ACCA F5
Performance
Management
Introduction
Aims of the course

Technical knowledge

Application of skills

Exam technique

PASS the exam
Links With Other Courses
Advanced
Performance
Management (P5)
Performance
Management (F5)
Management
Accounting (F2)
What are you going to do?
Study
Study
Study!!!
Part A
Specialist Cost and
Management Accounting
Techniques
Outlines


1. Costing
2. Accounting Techniques





2a. Activity Based Costing
2b. Target Costing
2c. Lifecycle Costing
2d. Backflush Accounting
2e. Throughput Accounting
Section 1
Costing
成本计量

1. Costing is the process of determine the
costs of products, services or activities.
Direct Cost
Indirect Costs
Material Labour Expense
Production Non-production
Absorbed overhead
Product Cost
TOTAL COST
Under/over absorbed OH

2. The problem of overhead



How to treat the indirect costs (or Overheads) ?
E.g. Factory rent and rates; supervision costs; machine
depreciation; heating and lighting etc.
2.1 Use Absorption Costing method
 Product cost = direct costs + a portion of all production
overhead expenditure
 Reasons:




Inventory valuations
Pricing decisions
Establishing the profitability of different products
2.2 Use Marginal Costing Method
 Product cost = all variable costs
 Absorption costing can be misleading

3. A revision of absorption costing

3 stages:




Direct costs
+ Overhead traceable to cost center
+ a share of general overhead costs
+ a share of service cost centers cost
Total overhead costs
1. Allocation stage
2. Apportionment
stage
Using overhead absorption rates to allocated to the
production cost: 3. Absorption stage
Cost per unit
calculation
Example: CD Factory

4. Overhead absorption



Absorption rate = estimated overhead / budgeted
activity level
E.g. a rate per machine hour; a rate per direct
labor hour
E.g. Produce 20,000 CDs


Pressing = $13,200/20,000 CDs = $0.66
Packing = $6,800/20,000 CDs = $0.34
$1.00 → add to cost card

Problem: Over and under absorption of overheads


Because the overhead absorption rate is based on
estimates (of both numerator and denominator), it is
possible has a variance at the end of period.
E.g. the budgeted overhead = $80,000, the budgeted
activity level = 40,000 direct labor hours, the actually
overheads = $84,000 and 45,000 direct labor hour:




1. absorption rate = $80,000 / 40,000 =$2
2. overhead absorbed = $2 x 45,000 = $90,000
3. overhead incurred (actual) = $84,000
4. over-absorption of overhead = $90,000 - $84,000 = $6,000

5. Marginal costing


In marginal costing, inventories are valued at
variable production cost whereas in absorption
costing they are valued at their full production
cost.
Contribution = sales revenue – variable (marginal)
costs.

6. Absorption Costing and Marginal Costing
Compared


If opening and closing inventory levels differ, profit reported
under the two methods will be different.
In the long run, total profit will be same whatever method is
used.
 (a) Production = sales (so inventory is constant)


(b) Production < sales (so inventory is falling)


AC profit < MC profit
(c) Production > sales (so inventory is climbing)


AC profit = MC profit
AC profit > MC profit
You can remember which profit will be highest using SIAM
 S – Stock (Inventories)
I – Increase
 A – Absorption profit
M – More

Advantages and disadvantages of absorption
costing


Advantages of absorption costing.
 It recognizes that selling prices must cover all costs.
 It complies with IAS 2 on accounting for inventory, whereby
the value of inventory must include an appropriate amount
of fixed production overhead.
Disadvantages of absorption costing.
 Profits can be manipulated by simply changing production
levels. This is because overheads will be carried forward in
closing inventory.
 It is based on the assumption that overheads are volume
related. In the next part we will see that ABC assumes that
many overheads are complexity and diversity related, not
merely volume related.

Advantages and disadvantages of marginal costing
 Advantages





Most appropriate for decision making as it highlights contribution.
(It is useful for short-term pricing decisions.)
Fixed costs are treated in accordance with their nature, ie as
period costs.
Profit depends on sales and efficiency not on production levels.
Slightly simpler variance analysis.
Disadvantages




There is a danger that products will be sold on an ongoing basis
at a marginal contribution which fails to cover fixed costs.
Does not comply with IAS 2, thus need year end adjustments for
the preparation of published accounts.
Need analysis of mixed costs between fixed and variable.
Seasonal variations in a year can cause unnecessary profit
variances.

(1) Prepare an income statement under absorption costing and
marginal costing respectively, and (2) reconcile the profit figures.
Solution
Direct cost = $2 +$3 +$1= $6
=$6 x 4400
= $8000/4000 x 4400
= ($6+$2) x (4400 – 4200)
=8800 - 8500
No proportion of
fixed production
costs
= actual fixed production cost
Section 2
a. Activity Based Costing
(ABC)
作业成本法
Outline


ABC was regularly examined in Paper 2.4 and is a
question on the Pilot Paper for F5. It is therefore a
crucial topic. You should expect both calculations
and interpretation.
Having studied this chapter you will be able to:




Identify appropriate cost drivers under ABC
Calculate costs per driver and per unit using ABC
Compare ABC and traditional methods of overhead
absorption
Explain the implications of switching to ABC for pricing,
sales strategy, performance management and decisionmaking
1. Activity Based Costing



An alternative to absorption costing is ABC.
Traditional absorption costing uses a single
basis for absorbing all overheads into cost
units for a particular production department
cost centre.
ABC considers what causes each type of
overhead category to occur. Each type of
overhead is absorbed using a different basis
depending on the cost driver.

Steps in ABC




1. Group overheads into activities, according to
how they are driven. These are known as cost
pools.
2. Identify the cost drivers for each activity, ie
what causes the activity cost to be incurred.
3. Calculate a cost per unit of cost driver.
4. Absorb activity costs into production based on
usage of cost drivers.

Cost driver analysis

complex business environment: costs are incurred
because cost drivers occur at different levels.


For costs that vary with production level in the short
term, the cost driver will be volume related (labor or
machine hours).
Overheads that vary with some other activity should
be traced to products using transaction-based cost
drivers, such as number of orders received and
number of production runs.
Identifying Activity
Unit-Level
Activity
Batch-Level
Activity
A part of the production
process for which management
wants a separate reporting of the
costs of the activity involved.
Product-Level
Activity
OrganizationSustaining
Activity
Customer-Level
Activity
Cost Hierarchy

Unit-level activities （单位层面作业）Performed when a unit
is produced.



Batch-level activities （批量层面作业）Performed each time
a batch (group) of goods is handled or processed.


Depend on volume of output.
e.g. maintenance done, supplies used, indirect labour required
e.g. placing purchase orders, setups of equipment, shipments
to customers
Product-level activities （产品层面作业）Performed as
needed to support the production of each different type of
product.

e.g. designing a product, advertising a product
Cost Hierarchy

Customer-level activities（客户层面作业） relate to
specific customers and include activities


E.g.: sales calls, catalogue mailings, and general
technical support that are not tied to any specific product.
Organization-sustaining activities （企业维持作业）
Costs of maintaining overall general manufacturing
capacity.


Cannot be directly traced to units, batches or product
lines.
E.g.: heating factory, cleaning executive offices,
arranging for loans
2. Absorption costing vs ABC


Overhead absorption rates using ABC
should be more closely linked to the causes
of overhead costs.
The modern business environment has
much wider product ranges than seen before,
complex production process and decreasing
product lifecycles. ABC recognizes these
factors by using multiple cost drivers when
absorbing overheads.
Overhead absorption rates
Stage One:
Costs assigned
to pools
Cost pools
（成本池）
Indirect
Labour
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3
Overhead absorption rates
Stage One:
Costs assigned
to pools
Cost pools
Stage Two:
Costs applied
to products
Indirect
Labour
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3
Products
Overhead absorption rates
Stage One:
Costs assigned
to pools
Cost pools
Stage Two:
Costs applied
to products
Indirect
Labour
Indirect
Materials
Other
Overhead
Department
1
Department
2
Department
3
Direct
Labour
Hours
Machine
Hours
Raw
Materials
Cost
Products
Departmental Allocation Bases
Example
Bell Co. produces two telephones: a cordless phone and a
regular model. The company has the following estimated
and actual data.
Budgeted overhead
Expected activity (in direct labour hours)
Actual overhead
Actual activity (in direct labour hours)
Budgeted OA
Fabrication
$252,000
Assembly
$108,000
$360,000
100,000
$380,000
100,000
TOTAL
$360,000
Cost drivers:
Assembly department – Direct labour hours (DLH)
Fabrication department – Machine hours (MH)
Stage One: Pool Formation
$252,000
$108,000
Fabrication
Assembly
Budgeted OA
Expected/actual
DLH
Cordless
Regular
Total
MH
Cordless
Regular
Total
Fabrication Assembly
TOTAL
$252,000
$360,000
$108,000
Fabrication rate:
$252,000 ÷ 40,000 MH = $6.30 per MH
7,000
13,000
20,000
3,000
77,000
80,000
10,000
90,000
100,000
4,000
36,000
40,000
1,000
9,000
10,000
5,000
45,000
50,000
Budgeted OH
Fabrication Assembly
TOTAL
$252,000
$360,000
$108,000
Assembly rate:
Expected/actual
$108,000 ÷ 80,000 DLH = $1.35 per DLH
DLH
Cordless
7,000
3,000
10,000
Regular
13,000
77,000
90,000
Total
20,000
80,000
100,000
MH
Cordless
4,000
1,000
5,000
Regular
36,000
9,000
45,000
Total
40,000
10,000
50,000
Stage Two: Costs Assigned
Overhead costs are then assigned to products. The
OARs are multiplied by the actual amount
of the cost drivers used in each department by each
product.
Cordless
Regular
Fabrication
$4,050
($1.35 x 3,000 DLH)
$103,950
($1.35 x 77,000 DLH)
Assembly
$25,200
($6.30 x 4,000 MH)
$226,800
($6.30 x 36,000 MH)
$29,250
$330,750
Total
ABC System 作业成本法

作业成本法的意义：

真正控制成本，不仅要控制成本的数量和成本的分
配，更应确定生成成本的关键因素 （成本动因）。
制造费用不仅随着产量变动，也随制造的差异性和
复杂性而变动。
Example
Bell Co. produces two telephones: a cordless phone
and a regular model. The company has the following
estimated and actual data.
Budgeted overhead
Expected activity (in direct labour hours)
Actual overhead
Actual activity (in direct labour hours)
$360,000
100,000
$380,000
100,000
Notice: a significant portion of overhead costs is not
driven or caused by direct labour hours. Look below.
Activity Cost Data
(overhead activities)
Activity
Activity Costs
Setup
$120,000
Material handling
60,000
Machining
100,000
Testing
80,000
Total
$360,000
Setup and materials handling activities (50% of the
overhead costs) are batch-level activities related to
the number of production runs and material moves,
respectively.
The following shows the activity usage measures
Units produced per yr
Prime costs
Direct labour hours
Machine hours
Production runs
Number of moves
Cordless
10,000
$78,000
10,000
5,000
20
60
Regular
Total
90,000 100,000
$738,000 $816,000
90,000 100,000
45,000
50,000
10
30
30
90
Now, let’s compute a rate for each overhead activity,
then use these activity rates to assign overhead costs.
Activity Cost Data
(overhead activities)
Activity
Activity
Activity
Rate
Costs
Measures
Setup
$120,000 30 runs
$4,000/run
Material handling
60,000 90 moves $666.67/move
Machining
100,000 50,000 MH
$2.00/MH
Testing
80,000 100,000 DLH $0.80/DLH
Total
$360,000
Stage One: Pool Formation
Allocation of the $360,000 overhead to four cost
pools for purpose of computing allocation rates
$60,000
$120,000
Setup
Machining
Testing
Materials
Handling
$80,000
$100,000
Let’s examine the manufacturing overhead cost
applied to both models
Cordless
Applied overhead costs:
Setups:
($4,000 x 20 runs)
($4,000 x 10 runs)
Material handling:
($666.67 x 60 moves)
($666.67 x 30 moves)
Machining:
($2 x 5,000 MH)
($2 x 45,000 MH)
Testing:
($0.80 x 10,000 DLH)
($0.80 x 90,000 DLH)
Manufacturing costs
Regular
80,000
40,000
40,000
20,000
10,000
90,000
8,000
$138,000
72,000
$222,000
Stage Two: Cost Allocation
Allocation of the $360,000
manufacturing overhead applied
$222,000
$138,000
Cordless
Regular
The Classic Brass
Activity Cost Pools at Classic Brass
Activity Cost Pool
Customer Orders
Product Design
Order Size
Customer Relations
Other
Activity Measure
Number of customer orders
Number of product designs
Machine-hours
Number of active customers
Not applicable
Example



Dodo Ltd manufactures three products, A, B and C. Data for the
period just ended is as follows
A
B
C
Output (units)
20,000
25,000
2,000
$/unit
$/unit
$/unit
Sales price
20
20
20
Direct material cost
5
10
10
Labour hours/unit
2
1
1
Wages paid at $5/hr
Total production overheads for Dodo Ltd amount to $190,000.
Required
(a) Calculate the profit per unit obtained on each product if
production overheads are absorbed on the basis of labour hours
(Traditional Absorption Costing).

Solution
Total labor hours = 20,000 x 2 + 25,000 x 1 + 2,000 x 1= 67,000
=$2.836 X 2 + 5 +2 X 5
=20,000 unit x2 +25,000 x 2 + 2,000 x 2
= 0.585 x (25,000 x 2)
Implications of ABC

When ABC should be used:




(a) When production overheads are high
relative to prime costs (eg service sector)
(b) When there is a whole diversity of product
range
(c) When there are considerable differences in
the use of resources by products
(d) Where consumption of resources is not
driven by volume
Benefits of ABC

The use of ABC provides opportunities for:





(a) Cost control and reduction by the efficient
management of cost drivers
(b) Better costing information used to assist
pricing decisions
(c) Reanalysis of production and output/product
mix decisions
(d) Profitability analysis (by customer, product
line etc)
(e) A more realistic estimate of costs and profits
which can be used in performance appraisal
Criticisms of ABC





(a) It is time consuming and expensive
(b) Will be of limited benefit if overhead costs are
primarily volume related
(c) Reduced benefit if the company is producing
only one product or a range of products with similar
costs
(d) Complex situations may have multiple cost
drivers
(e) Some arbitrary apportionment may still exist
Implications

Before considering a switch to ABC it is
important to consider whether the benefits
outweigh the costs and to ensure that the
appropriate cost drivers can be identified as
such a switch will have implications on:




Pricing
Sales strategy
Performance management
Decision making
Exercise

Activity rates in activity-based
costing are computed by
dividing costs from the firststage allocations by the activity
measure for each activity cost
pool.

In traditional costing systems, all
manufacturing costs are assigned
to products—even manufacturing
costs that are not caused by the
products.
true

If personnel department expenses are
allocated on the basis of the number of
employees in various departments, then the
number of employees in the personnel
department itself must be included in the
allocation base when the step method is used.
true
false
House Inc. manufactures 2 product on a common assembly line
by the same direct laborers. Different direct materials are used
in each type and the machinery is retooled for each product.
Until now, MO costs have been allocated on the basis of direct
labour-hours using a plant-wide rate. The manager is
considering the adoption of ABC method. Following
information is provided:
Required:
a. Use ABC and single OAR determine the total manufacturing
cost of each of the two product lines and the cost per unit.
b. Which of the two products is undercosted / overcosted? How
it affects cross-subsidization?
Solution- a: i) ABC
Solution- a: i) single OAR
Solution- b

Cross-subsidization can occur with plant-wide costing where
overhead, which is not closely connected with the actual
activities giving rise to the overhead amounts (i.e., the true cost
drivers), is applied to products using differing quantities of
those cost drivers. Such a broad application of overhead can
distort the true cost of manufacturing those products.

For House, the unit cost to manufacture product B is actually
higher than it appears using the plant-wide overhead rate, and
the unit cost to manufacture product A is less than it appears
using the plant-wide overhead rate.
This may affect the pricing of the two products, the revenue
generated by each product (price may affect demand) and,
consequently, the company’s overall profitability.



It may also negatively affect management decisions about
where to direct new resources available to the company.
In this case, product B are being undercosted and are being
subsidized by product A, which are being overcosted when a
plant-wide overhead rate is used.
Section 2
b. Target Costing
目标成本法

Objectives:





Derive a target cost in manufacturing and service
industries
Explain the difficulties of using target costing in service
industries
Explain the implications of using target costing on pricing,
cost control and performance management
Suggest how a target cost gap might be closed
Exam Context

Target costing may form all or part of a question. You
should be prepared to not only calculate a target cost but
also to discuss the difficulties and implications of using
target costing.
Overview
1. Cost plus pricing vs Target
costing

Cost plus pricing




traditional approaches
Businesses calculate the cost
of manufacturing and selling
a product, and then add mark
up, to give the profit element.
A major criticism: they do not
consider any external factors
(eg demand for product; no.
of competitors, etc).
They are therefore unlikely to
maximise the profits that a
business will generate.

Target costing





Short product life cycles
The planning, development
and design stage of a
product becomes critical.
Cost reduction must be
considered at early stage of
a product’s life cycle, rather
than during the production
process.
Target costing involves
setting a selling price for
your product by reference to
the market.
From this your desired profit
margin is deducted leaving
you with a target cost.
2. Deriving a target cost
Implementing target costing







(a) Define product specification and estimate
anticipated sales volume.
(b) Set a target selling price at which the company will
be able to achieve the desired market share.
(c) Required profit is estimated based on profit
margins or return on investment.
(d) Calculat target cost
(e) The estimated cost of the product is calculated
based on the product specification and current cost
levels.
(f) Estimated Product Cost – Target Cost = Cost Gap
(g) Efforts are made to close the cost gap. Aim to
"design out" costs before production starts.
3. Implications


Target costing turns the traditional cost plus
approach to pricing on its head, meaning pricing is
the first consideration. Cost control is considered
right up front as part of the development of the
product not merely as an activity which happens
alongside production.
Performance management will therefore focus on
ensuring sales targets are met: ie have we set the
right price and ways of improving processes /
development to drive down costs to at least the level
of the target cost.
4. Closing a target cost gap

How to close a target cost gap?






Cheaper materials
Fewer parts
Cheaper labour
No non-value adding activities
Training
Automation
5. Implications of target
costing in service industries



The target costing approach is a sensible basis for estimating /
driving down costs regardless of the type of business. However,
due to the nature of service industries this process is more
difficult in these businesses.
Unlike manufacturing, service industries have the following
characteristics which make cost and performance measurement
more difficult:
 Simultaneity – created at time consumed
 Heterogeneity – quality / consistency varies
 Intangibility – of what is provided
 Perishability – cannot make in advance and store up.
In addition to these problems, service organisations will require
more qualitative information to arrive at a price and evaluate
performance eg
 Quality of service
 Repeat customers etc
Exam Question (2006)

Edward Co assembles and sells many types of radio. It is
considering extending its product range to include digital radios.
These radios produce a better sound quality than traditional radios
and have a large number of potential additional features not
possible with the previous technologies.
A radio is produced by assembly workers assembling a variety of
components. Production overheads are currently absorbed into
product costs on an assembly labour hour basis.
Edward Co is considering a target costing approach for its new
digital radio product.
Required:
(a) Briefly describe the target costing process that Edward Co
should undertake. (3 marks)
(b) Explain the benefits to Edward Co of adopting a target costing
approach at such an early stage in the product development
process. (4 marks)
(c) Assuming a cost gap was identified in the process, outline
possible steps Edward Co could take to reduce this gap. (5 marks)
Solution

(a) Target costing process



Product specification. Target costing begins by specifying a product an
organisation wishes to sell. This will involve extensive customer analysis,
considering which features customers value and which they do not. Ideally
only those features valued by customers will be included in the product design.
Selling price. The price at which the product can be sold at is then
considered. This will take in to account the competitor products and the
market conditions expected at the time that the product will be launched.
Hence a heavy emphasis is placed on external analysis before any
consideration is made of the internal cost of the product.
Cost calculation.



From the above price a desired margin is deducted. This can be a gross or a
net margin. This leaves the cost target. An organisation will need to meet this
target if their desired margin is to be met.
Costs for the product are then calculated and compared to the cost target
mentioned above.
If it appears that this cost cannot be achieved then the difference (shortfall) is
called a cost gap. This gap would have to be closed, by some form of cost
reduction, if the desired margin is to be achieved.

(b) Benefits of adopting target costing





The organisation will have an early external focus to its product development.
Businesses have to compete with others (competitors) and an early consideration
of this will tend to make them more successful. Traditional approaches (by
calculating the cost and then adding a margin to get a selling price) are often far
too internally driven.
Only those features that are of value to customers will be included in the product
design. Target costing at an early stage considers carefully the product that is
intended. Features that are unlikely to be valued by the customer will be excluded.
This is often insufficiently considered in cost plus methodologies.
Cost control will begin much earlier in the process. If it is clear at the design stage
that a cost gap exists then more can be done to close it by the design team.
Traditionally, cost control takes place at the ‘cost incurring’ stage, which is often far
too late to make a significant impact on a product that is too expensive to make.
Costs per unit are often lower under a target costing environment. This enhances
profitability. Target costing has been shown to reduce product cost by between
20% and 40% depending on product and market conditions. In traditional cost plus
systems an organisation may not be fully aware of the constraints in the external
environment until after the production has started. Cost reduction at this point is
much more difficult as many of the costs are ‘designed in’ to the product.
It is often argued that target costing reduces the time taken to get a product to
market. Under traditional methodologies there are often lengthy delays whilst a
team goes ‘back to the drawing board’. Target costing, because it has an early
external focus, tends to help get things right first time and this reduces the time to
market.

(c) Steps to reduce a cost gap






Review radio features

Remove features from the radio that add to cost but do not significantly add value to the product when
viewed by the customer. This should reduce cost but not the achievable selling price. This can be
referred to as value engineering or value analysis.
Team approach

Cost reduction works best when a team approach is adopted. Edward Limited should bring together
members of the marketing, design, assembly and distribution teams to allow discussion of methods to
reduce costs. Open discussion and brainstorming are useful approaches here.
Review the whole supplier chain

Each step in the supply chain should be reviewed, possibly with the aid of staff questionnaires, to
identify areas of likely cost savings. Areas which are identified by staff as being likely cost saving areas
can then be focussed on by the team. For example, the questionnaire might ask ‘are there more than
five potential suppliers for this component?’ Clearly a ‘yes’ response to this question will mean that
there is the potential for tendering or price competition.
Components

Edward Limited should look at the significant costs involved in components. New suppliers could be
sought or different materials could be used. Care would be needed not to damage the perceived value
of the product. Efficiency improvements should also be possible by reducing waste or idle time that
might exist. Avoid, where possible, non-standard parts in the design.
Overheads

Productivity increases would also help here by spreading fixed overheads over a greater number of
units. Equally Edward Limited should consider an activity based costing approach to its overhead
allocation, this may reveal more favourable cost allocations for the digital radio or ideas for reducing
costs in the business.
Assembly workers

Productivity gains may be possible by changing working practices or by de-skilling the process.
Automation is increasingly common in assembly and manufacturing and Edward Limited should
investigate what is possible here to reduce the costs. The learning curve may ultimately help to close
the cost gap by reducing labour costs per unit. Clearly reducing the percentage of idle time will reduce
product costs. Better management, smoother work flow and staff incentives could all help here.
Focusing on continuous improvement in production processes may help.
solution
给分
标准
Section 2
c. Life Cycle Costing
生命周期成本法

Objectives:



Identify the costs involved at different stages of the life
cycle
Explain the implications of lifecycle costing on pricing,
performance management and decision-making
Exam Context


Life cycle costing is likely to be examined via a discussion
question.
You should be aware of not only the stages of the product
life cycle but also the implications of the life cycle on pricing.
Overview
1. Introduction



Life cycle costing aims to cost a product, service,
customer or project over its entire lifecycle with the
aim of maximising the return over the total life while
minimising costs.
Traditionally the costs and revenues of a product are
assessed on a financial year or period by period
basis.
Product life cycle costing considers all the costs
that will be incurred from design to abandonment of
a new product and compares these to the revenues
that can be generated from selling this product at
different target prices throughout the product's life.

Life cycle costs including:








R&D costs
Training costs
Production costs
Inventory costs
Distribution costs
Marketing costs
Retirement and disposal costs
Etc…
2. Product life cycle

The product life cycle (PLC) can be divided
into five stages.

Characteristics of the PLC
Life cycle costing
Life cycle costing (LCC)
Traditional accounting
Cost of a product over
its entire lifecycle, with
the aim of maximising
return over the total life
1. Relates costs and
revenues to time
periods, hence difficult
to see total profitability
2. Excludes R&D costs
from the product
7.11
92
Maximizing return over the
product lifecycle

How to increase the return over a product’s life cycle?
 (a) Design costs out of products


(b) Minimize the time to market


This is the time from the conception of the product to its launch. The
quicker to get a product to the market place, the better to win market
share in the long run.
(c) Minimize breakeven time


Approximately 70% – 90% costs are determined at the design and
development stage. Thus design and production teams must work
together to ensure costs are minimized.
Pricing strategies will affect both contribution and volumes generated.
A short breakeven time is very important for liquidity purposes.
(d) maximize the length of the life span

For example, product development, finding other uses for a product
or staggering the launch of the product in different markets.

(e) minimize product proliferation


If products are updated or superseded too quickly, the
life cycle is cut short and the product may just cover its
R&D costs before its successor is launched.
(f) Manage the product’s cashflows
Impact of PLC in the modern
environment




Shorter product life cycles.
Clearer strategic planning required.
90% of costs to be incurred throughout its life
cycle will have been determined before a
product reaches the market.
The planning, design and development
stages of a product’s cycle are therefore
critical to an organization’s cost management
process.
3. Implications

Life cycle costing has implications on pricing,
performance management and decision-making.




The total costs for each individual product can be
reported and compared with revenues generated in the
future.
The visibility of such cost is increased.
Individual product profitability can be better understood
by attributing all costs to products.
More accurate feedback information is available to the
organization.
What else can we learn from
PLC?




Given that there will be different levels of demand for a
product over its expected life, it would not be appropriate to
set one price for the product's entire life.
An understanding of the stages a product goes through
enables you to price accordingly to either manipulate demand
(low price, demand will rise and the intro stage is shortened)
or to maximise profit.
All costs relating to a product including R&D are associated
with the product. This enables true assessment of a products
profitability.
Having looked at a product’s PLC it is clear that initially the
product will make a loss. Viewing profitability on a periodic
basis can put unnecessary pressure on management due to
the visibility of the loss and could lead to wrong decisions
being taken.
Advantages



Considers external factors throughout a
products expected life.
Considers all costs incurred on a product,
and therefore leads to cost reduction.
Very useful in the modern competitive
environment, in which products often have a
short life cycle and when a large portion of
costs will be committed prior to production
commencing.
Question

Why might Target costing and Product life
cycle be useful in providing management
information for a manufacturer of mobile
phones?
Solution

Product lifecycle costing

The life cycle of mobile phones:






Development & Introduction stage: higher costs, eg product development,
promotion and other marketing activities.
Growth stage: the cost per phone will fall dramatically as the initial start up
costs are no longer incurred and economies of scale are achieved.
Maturity stage: the cost per phone will continue to fall the main cost being
variable costs.
Decline stage: sales volumes fall and cost per unit begins to climb. Extra costs
associated with discontinuing the product will put upward pressure on the cost
per phone.
Product lifecycle costing reflects the need for phone manufacturers to
assess costs and profitability over the entire life of each of their phones.
Target costing



considers the price that ought to be charged in order to achieve a desired
market share for a given product.
Then the level of profit to be earned on the product is decided. The level of
profit can be determined on a per unit basis but usually it could be
determined for the entire product lifecycle.
The balancing figure in the price-cost-profit relationship is cost. The
difference between profit and price represents the target cost which would
be a significant factor for consideration when designing new phones.
Section 2
d. Backflush Accounting
倒推成本法（倒冲法）

Objectives:





Describe the process of backflush accounting and contrast
with traditional cost accounting
Explain the implications of backflush accounting on
performance management and the control of a
manufacturing process
Identify the benefits of introducing backflush accounting
Evaluate the decision to switch to backflush accounting
from traditional process control
Exam Context


This topic could feature in part or all of a question but you
will not have to prepare T accounts.
Techniques such as backflush accounting are often
compared with the traditional techniques you will have
seen in F2.
Overview
1. Costing systems and
manufacturing philosophy

Costing systems have evolved to reflect a
manufacturing philosophy that is based on
the need to achieve competitive advantages



Flexibility and the ability to respond quickly to
customer demand are vital.
Product life cycles are shorter and products must
be brought to the market quickly.
New technology has been introduced.
Just-in-time（JIT）适时制




JIT is an approach to operations based on the idea
that goods and services should be produced only
when they are needed.
JIT system seeks to hold zero inventories.
Problem: a disruption at any point in the system will
cause serious trouble to the whole production
operation.
JIT is an approach to management that
encompasses a commitment to continuous
improvement and the search for excellence.
2. Backflush accounting

A simplified standard costing system

Suitable for use in a JIT environment

Focuses on the output of an organisations manufacturing process and then
using standard costs works backwards to attribute costs to inventory and
sales.
Cost accounts are simplified to reduce the amount of data handling. In
backflush, there are no process accounts.
When a sale is made, the following is recorded:





All at standard cost.
 Labour is treated as an indirect cost. Production is dependent on
demand and so labour is paid regardless of activity.
Trigger points determine when entries are made in the accounting system,
for example:
 Purchase of materials
 Sale of goods


Dr Cost of sales
Cr Materials
Cr Conversion costs

倒推成本法




指当产品完工或销售时，倒过头来计算在产品、产成品等生
产成本的方法。这与传统的成本计算方法正好相反。
传统的生产成本的记录、归集和分配，是随着材料与产品实
体的转移而转移，即生产成本会计记录和生产成本发生的实
物流是同步的。
但在采用JIT的企业，从收到原材料到产品制成所耗用的时
间大幅缩短，而且期末存货量也变得很小，使得传统的分批
或分步成本法详细记录各类存货（如原材料、在产品及产成
品）的必要性受到怀疑。
出于成本－效益原则，对少量的存货做详尽精确追溯，无疑
得不偿失。为了克服上述问题,倒推成本法便应运而生。
Traditional cost accounting
system
Raw materials
B/f X WIP X
Cred X C/f X
X
X
Direct labour
Bank X WIP X
Prod O/h control
Cred X WIP X
Finished goods
Work-in-progress
B/f
Mat
Lab
O/H
X FG
X C/f
X
X
X
X
X
X
B/f
WIP
X C of S
X C/f
X
X
X
X
To Cost
of Sales
Note:
B/f: Bring forward
C/f: Carry forward
7.6
108
Backflush accounting
Creditors
C of S
Trigger = sale of goods
X
Cred’rs X
Conv’n X
X
Conversion costs
C of S
Cost of sales
To P&L
X
X
X
7.6
109
Traditional costing systems v.s.
backflush costing


Traditional costing systems use sequential
tracking to track costs as units pass from raw
materials throughout the production process
to their eventual sale.
Backflushing costing systmen focuses first on
the output of the firm and then works
backwards when allocating cost between cost
of goods sold and inventories, with no
separate accounting for WIP.
Backflush accounting

Advantages



Fewer accounting entries
saves time
Accounting function can
now take on a strategic
role
Disadvantages




7.7
Does not suit all
 Not suitable in
situations where
inventory levels are
significant and tend to
fluctuate
Standard costs need to
be accurate
Control harder
Reconciliation harder
When backflush costing is
appropriate?


1. It is uitable where inventories is kept to
minimum.
2. In an effort to eliminate non-value adding
activities, a complex costing system may be
replaced by a simplified system focusing on
output.
3. Implications of backflush
accounting

Suitability of backflush accounting

It is particularly applicable under the following
circumstances:


In a JIT environment, or a situation where the overall
process time is short, there should be very little
inventory of raw materials, WIP and even finished
goods, so the bulk of manufacturing costs should be
the costs of sale.
In a TQM environment, where there are strong
relationships with suppliers, costs should be known
with a high degree of certainty. Hence there will be
minimal variances arising during production.
Example
Solution
？
Section 2
e. Throughput accounting
产出会计

Objectives:




Calculate and interpret a throughput accounting
ratio (TPAR)
Suggest how a TPAR could be improved
Apply throughput accounting to a multi-product
decision-making problem
Exam Context

This topic could be the focus of an entire question.
Be prepared to perform calculations and to
discuss the results.
Overview
1. Theory of constraints
限制理论


TOC is an approach to production
management which aims to maximize sales
revenue less material and variable overhead
cost. It focuses on factors such as
bottlenecks which act as constraints to this
maximization.
A JIT environment is operated, with buffer
inventory kept only when there is a bottleneck
resource.
2. Throughput accounting


Throughput accounting is a product management system which
aims to maximize throughput, and therefore cash generation from
sales, rather than profits.
TA emphasizes throughput, inventory minimization and cost control.

Three concepts:
 (a) All factory costs are fixed in the short run, with the exception of
material cost.
 (b) In a JIT environment, producing for inventory is bad. Ideally
inventory would be zero. This means accepting some idle time in
non-bottleneck operations. WIP should be valued at material cost
only, so that no value is added to profit until a sale is made.
 (c) Profit is determined by the rate at which throughput can be
generated, ie how quickly raw materials can be turned into sales to
generate cash. Producing just to increase inventory creates no profit
and so should not be encouraged.





Throughput accounting focuses on
maximizing throughput
Throughput = sales – materials
All labor and variable overheads are seen as
fixed in the short term
Decisions are made with reference to the
Throughput Accounting Rate (TPAR)
Limiting factor decisions are based upon
return per limiting factor
3. Ratios
Example


MN Ltd manufactures automated industrial trolleys, known as TRLs:
selling price / per = $2,000, material cost /per = $600,
Labour and variable overhead are $5,500 and $8,000 per week
respectively. Fixed production costs are $450,000 per annum and
marketing and administrative costs are $265,000 per annum.
The trolleys are made on three different machines.
Machine X makes the 4 frame panels required for each TRL, maximum
output = 180 frame panels per week. Machine X is old and unreliable, on
average, between 15 and 20 hours of production are lost per month.
Machine Y can manufacture parts for 52 TRLs per week and machine Z,
which is old but reasonably reliable, can process and assemble 30 TRLs
per week.
The company has recently introduced a JIT system to hold little work-inprogress and no finished goods inventory from week to week.
The company operates a 40-hour week, 48 weeks a year.
Required
Calculate the throughput accounting ratio for the key resource for an
average hour.
Solution
Question

What actions could you take to improve a
throughput accounting ratio?
Answer




Increase selling price
Buy cheaper materials
Decrease labour
Decrease overhead
Throughput v.s. limiting factor
analysis


The throughput approach is very similar to
the approach of maxmising contribution per
unit of scarce resource.
Difference:



Throughput = sales – material costs
Contribution = sales – all variable costs
Example: p106 4.3.1
4. Throughput accounting and
decision making

Ranking production



Target for decision making



Products/divisions are ranked by TPA ratio.
If two or more products are made in the same factory, they can be ranked on
return per factory hour, not TPA ratio, since their costs will be identical.
The TPA ratio should be greater than one if a product is to be viable.
Return/hour enables businesses to make short-term decisions when there is
a scarce resource.
Priority must be given to products generating the best ratios.
Use in performance management


A division of a company is not discouraged from inventory building if
reported profit is used as a principal performance measure.
This is at odds with the JIT philosophy where purchase and production costs
should only be incurred if there is to be an immediate return generated.
Use of TPAR instead of (or in addition to) profit should resolve this problem.
Example


Will and Grace operate separate divisions making and selling
products with identical cost structures.
Sales price per unit
$50
Direct materials per unit
$12
Direct labour per unit
$8
Fixed production overheads of $200,000 per month are absorbed
across the normal production level of 10,000 units per month. In
each division assume a bottleneck capacity of 20,000 hours.
In April, Will makes and sells exactly 10,000 units whilst Grace
makes 12,000 units and sells only 9,500.
Neither Will nor Grace has any opening or closing inventory of raw
materials or components.
Required
Show which manager would benefit if bonuses were given on
(a) Profit
(b) Throughput accounting ratios
Solution
End of Part A!