two methods of cost allocation
(1) The weighted average (or averaging) method
(2) The FIFO method.
Weighted average method
In the weighted average method opening stock values are added to current costs
• It is more complicated to operate
• In process costing, it seems unrealistic to relate costs for the previous period to the current Period of activities
Choosing the valuation method in examinations
In order to use the weighted average or FIFO methods to account for opening work-in-process different information is needed, as follows:
For weighted average An analysis of the opening work-in-process value
Into cost elements (i.e. materials, labor)
For FIFO The degree of completion of the opening work in process for each cost element.
TYPES OF BUDGET
Determining the future is a summary of the firm's expected cash inflows and outflows over a particular period of time.
Cash budget is to enable the firm to meet all its commitments in time
And at the same time prevent accumulation at any lime of unnecessary large cash balances with it:
Format of Cash Budget
For the month of XXX – XXX
Add Receipts (Anticipated cash
Receipt from all sources)
Less Payments (Anticipated utilization of cash)
Excess / Deficit
Bank barrowing / Overdraft
COMPLEX CASH BUDGET & FLEXIBLE BUDGET
The Flexible Budget is designed to change in accordance with the level of activity attained. Such a budget is prepared after considering the fixed and
Variable elements of cost and the changes that may be expected for each item at various levels of Operations
FLEXIBLE & ZERO BASE BUDGETING
Budget is a part of the planning process.
(1) Activity Ratio
(2) Capacity Ratio
(3) Efficiency Ratio
If the ratio works out to 100 per cent or more, the trend is taken as favorable, if the ratio is less than 100 per cent, the indication is taken
Standard hours for actual production
Activity Ratio = ___________________________________ x 100
Actual hours worked
Capacity Ratio = ____________________ x 100
Standard hours for actual production
Efficiency Ratio = ____________________________________ x 100
Actual hours worked
A performance budget presents the operations of an organization in terms of functions, programmers, activities, and projects.
The primary purpose of traditional budget particularly in government administration is to ensure financial control and meet the requirements of legal accountability, that is, to ensure that appropriation.
Objectives of PB
(1) to coordinate the physical and financial aspects
(2) To improve the budget formulation, review and decision-making at all levels of management
(3) To facilitate better appreciation and review by controlling Authorities (legislature, Board of Trustees or Governors, etc.) as the presentation is more
Purposeful and intelligible
(4)To make more effective performance audit possible
(5) To measure progress towards long-term objectives which are envisaged in a development plan
Zero base Budgeting
Zero base Budgeting technique suggests that an organization should not only make decisions about the proposed new programmers, but should also, from time to time, review the appropriateness of the existing.
The concept of Zero base Budgeting has been accepted for adoption in the departments of the Central Government and some State Governments.
DECISION MAKING IN MANAGEMENT ACCOUNTING
Costs appropriate to a specific management decision
The amount by which costs increase and benefits decrease as a direct result of a specific management decision’ Relevant benefits are ‘the amounts by which costs decrease and benefits increase as a direct result of a specific management decision’
An incremental cost can be defined as a cost which is specifically incurred by following a course of action and which is avoidable if such action is not taken.
These are costs, which will not be affected by the decision at hand. Non-incremental costs are non-relevant costs because they are not related to the decision at hand
The labor cost is non-relevant
Opportunity costs (relevant cost)
An opportunity cost is a level of profit or benefit foregone by the pursuit of a particular course of action.
Sunk cost(non-relevant cost)
A sunk cost is a cost that the already been incurred and cannot be altered by any future decision
Sunk costs are the opposite of opportunity costs in that they are not incorporated in the decision making process even though they have already been recorded in the books and records of the enterprise.
Q: why companies close down temporarily?
ANS: Companies are often faced with the problem of whether to close down temporarily a part of the plant during periods of low demand.
Arguments against shut-down
(a) If the company continues operation, expenses that would be incurred with the closing down of the plant will be saved; e.g. an increase in factory security.
(b) Continued operation means saving (he expenses that will otherwise be incurred if the plant is reopened again at a later stage.
(c) A shut-down for a short period of fine will not eliminate all costs. Rent, rates, depreciation and insurance will have to be incurred during the shutdown period.
(d) If the factory is shut down, this will affect not only morale but also its market standing if it cannot meet consumer demand.
The role of fixed costs
If the decrease or increase in the level of activity affects fixed costs then these costs should be considered differential costs.
It is generally accepted that if the plant has excess capacity then new or additional volume may be accepted if the selling price ii greater than variable costs. In such a situation, fixed costs arc not relevant if they remain fixed at an increased level of output
The role of variable costs
In differential cost studies, if the plant is not operating at practical capacity owing to lack of orders, variable costs usually represent the differential cost whether they are incremental or avoidable. The term refers to those costs that will change. It is often assumed that the variable cost per unit will remain constant regardless of the level of activity.
DECISION MAKING (Contd.)
Decision making should be based on relevant costs.
• Relevant costs are future costs
• Relevant costs are cash flows
• Relevant costs are incremental costs
Differential Costs and Opportunity Costs
Relevant costs are also differential costs and opportunity costs.
• Differential cost is the difference in total cost between alternatives.
For example, if decision option A costs Rs. 300 and decision option B costs Rs. 360, the differential costs is Rs. 60.
• An opportunity cost is the value of the benefit sacrificed when one course of action is chosen in preference to an alternative.
Controllable and Uncontrollable Costs
Controllable costs are items of expenditure which can be directly influenced by a given manger within a given time span.
As a general rule, committed fixed costs such as those costs arising form the possession of plant, equipment and buildings (giving rise to deprecation and rent) are largely uncontrollable in the short term because they have been committed by longer-term decisions.
Fixed and Variable Costs
• Variable costs will be relevant costs.
• Fixed costs are irrelevant to a decision
Attributable Fixed Costs
There might be occasions when a fixed cost is a relevant cost, and you must be aware of the distinction ‘specific’ or ‘directly attributable’ fixed costs, and general fixed overheads
Absorbed Overhead and fixed overhead
Absorbed overhead is a national accounting cost and hence should be ignored for decision making purposes.
It is overhead incurred which may be relevant to a decision.
General fixed overheads are those fixed overheads which will be unaffected by decisions to increase or decreased the scale of operations, perhaps because they are an apportioned share of the fixed costs of items which would be completely unaffected by the decision.
General fixed overheads are not relevant in decision making.
CHOICE OF PRODUCT (PRODUCT MIX) DECISIONS
Make or Buy Decisions and Limiting Factors
In a situation where a company must subcontract work to make up a shortfall in its won production capability, its total costs are minimized if those components/products subcontracted are those with the lowest extra variable cost of buying per unit of limiting factor saved by buying.
DECISION MAKING (Contd.)
Shut Down Decisions
(1) Whether or not to shut down a factory, department, or product line either because it is making a loss or it is too expensive to run.
(2) If the decision is to shut down, whether the closure should be permanent or temporary.
The decision to accept or reject a contract should be made on the basis of whether or not the contract increases contribution and profit.
Other factors to consider in the one-off contract decision.
A. The acceptance of the contract at a lower price may lead other customers to demand lower prices as well.
B. There may be more profitable ways of using the spare capacity.
C. Accepting the contract may lock up capacity that could be used for future full-price business.
D. Fixed costs may, in fact, if the contract is accepted.