KCE
COLLEGE
ADVANCED MANAGEMENT ACCCOUNTING
SECTION 5
INVENTORY CONTROLS
Question 1
A company has an annual demand of 15,000 units each costing 80. Fixed cost per order is 2,500
while the cost of capital is 20%. The company works for 300 days in a year and has a lead time
of 7 days.
Required:
a. Optimal order size.
b. Number of annual orders.
c. Re-order level.
d. Cost of prediction error (COPE) if the actual cost of capital and the ordering cost were
18% and 3,000 respectively.
Question 2
A company has a weekly demand of 200 units each costing 150.Fixed cost per order is 1,800
while insurance premium is 8% of inventory value. Obsolescence is valued at 4 per unit while
storage space is charged at 6 per unit. The company works for 52 weeks in a year and has a lead
time of 5 weeks.
Required:
a. Optimal order size.
b. Annual orders.
c. Re-order level.
d. COPE if the actual purchase cost per unit was 2500.
Question 3.
Single discount.
A company has a monthly demand of 2,000 units each costing 40. Cost of capital is 15% while
fixed cost per order is 6,000. For the purchase of 9,000 or more units a discount of 20% per unit
is offered. Determine the optimal order size?
Question 4
A company has an annual demand of 10,000 and the ordering cost is given as 500. Cost of
capital is given as 12%. The following data is also provided.
Purchase level
Price
0—999
50
1000—1999
45
2000---2999
42
3000---above
36
Determine the optimal order level.
JOHNMARK CPAK
KCE COLLEGE
Page 1
Question 5
Known shortages (DEC 2002 Q2B)
A company has determined that the EOQ for its only raw material is 2,000 units every 30 days.
The company knows with certainty that a 4 days‘ lead is required for ordering. The following
distribution of estimated usage of raw material for the month of Dec 2016.
Usage (units)
probabilities
1800
0.06
1900
0.14
2000
0.30
2100
0.16
2200
0.13
2300
0.10
2400
0.07
2500
0.04
Stock –out will cost the company 100 per unit and the average monthly holding cost will be 10
per unit.
Required:
i.
Determine the optimal safety stock
(12 MARKS)
ii.
Compute the probability of being out of stock.
(2 marks)
QUESTION 6
Unknown shortages
A company has a desired service level of 92% and the demand during lead has the following
probability distribution.
Units
probabilities
10
0.18
15
0.22
20
0.30
25
0.12
30
0.09
35
0.09
Required; optimal safety stock level.
Question 7
A company has a risk level of 17% with the following probabilities distribution.
Units’
prob
22
0.19
25
0.24
30
0.31
34
0.22
40
0.04
Required; Optimal safety stock level.
JOHNMARK CPAK
KCE COLLEGE
Page 2
QUESTION 8 (JULY 2015 Q4)
Muthoni ltd operates a convectional stock control system based on re-order level and EOQ. The
various control levels were set originally based on estimates which did not allow for any
uncertainty. As part of review of the system. Typical stock item part X, has been studied in
details as follows;
Data for part X
Lead times
prob
Demand (daily)
prob
15
0.2
5000
0.4
20
0.5
7000
0.6
25
0.3
The company works for 360 days per year and it costs 1000 to place an order. The holding cost is
estimated at 0.025 for storage plus 10% opportunity cost of capital.
Each unit is purchased at 2. The re-order level for this part is currently 150,000 units and it can
be assumed that the demand would apply for the whole of the appropriate lead-time.
a. Calculate the level of buffer stock implicit in a re-order level of 150,000 units (5 marks)
b. Calculate the probabilities of stock-outs. (2 marks)
c. Calculate the expected annual stock –outs in units (4 marks)
d. Compute the stock-out cost per unit at which it would worthwhile raising the re-order
level to 175,000 units.
Question 9
Marginal analysis
A retailer buys a fruit at a cost of 40 and sells for 100. Any fruit unsold fruits at the end of the
days is sold the following day for 10. Determine the optimal size if the daily demand has the
following distribution.
Units
Prob
10
0.18
15
0.32
20
0.15
25
0.18
30
0.17
QUESTION 10
JM ltd stocks a seasonal product named ‗sawa‘ at the beginning of each Christmas period. The
product costs 5,000 and sells at 10,000.
The following data relates to probabilities distribution of demand for the product.
Number of units stocked
Prob of demand
Cumulative prob
6000
0.05
0.05
5000
0.15
0.20
4000
0.15
0.35
3000
0.25
0.60
2000
0.40
1.00
JOHNMARK CPAK
KCE COLLEGE
Page 3
Additional information.
1. JM ltd cannot re-order the product in the event of shortage due to the long delivery period
required.
2. The stock out cost is 300 per product.
3. The unit of the product unsold at the end of Christmas period has a salvage value of 2000.
4. The holding cost during the period is estimated at 10% of the cost of the product.
Required.
a. Determine the optimal order level for JM ltd
( 5 marks)
b. Given that products out of stock can be re-ordered at a cost of 7,400 per unit and the
customer will wait until the arrival of the product, determine the optimal order level.
(5 marks)
Question 11
EBQ
A company has an annual demand of 15,000 units each costing 40 to manufacture. Cost per set
up is 3,000 while the cost of capital is 15%. The company works for 300 days in a year and has a
production rate of 80 units per day.
Required:
a. Optimal production size.
b. Annual set ups.
QUESTION 11(DEC 2005 Q1B)
Mark ltd produces component X on machine Y at a rate of 4000 units per month. Machine Z uses
component X at the rate of 1000 units per month, the reminder being put into stock. It costs 2000
to set up machine Y while the stock holding cost is estimated at 2.5 unit per annum plus a 20%
opportunity cost of capital per annum. Each component costs 25 to produce.
Required;
a. Compute the optimal batch that should be produced using machine Y.
b. Assume the actual set-up cost of machine Y is 1000 instead of 2000.Calculate the COPE
CVP ANALYSIS
QUESTION 1.
A company produces and sold 4,000 units at a selling price of 50. Variable cost per unit was 20
while fixed cost was 75,000. Target profit was 60,000.
Required:
a. Profit made in units and in Sh.
b. Break even points.
c. Margin of safety.
d. Sales to earn target profit.
JOHNMARK CPAK
KCE COLLEGE
Page 4
QUESTION 2 (JUNE 2005 Q3)
Single product (stochastic)
Mac ltd manufactures a hedge trimming tool which has been selling at 1,600 per unit for the
number of years. The selling price is to be reviewed and the following information has been
provided.
1. The standard variable cost of the tool is 1000 per unit and the analysis of the cost
variance in the past 20 months shows the following pattern which the production
manager expects to continue in the future.
 Advance variance of 10% of the standard variables cost occurred in 10 of the 20
months.
 Nil variance occurred in 6 of the 20 months.
 Favorable variance of 5% of the standard variable cost occurred in 4 of the 20
months.
2. Fixed cost have been 400 per unit at an average sales level of 20,000 units, but are
expected to rise in the future.
3. The following estimates have been made of the total fixed costs‘
SHS
Probabilities
Optimistic estimates
8,200,000
0.3
Most likely estimates
8,500,000
0.5
Pessimistic estimates
9,000,000
0.2
4. The demand estimates at the two proposed selling prices being considered are as follows.
Proposed prices
1,700
1,800
No. of units demanded
No. of units demanded
probability
Optimistic
21,000
19,000
0.2
Most likely
19,000
17,500
0.5
Pessimistic
16,500
15,500
0.3
Assume that all estimates and the probabilities are independent.
Required;
a. Advice based on the above information whether they should change the selling price.
Indicate which price would you recommend (6 marks)
b. The expected profit you have recommended in (a) above and the resulting margin of
safety
c. Comment on the method used on the above analysis.
QUESTION 3(DEC 2005 Q1)
JM ltd produces a designer perfume called ‗Hint of elegance‘. Production of the perfume
involves the use of two ingredients X1, & X2 represented by the production function given
below.
JOHNMARK CPAK
KCE COLLEGE
Page 5
Y = X1X2
Currently the company is operating at a level where the daily usage of X1 and X2 is set at 250
units and 360 units respectively. The price of designer‘s perfume and the cost of ingredients X1
and X2 are random variables. The data below relates to three random variables.
Selling price of Y (per bottle) sh. Probabilities
4000
0.15
4500
0.35
5000
0.20
5500
0.30
Cost of ingredient X1
1000
1500
2000
2500
Probabilities
0.10
0.05
0.35
0.50
Cost of ingredient X2
Probabilities
1500
0.20
2000
0.25
2500
0.15
3000
0.40
Required;
i.
Calculate the daily expected profit of the company. (5 marks)
ii.
Simulate the company‘s profit for 10 days using the following random numbers.
58 ,71 ,96 ,30 ,24 ,18, 46 ,23 ,34 ,27 ,85 ,13 ,99 ,24 ,44 ,49 ,18 ,09 ,79 ,49 ,74, 16 ,32 ,23 ,02
,56 ,88 ,87 ,59 ,41 ,06.
(10 marks)
QUESTION 4
M ltd manufactures three products which have the following revenue and costs (sh per unit)
Product
Selling price
Variable
Fixed cost: specific
: General
Production and sales (000)
A
30
15
3
3
98.2
B
15
7.5
2
3
42.1
C
28
10
4
3
111.8
Unit fixed cost are based upon the above annual sales and production volume (000)
Required:
JOHNMARK CPAK
KCE COLLEGE
Page 6
The break-even point sales of M ltd based on the current production mix.
QUESTION 5
Thrones ltd is considering the possibility of adding a new 12 tonnes Fuso lorry to its vehicle
fleet. It bases its pricing and cost calculation on the expectations of running the vehicle on an
average ¾ loaded at 500 km per week over 40 weeks of the year. Past experience shows that a
variety of reason there is a standard deviation of 60,000 ton-km per annum. The company
intends to charge sh 45 per ton-km; variable operating cost are calculated as sh.40.5 per ton-km
and the fixed cost is sh 585,000 per annum.
Required:
a. Calculate the break-even point for operating the lorry.
b. Calculate the expected annual profit
c. Calculate the probability that the lorry will at least break even
d. Calculate the probability that the lorry will make a profit of at least sh.180,000
e. Calculate the probability that the lorry will make a profit of 300,000.
QUESTION 6
ABC Ltd is currently producing product A whose selling price is sh 150. Demand for product A
is uncertain but it is normally distributed with a mean of 20,000 units and a standard deviation of
5,000. Unit variable cost of product A is sh 70 while the fixed cost is sh 1,200,000. The company
is considering introducing another product B whose selling price =sh 120.demand for product B
is also uncertain with a mean of 80,000 units and a standard deviation of 8,000.the variable cost
for product B=sh 80. Additional fixed cost will be sh. 2,000,000. The mean sales of A will
increase by 3,000 units while the standard deviation will be 4,000.there will be no change in the
cost of but selling price will increase to sh 180.the correlation coefficient between A & B is
0.7.for each of the option above determine:
(a) B.E.P
(b) Profit made
(c) C.V
COST FORECASTING
QUESTION 1.
Using account analysis method, formulate an equation for the following costs which were
incurred after production of 2000 units.
COSTS
Direct materials
Labour (20% indirect)
Indirect material
Rent
Salaries
AMOUNT
300,000
400,000
50,000
30,000
40,000
JOHNMARK CPAK
KCE COLLEGE
Page 7
Royalties
Depreciation
Other direct cost
80,000
10,000
200,000
QUESTION 2
Formulate a cost function using the following data that relates to 50 units and use the equation to
predict the cost of making 78 units.
Cost items
amount
Material (10% indirect)
200,000
Labour (sh 15,000 indirect)
140,000
Salaries
50,000
Repairs (25% indirect)
20,000
Canteen cost
5,000
Utilities (30% variable)
10,000
Supervisors (sh 4000 variable)
12,000
QUESTION 3
Consider the following data and use it to develop a simple regression equation.
Labour hours (X)
15
12
20
17
12
25
22
9
18
30
Labour cost (Y)
180 140
230 190 160 300
270 110 140 320
Multiple regression
Question 1
Formulate a multiple regression equation using the following data.
X1
X2
y
2
5
20
4
7
24
6
10
25
8
12
29
10
15
30
AN0VA ANALYSIS
Question 1
A study was conducted to predict the ability of economist and financial specialist on the future
performance of their country‘s economy. Below is part of computer output result produced using
statistical software.
Variables
Constant
X1
X2
Coefficient
0.983
B
0.587
JOHNMARK CPAK
Parameter estimates.
Standard error
t-ratio
A
0.34
0.257
2.42
0.225
2.61
KCE COLLEGE
Page 8
Analysis of variance (ANOVA)
Source
Degrees of freedom Sum of squares
Mean of square
F-value
Regression
2
2904.8
D
E
Error (residual)
11
100.1
9.1
Total
13
C
Required:
(i)
Compute the values of A, B, C, D and E.
(5 marks)
(ii)
The estimated regression model.
(2 marks)
(iii)
Explain the coefficient of parameter estimates
(6 marks)
(iv)
The explanatory power of the model.
(3 marks)
(v)
Test the statistical of each of the predictor variables; X1 and X2(use a significant
level of 5%)
(3 marks)
(vi)
Comment on the statistical significant of the model at the 5% significant level given
that the F-tables values 3.98.
(2 marks)
NON ROUTINE DECISIONS
QUESTION 1(JUNE 2007Q2B)
ABC ltd has received a special order of 2,000 units of component X. The units‘ production cost
of component X is as follows.
Sh
Direct labour (1 hour at sh 20 each)
20
Direct material
10
Variable overheads
5
Additional information:
1. The production of component X will require a reduction in the production of component
Y due to the scarcity in skilled manpower. Both products require skilled manpower for
their production.
2. Details of the cost per unit and the selling price per unit of the component Y are as
follows.
Sh
Selling price
190
Direct labour (4 hours)
80
Direct material
30
Variable overheads
20
Contribution
60
Required:
The minimum selling price per unit that ABC ltd should accept for the special order. (8 marks).
JOHNMARK CPAK
KCE COLLEGE
Page 9
QUESTION 2
MC ltd is an established supplier of precision parts .The Company has been offered an order
choice for making either part A or part B for the next period but not both. Both part uses the
same metal, Titanium alloy of which only 13,000 kg are available, at sh 12.5 per kg.The parts are
made by passing each one through two full automated computer machines-S and T whose
capacity are limited. Target prices has been set and the following data are available for the
period.
Parts details
PART A
PART B
Demand
7000
9000
Target price (sh)
145
115
Usage per unit
Alloy usage
1.6kg
1.6kg
Machine S
0.6hours
0.25hours
Machine T
0.5 hours
0.55 hours
There are 4000 hours for machine S at sh 80 per hour and 4500 hours for machine T at sh 100
per hour.
Required:
Determine which part that should be made in order to maximize the contribution.
QUESTION 3.
ROBBER ltd manufactures control panels for burger alarms. It has a current production and sales
of 80,000 units per annum.Each control panel includes two main components:-one key pad and a
one display screen. At present ROBBER ltd manufactures the product in-house. However the
company is currently considering outsourcing the production of keypads/display screen. A newly
established company based in Tokyo is keen to secure a place in the market and has offered to
supply the Keypads for sh4.10 per unit and the display screen for sh.4.30 per unit. This price are
guaranteed for the next 5 years.
The current total annual cost of producing the key pads and the screens are:
KEYPADS
DISPLAY
SCREEN
PRODUCTION
80,000
80,000
Sh 000
Sh 000
Direct material
160
116
Direct labour
40
60
Heat and power
64
88
Machine costs
26
30
Depreciation & insurance
84
96
Total production cost
374
390
JOHNMARK CPAK
KCE COLLEGE
Page 10
Additional information.
1. Material cost for key pads are expected to increase by 5% in six month time and the
material cost for screen are expected to increase by 2% with immediate effect.
2. Direct labours is purely variable and are not expected to change.
3. Heat and power costs include an apportionment of the general factory overhead for heat
and power. The general apportionment is calculated using 50% of the direct labour cost
for each component and would be incurred irrespective of whether the component are
manufactured in-house or not.
4. Machine cost are semi-variable: the variable element relates to set up cost which are
based upon the number of batches made. The keypads machine has a fixed cost of sh
4,000 per annum and the screens has a fixed cost of sh 6,000 per annum. While both
components are currently made in batches of 500, this would need to change with
immediate effect, to batches of 400.
5. 60% of depreciation and insurance cost relates to the apportionment of the general
factory, the remaining 40% is specific to the manufactures of keypads and screen.
Required:
Advice the management either it should continue making the component in-house or it
should outsource for each component.
QUESTION 4
Marcos ltd manufactures a product that uses components made by the company. Due to market
liberalization, the same component can be bought from an importer. The management accountant
has provided the following manufacturing data for the component.
Sh
Direct material (10kg of zero @sh 25 per kg)
250
Direct labour
165
Variable overhead
80
Production overhead are recovered on the basis of 20% of the labour cost. The cost accountant
anticipates that ¾ of fixed overhead will be incurred irrespective of the decision made. The
importer is willing to sell the component at sh 510 per unit.
Required:
Advise the management of Marcos ltd on whether to make or buy the component.
QUESTION 5
T Company is a company specializing in the provision of telephone system for commercial
clients‘ company has been approached by a potential customer, Push co, who wants to install a
telephone system in new offices it is opening. While the job is not a particularly large one, T co,
is hopeful of future business with Push co. the following information should be considered.
1. One of the company‘s salesmen has already been to push co, to give them a
demonstration of the new system together with a complementary lunch of which the total
cost was 500.
JOHNMARK CPAK
KCE COLLEGE
Page 11
2. The installation is expected to take one week to complete and would require 3 engineers,
each of whom is paid a monthly salary of 40000. One of the three engineers has a spare
capacity to complete the work, but the other 2 would have to be moved from contract X
in order to complete this one. Contract X generates a contribution of sh 5 per engineer
hour. There are no other engineer available to continue with contract X if these 2
engineer are taken off the job. This would mean that T Company would miss its
contractual completion deadline on contract X by one week. As a result T co, would have
to pay a one off penalty of 5000.you should assume that there are 4 weeks each month
and that the standard working week is 40 hours long.
3. T co technical advisor would also need to dedicate 8 hours of his time to this job. He is
working at a full capacity so he would have to work overtime in order to do this. He is
paid an hourly rate of 400 and for all overtime 50% premium above his usual hourly rate.
4. Two visit would need to be made by the site inspector to approve the completed work. He
is an independent contractor who is not employed by T co, and charges Push co, directly
for the work. His cost is 2000 for each visit made.
5. T co, system trainer would need to spend one day at Push co, delivering the training .he is
paid a monthly salary of 15000 but also receives commission of 500 for each day spent
delivering training at a client site.
6. 120 telephone handsets would need to be supplied to push co. The current cost of these is
18.20 each, although T co, already has 80 handsets in inventory. These were bought at a
price of sh.16.80 each. The handset are the most popular model on the market and
frequently requested by T co, customers.
7. 1000 meters of cable would be required to wire up the system. The cable is used
frequently by T co, and it has 200 meters in the inventory which cost 1.2 per meter. The
current market price for the cable is sh 1.30.
Required:
Prepare a cost statement, using relevant costing policies, showing the minimum cost that T co
should charge for the contract.
PRICING DECISION
QUESTION 1(JULY 2005 Q3B)
A manufacturer produces and sells two products A and B. The unit variable cost is 12 and 8 for
A and B respectively. A review of the selling price is in progress and it has been estimated that
for each product and increase in the selling price would result in a fall of demand of 500 units
per every sh.1 increase in price and similarly a decrease of sh.1 in price would result in an
increase in demand of 500 units.
The current sales price and sales demand are:
Price
Demand (units)
A
30
15,000
B
58
21,000
Required; calculate the profit maximizing price for each product. (14 marks)
JOHNMARK CPAK
KCE COLLEGE
Page 12
QUESTION 2
Differential pricing (transfer pricing) (NOV 2016 Q5)
Kanorer ltd has two divisions Mugaa and Gwashati. Mugaa division manufactures an
intermediate product into a final product which there is no external market. Gwashati division
incorporates the intermediate product into final product which it sells. The expected units of the
final product which Gwashati division estimates it can sell at various selling prices are as
follows:
Net selling price
quantity sold
100
1000
90
2000
80
3000
70
4000
60
5000
50
6000
The variable and fixed costs of each division are as follows.
Mugaa
Gwashati
Variable cost per unit
11
7
Fixed cost per annum
60,000
90,000
The transfer price is 35 for the intermediate product, and is determined on a full cost basis,
Required:
Profit statement for each division and the company as a whole for the various selling prices
(12 marks)
BUDGETING AND VARIANCE
QUESTION 1
JM ltd is a manufacturing company that makes three products P, Q, R. Data for the period ended
last month are as follows.
P
Q
R
Units produced and sold
12,000
16,000
8,000
Selling price per unit
Direct material cost per unit
Direct labour cost per unit
50
16
8
70
24
12
Production overheads costs
Machine costs
Production scheduling
Total
102,000
84,000
Cost drivers
Machine hours
Machine hours
JOHNMARK CPAK
KCE COLLEGE
60
20
8
Page 13
Set-up cost
Quality control
Receiving material
Packing material
54,000
49,200
64,800
36,000
390,000
Number of production runs
Number of production runs
Number of component receipt
Number of customer orders
Information in the cost drivers is given below:
P
Direct labour hours per unit
1
Machine hours per unit
0.5
Number of component per unit
3
Number of components receipts
18
Number of customer orders
6
Number of production runs
6
Required:
Using ABC show the cost and gross profit and net profit
period.
Q
1.5
1
5
80
20
16
R
1
1.5
8
64
10
8
per unit for each product during the
(20 marks)
QUESTION 2
(a) Citing suitable cost driver, briefly explain the following classification of manufacturing
activities.
i)
Unit level activities
ii)
Batch level activities
iii)
Product sustaining activities.
iv)
Facility sustaining activities
(b) Walter ltd produces two products, X and Y for the export market.
The following information relates to the budgeted production activities of products X and Y for
the six months‘ period ending 31 Dec 2016.
Products
X
Y
Material cost per unit
600
450
Production line A (machine hours per unit)
0.8
0.5
Production batch size (units)
100
200
Total production (units)
9,000
15,000
Number of components required per unit of product
20
12
Number of customers
5
10
Production line A-number of machine set ups
15
25
Production line A-maintenance (number of hours)
300
150
JOHNMARK CPAK
KCE COLLEGE
Page 14
Labour cost
Electricity
Set-up costs
Production scheduling
WIP Movement
Purchase and receipt of material
Material scheduling
Design and testing routine
Production line development
Production line maintenance
General factory administration
General factory occupancy
Production cost
Production line A
Factory total
1,470,000
1,470,000
400,000
296,000
364,000
495,000
180,000
160,000
250,000
90,000
5,000,000
2,680,000
Additional information:
1. Design and testing costs are to be allocated in the ratio of 3:2 for products X and Y
respectively.
2. Production line development costs are to be allocated in the ration of 4:1 for products X
and Y respectively.
3. Only 25% of the general factory costs relates to the production of products X and Y. The
costs are to be allocated to products based on numbers of units produced.
Required:
a. Using ABB prepare the production budget for both products. Clearly indicating the
classification of the activities under the cost hierarchy dimensions in (a) above
(16marks)
ACTIVITY BASED VARIANCE
QUESTION 1 (DEC 2004 Q2)
Toby ltd produces chemical Y. The standard ingredient of 1 kg of Y are:
0.65 kg of ingredient F @ sh 40 per kg, 0.3 kg of ingredient D @ sh 60 per kg.
0.2 kg of ingredient N @ sh 25 per kg.
The following data has been provided:
1. Production of 4,000 kg of chemical Y was budgeted for October 2016.
2. The production of chemical Y is entirely automated and production cost attributed to its
production comprises only direct material and overheads.
3. Toby‘s production process works on JIT inventory system.
4. Overhead budgeted for the production of Y in the month of October 2016 was as follows:
JOHNMARK CPAK
KCE COLLEGE
Page 15
Activity
Receipt of deliveries from supplier (standard delivery
Quantity is 460 kg)
Dispatch of goods to customer (standard dispatch
Quantity is 100 kg)
Total amount
40,000
80,000
120,000
5. In Octomber2016, 4,200kg of Y were produced and the cost details were as follows:
Material used.
2,840 kg of F, 1,210kg of D and 860 kgs of N at a total cost of sh 203,800.
Actual overhead costs
12 supply deliveries at a cost of sh 48,000 and 38 customer dispatches at a cost of sh 78,000
were made.
6. Toby budget committee met recently to discuss the preparation of the cost control report
for October 2016.
Required: Prepare a variance analysis of the overhead production costs on Y in Oct 2016 on
activity based basis. (14 marks)
VARIANCE INVESTIGATION
Q1 (JUNE 2004 Q2)
From the past experience, a company operating a standard cost accounting system has
accumulated the following information in relation to variances in its monthly management
accounts:
1. Its variance falls into two categories.
Category
% of total number of variance
Those which are not worth investigating
64
Those worth investigation
36
2. From the first category corrective action has eliminated 70% of the variances, but the
remainder has continued unchanged.
3. The cost of an investigation averages sh. 3,500 and that of correcting variances averages
sh. 5,500.
4. The average cost of any variance uncorrected is sh.5, 250 per month and the company‘s
policy is to assess the present value of such costs at 2% per month for a period of 5
months.
Required:
(i)
Decision tree to represent the position if an investigation is carried out and when not
carried out.
(ii)
Recommend with the supporting computation, whether or not the company should
follow the policy of investigating variances.
JOHNMARK CPAK
KCE COLLEGE
Page 16
QUESTION 2
SQC
Skyline ltd operates round flight on the Nairobi –Mogadishu route using a fleet of 3 aircrafts,
Skyline 1, 2 and 3. The standard quantity of fuel used in each round trip over the 12-month
period has a mean of 100KL and the standard deviation of 10KL. (1KL=1000 litres).
Jackie, the operating manager of skyline ltd uses statistical quality control (SQC) approach in
deciding whether to investigate the variance from the standard fuel usage per round trip flight.
He investigates all those flight with fuel usage greater than 2 standard deviations from the mean.
Jackie received the following report from round trip usage for the month of May 2016 from the
pilots of the 3 planes operating on that route.
Flight
Skyline 1
KL
104
94
97
101
105
107
111
112
115
119
Skyline 2
KL
100
90
98
107
92
113
99
106
101
93
Skyline 3
KL
97
104
111
104
122
118
126
114
117
123
1
2
3
4
5
6
7
8
9
10
Required:
1. Using the ±2Ꝺ (standard deviation) rule, indicate the variance investigation decision
which should be made
2. Present the SQC charts for round trip fuel usage by each of the 3 aircrafts.
3. What inference can be made from the 3 SQC charts developed above?
PERFORMANCE EVALUATION
Q1.
The Z division of XYZ ltd, produces a component which it sells externally and can also be sold
internally to other divisions. The division has set a performance target for the coming year of
residual income (RI) of sh 5,000,000.
The following budget information relating to Z division has been prepared for the coming
financial year.
1. Maximum production /sales capacity 800,000 units.
2. Sales to external customers 500,000 units at sh. 37.
JOHNMARK CPAK
KCE COLLEGE
Page 17
3. Variable cost per component sh. 25.
4. Fixed cost directly attributable to the division sh. 1,400,000.
5. Capital employed: 20,000,000 with cost of capital of 13%.
The X division of XYZ ltd has been asked to quote a transfer price for the units of the
component.
Required;
Calculate the transfer price per component which Z division should quote to X division so that its
residual income target achieved. (8 marks).
QUESTION 2
Kameme media group has three major divisions: Newspaper, Television, Film studios.
Summary financial data (in millions of shillings) for the year 2015 and 2016 is given as follows.
Operating income
Revenue
Total assets.
Year
2015 2016
2015
2016
2015
2016
Newspaper
900
1,100
4,500
4,600
4,400
4,900
Television
130
160
6,000
6,400
2,700
3,000
Film studios
220
200
1,600
1,650
2,500
2,600
The manager of each division has an annual bonus plan based on his division return on
investments (ROI).
The company has defined ROI as operating income by the total asset.
Mark, the manager of the newspaper division is considering a proposal to invest sh. 200M in fast
speed printing process with color options. The estimated increment to year 2017 operating
income would be sh. 30M. The media group has a 12% required rate of return for investment in
all the 3 division.
Required:
a. Using the DuPont Method to explain the difference among the 3 division in their 2016
ROI and residual income (use 2016 total asset as the denominator) (8marks)
b. Explain whether Mark should undertake the fast speed printing press investment
proposal.
QUESTION 3
The most recent published results for X ltd are shown below.
Analyst’s adjusted summary income statement.
Profit before tax
13.6
Adjustments
Add: interest paid (net)
1.6
Research and development
2.1
Advertising
2.3
JOHNMARK CPAK
KCE COLLEGE
Page 18
Amortization of goodwill
Less tax paid
Adjusted profit
1.3
(4.8)
16.1
Analyst’s adjustments to summarized balance sheet as at 31 Dec
Capital and reserves
54.8
Adjustments
Add; borrowings
15
Deferred tax provisions
7.6
R&D
17.4
Advertising
10.5
Goodwill
40.7
Adjusted capital employed 146
Required return
17.5 12% cost of capital
Adjusted profit
16.1
Value destroyed
1.4
The chairman of X ltd has obtained a copy of the analyst report and wishes to know which
divisions or division are destroying value. The following summary statements are available:
Division performance for the year ended 31 December.
Division A
division B
division C
head office
total
Turnover/sales
81.7
63.2
231.8
-
376.7
Profit b4 interest and tax
5.7
5.6
5.8
(1.9)
15.2
Total assets less liabilities
27.1
23.9
23.2
3.2
77.4
ROI
21%
23.4%
25%
Some of the adjustments made by the analyst can be related to specific divisions:
 Advertising relates entirely to division A
 R&D relates entirely to division B
 Goodwill written-off relates to:
division B
 Division C
 Deferred tax relates to:
division B
o Division C
10.3M
30.4M
o 40.7
1.4M
6.2M
Required;
Explain using EVA whether the value is destroyed as per analyst report.
JOHNMARK CPAK
KCE COLLEGE
Page 19
ADVANCED MANAGEMENT ACCOUNTING
THEORIES
INTRODUCTION
Management accounting-is the process of identification, measurement, analysis and
communication of the information required for effective execution of managerial functions.
Scope of management accounting
Scope refers to the areas of knowledge that the management accountant should be familiar with
in order to effectively execute their functions.
A good manager should know everything and therefore scope defines the minimum knowledge
area .The common areas are;
 Financial accounting
 Commercial law
 Economics
 Auditing and assurance
 Financial reporting
 Financial management
 Taxation
Differences between management accounting and financial accounting.
Financial accounting
Management accounting
Mandatory as required by the company‘s Act Its optional
CAP 486
Has guiding principles
Has no guiding principles
Uses monetary terms only
Uses both monetary and non-monetary terms
Based on past data
Based on future data
It‘s an end by itself
It is a mean to an end
Its audited
Not audited
Factors making management accounting to change.
1. Technological innovations.
2. Global competitions.
3. Customer demand.
Advantages of management accounting.
1. Reducing cost
2. Improving cash flows
3. Enhancing business decisions.
JOHNMARK CPAK
KCE COLLEGE
Page 20
Limitations of management accounting.
 Evolutionary in nature.
 Lack of knowledge in the required areas
 It‘s based on accounting information which at times may be inaccurate.
 It requires a lot of resources.
 It is highly affected by personal biasness.
 Provides only data.
 Unquantifiable variables.
 Requires continuity and participation.
Role of management accountant.
1. Managing functions that are critical to the business performance.
2. Supporting the organization, management and strategic development.
3. Provide accurate and useful information for better decisions
4. Ensuring organization operates with integrity.
Benefits of ethical behaviors in an organization.
(a) It promotes a higher standard of self-regulation.
(b) It helps in minimizing the conflicts of interest between professionals and clients.
(c) It helps in boosting public confidence in the world of professionals.
(d) It improves or promotes credibility and trust.
(e) It regulates the behaviors of professional leading to best practices.
(f) It reduces cases of legal litigation.
Ethical standards of management accountant.
1. Competence and professional behavior-maintaining higher levels of professionalism
and should not behave in a way against their profession.
2. Confidentiality-management accountant are not expected to disclose information of a
client to third party.
3. Integrity-Management accountant are expected to be honest and straight forward in all
their dealings.
4. Objectivity- Management account should avoid conflicts of interest while discharging
their duties.
5. Credibility
ENVIRONMENTAL MANAGEMENT ACCOUNTING.(EMA)
This is defined as the identification, collection, estimation, analysis, internal reporting and use of
material and energy flow information.
Environmental management accounting (EMA) is a systematic approach to finding practical way
of saving water, energy and material and reducing negative environmental impact.
JOHNMARK CPAK
KCE COLLEGE
Page 21
EMA is defined as the identification, collection, estimation, analysis, internal reporting and use
of material and energy flow information. EMA focuses mainly on providing information for
internal decision making purposes. EMA is concerned with accounting information needs for
managers in relation to corporate activities that affect the environment as well as environmentrelated impacts on the corporation.
By considering environmental concerns in business decision making, corporate can also link
financial and environmental performance indicators for benchmarking purposes. As such, in
general environmental management accounting serves managers with environmental related
information which support decision making processes that lead to improved environmental and
financial performance.
EMA covers both physical and monetary procedures which are later named as physical EMA
(PEMA) and monetary EMA (MEMA)
Further, EMA is categorized into 2 elements: MEMA and PEMA. MEMA focuses on
―environmental aspect of corporate activities expressed in monetary terms‖ such as measures
expressed as ―measures expressed in expenditure on cleaner production costs of fines for
breaking environmental laws, investment in capital projects that improve the environment and
monetary values of environmental assets‖.
Meanwhile, PEMA refers to ―company‘s impact on the natural environment, expressed in terms
of physical units suck as kgs, cubic meters or joules
Roles of management accountant in Environmental Management Accounting (EMA).
1. Capital investment decision decisions
Management accountants (MA) evaluate the impact of environmental costs on projects viability
and implementation. They will then advice the management whether the projects are feasible in
the right cost and benefits.
2. Cost determination
Management Accountants have a responsibility of quantifying environmental cost and then
disseminating this information to the relevant production units.
3. Process and product design.
Management Accountants have a responsibility of assisting the production departments
implement process and product designs that are environmentally friendlier.
4. Performance evaluation.
Management Accountants are responsible for setting budgets and detailing budgeted
environmental cost. The budgeted environmental costs are then compared with the actual cost
incurred in order to evaluate the performance.
5. Provision of information.
JOHNMARK CPAK
KCE COLLEGE
Page 22
Management Accountants provides important monetary data needed for environmental
management accounting activities.
Benefits of adopting environment management accounting (EMA)
1. Compliance -this entails using EMA to support environmental protection through costefficient compliance with environmental regulations.
2. Cost reduction/savings-implementation of eco-efficiency systems enables to identity
cost of waste processing and losses from processes of large raw material. This cost
analysis assist in on cost savings as well as monetary and physical environmental
information
3. Better pricing decisions.
4. Enhanced shareholders value- EMA improves corporate reputation f due to launching
environmental-friendly product into the market and performing corporate activities with
less harmful effects on the surrounding environment
5. Eco-efficiency-this involves the use of EMA to help reduce costs and environment
impact simultaneously via more efficient use of water, energy material and waste.
6. Strategic position-this relates hoe EMA could support the assessment and
implementation of environmentally sensitive and cost effective programme.
Ways in which management accountant might assist in developing environmental analysis
tools and techniques.




Assessing the need for new or modified management information and financial systems.
Developing or seeking capital investment and appraisal tools that are more efficient
Isolating and computing individual environmental cost.
Helping resolve conflict between environmental management and traditional financial
management system.
 Considering the financial costs and risks associated with an investment product/process.
 Training line personnel in environmental accounting reports and concepts.
 Assisting in improving methods for reallocating internal environmental cost and specific
products and activities.
Ways in which an environmental costing system could lead to improved financial
performance.
1. Cost reduction
Companies that have an effective environmental costing system are more likely to have and take
advantage of cost reduction and other improved opportunities.
2. Increased revenue
3. Improved decision making
3. Avoidance of costs of failure
JOHNMARK CPAK
KCE COLLEGE
Page 23
An awareness of environmental costs could results in environmental failures.
Types/classification of environmental costs.
1. Environmental prevention and management costs. This covers the annual cost
incurred in preventing waste and emission, design and operations processes, training and
recycling products
2. Environmental appraisal costs-inspection of product processes.
3. Waste disposal and emission treatment: this involves all costs to conventionally treat,
dispose and clean up extant wastes and emission.
4. Material purchase value and non-product output: this involves cost of wasted
material because of inefficient production. Waste materials are assessed based on their
purchase value or material used value.
5. Processing cost: This comprises labour hours, depreciation of machinery and operating
material, and financing cost. They will be added up to environmental cost scheme based
on the respective production cost pro rata charges.
6. Internal failure costs.
7. Environmental external failures.-cleaning up contaminated soil.
Fields in which the use of environmental management accounting is applied.






Project implementation.
Investment appraisals.
Product pricing.
Budgeting.
Cost control and measurement.
MIS management to give accurate output.
Internalized environment costs, externalized environment cost and external environment
impact.
1. Internal environment cost –are costs which have a direct impact on the income
statement of the company. They are producer costs included in the total cost of the
product to make the environment as important as capital, labor, resources, technology and
other factors of production.
Examples of internal environment cost.
o Cost of improving systems for compliance.
o Penalties and fines.
o Taxes.
o Cost of obtaining licenses.
o Disposal costs.
2. External environment cost.
Are costs generated by producer but carried by society as a whole eg a factory may
pollute water by dumping waste in the river without paying for it, the local government
JOHNMARK CPAK
KCE COLLEGE
Page 24
some miles away has to clean the water to use it as drinking water. POLLUTION is an
example of external cost.
3. Externalized environment impact.
This is the use of energy technology which is often associated with impact on human
health and environment. The quantified impact includes damage on human health, impact
on crop yield, and damage on ecosystem.
Types of environmental costs.
1. Environmental prevention costs. Design and operations processes, training and
recycling products
2. Environmental appraisal costs-inspection of product processes
3. Internal failure costs.
4. Environmental external failures.-cleaning up contaminated soil.
PRICING DECISIONS
Pricing decisions involves setting of prices. Prices are very important in the survival and the
competitiveness of the business. In terms of survival the price set ensures there is enough profit
required to sustain the business.
When the competition and the quality of the items is the same then the price should be on the
lower side to ensure maximum sales.
Prices are influenced by (3 c’s)
 Costs
 Customers
 competition
There are several methods used to estimate cost and hence the price. They are generally known
as pricing methods. They include:
1.
2.
3.
4.
5.
6.
7.
8.
9.
differential pricing
macro-economic method
life cycle costing
Target costing
Cost plus method
Rate of return method
Transfer pricing
Skimming pricing method
Penetration pricing method
JOHNMARK CPAK
KCE COLLEGE
Page 25
1. MACRO-ECONOMIC THEORY PRICING
This method assumes that, if the price of a commodity is changes, the demand will also
change.it states that if the price is decreased, then the demand will eventually increase and
vice versa. It assumes that price and demand are inversely related and that the optimal price
is the one which gives the maximum profit.
At maximum price the Marginal cost=Marginal revenue.it is expressed as follows
P=a-bq
2. TARGET COSTING
This is where a market research is carried out to determine the price at which the customers
are willing to buy the item.
Target cost=Market price –Desired profit
Target gap=Target cost-Actual cost
3. LIFE CYCLE COSTING/WHOLE LIFE COSTING
This is a method of pricing where all costs that the producer expects to incur over the
lifespan are compiled together. It‘s a process of estimating how much money will be spent on
the product/asset over the course of its useful life. Whole life covers all the costs from the
time the product is purchased to the time you get rid of it.
4. DIFFERENCIAL PRICING
This is a system of pricing where the same item is sold to different customers at different
prices. Mostly this is done for:
 Providing the product/service at different times i.e. peak and off peak times
 Offering quality discount.
 Bargaining with customer
For this policy to hold the following conditions must be met:
a)
b)
c)
d)
e)
f)
The firm must be commanding high level of customer loyalty.
The firm is a monopoly.
Different customers are able to bear different prices.
There are intermediaries
The policy is acceptable in the industry.
There is no flow of information
5. TRANSFER PRICING.
Transfer price is the price at which goods are moved from one department (Supplying
department) to another (receiving department0 in the same company.it is the price which the
supplying department is willing to sell and the receiving department is willing to buy. The
item which is moved from one department to the other is known as intermediate product.
JOHNMARK CPAK
KCE COLLEGE
Page 26
The last department which receives the intermediate product is the one which finally sells to
the external market in the name of the whole company. The item sold to the external market
is known as the Final product. The transfer price becomes the revenue of the supplying
department and the cost to the receiving department. The price to the external market
becomes the revenue of the whole company.
Objectives of transfer pricing.
(i)
Goal congruence-this is where departments operate differently in order to achieve
company‘s objective at the whole company i.e. each department should act in the
manner that would lead to the realization of the overall goal.
(ii)
Performance evaluation-this involves appraising department managers.it mostly
done on the basis of the profit reported by a department.
(iii)
Autonomy-this refers to the independence of a department from the others. A transfer
price should ensure that the particular department earns profit to be autonomous
financially and the department manager should have their freedom of determining the
transfer price
(iv)
Legal obligation-the transfer price determined should help the firm to comply with
the legal requirement such as taxation and custom duty.it should not be designed in a
manner which will penalize the company.
METHODS OF DETERMINING TRANSFER PRICES
1. Market price method-This is where the transfer price is based on the existing market
price if the intermediate terms have audited the external market. There should be
existence of a perfect market structure when this method is used.
2. Marginal cost-this is where the marginal cost (variable cost) of the supplying department
forms the transfer price. This method is said to be most optimal.it assumes there are no
limiting factors and that the fixed cost belongs to the entire company but not the
particular department. The supplying manager does not make any profit.
3. Full cost method-in this method the transfer price will be equal to the full cost of the
item.in this method the supplying manager does not make profit but he is able to recover
all his cost.
4. Cost plus method-This is where the transfer price would be determined on the basis of
full cost prices of profit mark-up.
5. Negotiation method-this is where the supplying manager and the receiving manager
negotiate on the best transfer price. This method is said to promote goal congruence, cooperation and reduction at prices.
INTERNATIONAL TRANSFER PRICING.
This involves determining the prices that will be used to transfer items to a department which is
in another country. The earlier on noted method will still be applied in this case. However, the
following additional factors should be considered:
JOHNMARK CPAK
KCE COLLEGE
Page 27
(a) Exchange rate fluctuations
(b) Import duties and tariffs.
(c) Anti-dumping regulations.
(d) Taxation-if the tax rate differs o point, multinational will try to manipulate profit by
increasing or reducing transfer price sot that points are maximized by reducing taxes.
(e) Exchange controls-if a country imposes restrictions on transfer or profits from domestic
market to subsidiary, the restrictions on transfer can be overcome if the head office
provides goods to the subsidiary and charges a high price and therefore it‘s able to
transfer profits as revenue from the subsidiary.
(f) Competition consideration-transfer price can be used by profit centers to make them
competitive i.e. they are able to match competitor‘s prices by reducing the transfer price
so that the cost is reduced.
(g) Minority interest/shareholders
PERFORMANCE EVALUATION
Performance evaluation refers to the exercise of comparing actual and expected performance.
The primary objective is to ensure that the original objective of the company is being
implemented. The secondary objective is to establish responsibility which forms the ground of
either rewarding or punishing the subject of appraisal
In order to effectively measure responsibility, the company is divided into responsibility Centre.
A RESPONSIBILITY CENTRE is a Centre whose manager is held accountable for what
happens in the Centre. A good responsibility Centre should have the following characteristic:
 Clearly defined boundaries.
 A direct link with manager‘s i.e. appropriate span of control.
 Clearly defined categories of cost.
Types of responsibility Centre.
1. Cost Centre
This is where responsibility is judged on the amount of costs. This is done by computing
production cost variances.
2. Revenue Centre
This is where the manager is held responsible for the revenues generated only. This is
done using the sales variances.
3. Profit Centre.
This is where the manager is held responsible for the profit earned. Profit ratios are used
as measures of performance. The manager is superior to both cost and revenue managers.
4. Investment Centre
This is where the manager is held responsible on the basis of success or failure of capital
budgeting decisions. This is headed by senior most managers or the owner of the firm.
JOHNMARK CPAK
KCE COLLEGE
Page 28
Method of evaluating performance
(a) Return on investment (ROI)
(b) Residual income (RI)
(c) Economic Value Added (EVA)
.
1. RETURN ON INVESTMENT (ROI)
This shows the amount of return generated by a given investment amount over a defined period
of time. It indicates how assets are utilized in-order to generate returns
It is computed as follows:
ROI= operating income
χ100
Operating asset/capital
Using du-point method
ROI= income × sales × 100
Sales
assets
 ROI is preferred for economic performance measurement and comparison of
dissimilar units.
 When used in appraising project, a new project should only be accepted if its ROI is
greater than the existing divisional ROI.
Advantages of ROI as a performance measure.
1. It’s a better measure of profitability
It relates to net income to investment made in a division giving a better measure of
division profitability. All division managers know that their performance will be judged
in terms of how they have utilized assets to earn profit.
2. Achieving goal congruence.
ROI ensures goal congruence between different divisions and the firm. Any increase in
divisional ROI will bring improvement in overall ROI of the entire organization.
3. Comparative analysis
ROI helps in making comparison between different business unit in terms of profitability
and asset utilization. It may be used for internal comparison.
4. Matching with accounting measurements
ROI is based of financial accounting measurement accepted in traditional accounting . It
does not require a new accounting measurement to generate information for calculating
ROI.
5. Performance of investment division.
ROI is a significant measure of performance of investment division which focuses on
earning maximum profit and making appropriate decisions regarding acquisition and
disposal of capital asset.
Disadvantages of ROI/RI
1. ROI focuses on short-term results and profitability: long term profitability focus is
ignored.
2. It ignores the time value of money.
JOHNMARK CPAK
KCE COLLEGE
Page 29
3.
4.
5.
6.
7.
It ignores the external factors.
It does not recognize the effect of qualitative factors.
It ignores the effect of inflation.
It ignores different useful lives of different projects.
Investment managers may manipulate ROI by changing accounting policies to attain their
personal objectives for their personal gain.
8. Sometimes it may be difficult to use ROI for comparability mostly when different
companies use different accounting policies and methods in respect of valuation of stocks
and assets.
9. ROI may influence divisional manager to select only investment with high rates of return
ie rate which are higher above the target ROI
2. RESIDUAL INCOME (RI)
This is the excess of profit over cost of capital computed as
RI=contribution/income-assets× cost of capital
 This is preferred for managerial performance but it is not suitable for comparison of
dissimilar divisions since it‘s an absolute measure.
 It is accepted if RI is greater than the existing the cost of capital.
Advantages of residual income.


It takes into account the opportunity cost of tying up assets in the division.
It encourages investment Centre managers to make new investment if they add to residual
wealth.
3. ECONOMIC VALUE ADDED (EVA)
This refers to the difference between sales and cost of sales. Is an economic model developed by
Stern & Steward. It uses the residual of wealth to value the firm.
 The higher the EVA, the better the performance.
 Eva uses cash flows which will be determined by adjusting the profits.
 EVA is the difference between net operating profit after tax (NOPAT) and the return on
capital employed (ROCE).
EVA=revised income (NOPAT) – (revised capital ×cost of capital)
EVA=NOPAT-ROCE (return on capital employed)
The following steps are used:
(a) Determine the NOPAT.
(b) Determine the capital employed.
Capital employed=equity=share capital +reserves +retained profit.
(c) Determine the WACC if not provided by either using CAPM or the weighted average.
(d) Determine the return on capital employed.
(e) Determine EVA.
JOHNMARK CPAK
KCE COLLEGE
Page 30
Advantages of using EVA.
1. It‘s a true indicator of the actual wealth created for the shareholders
2. It‘s a good measure of performance evaluation.
3. It‘s simple to understand and explain to managers.
4. EVA is consistent with the objective of maximizing shareholders wealth.
5. It uses cash flows and hence less easy to be manipulated.
6. It‘s widely used to evaluate manager‘s performance.
Disadvantages of EVA
1. It‘s complex to calculate where large transactions are involved.
2. It‘s based on historical information and hence does not consider the future flow.
3. It is not suitable for small enterprises since it doesn‘t take into account the size of the
firm.
4. The term value added has different meaning in taxation, economics and business studies.
This hence creates confusion among the audience.
5. They include suppliers as part of the value creation. This is contested by many people.
6. Different companies uses different policies which creates different value
7. It uses the assumptions of CAPM to determine the required rate of return.
8. It‘s not good for comparison since it doesn‘t consider the size of the company.
Why EVA has gained prominence.
 It‘s less easy to manipulate then accounting figures.
 It takes into account the cost of capital.
 It makes managers accountable.
 It helps the managers to link the balance sheet to the P&L account.
EVA has the following additional benefits.
I. Shows the extent of interest each team member has in the firm.
II. Replaces the unpopular term profit with a more acceptable term value.
Drawbacks of EVA.
1. The term value added has different meaning in taxation, economics and business studies.
This hence creates confusion among the audience.
2. They include suppliers as part of the value creation. This is contested by many people.
3. Different companies uses different policies which creates different values
Accounting adjustments;
1. Interest on debt capital should be added back net of tax.
2. Marketing and advertising expenses, research and development costs and goodwill
written off should be added back, capitalized and then amortized over the economic
period.
3. Non-cash expenses should be added back and computed on economic basis.
4. Depreciation and amortization should be added back.
5. Goodwill should be added back to the capital employed.
EVA is presented using statement which is divided into two main parts.
JOHNMARK CPAK
KCE COLLEGE
Page 31
 Part one-shows how the value is created.
 Part two-shows how value is shared among the team members who are owners.
.
Specific objectives of financial statement analysis.
(i) Assess the past, present and future performance.
(ii) Assess the operational efficiency of the firm.
(iii)Determine short term and long term liquidity of the company.
(iv) Assess the performance of the firm against other firms and industry in general.
Techniques of analysis.
1.
2.
3.
4.
Ratio analysis.
Trend analysis.
Cross-sectional analysis.
Common size analysis.
RATIO ANALYSIS.
A ratio is a mathematical expression of an amount in term of another. Commonly used ratios are
group as follows:
1. Profitability ratios
2. Trading/turnover ratios
3. Investment/valuation ratios
4. Capital ratios.
5. Gearing ratios.
6. Liquidity ratio.
Advantages of ratio analysis.
(a) It provides greater clarity and deep understanding of the information.
(b) Helps in formulating future financial policies.
(c) Helps in effective cost control.
Disadvantages of ratio analysis.
(a) Difficult to decide on the proper basis of comparison.
(b) Price level changes makes interpretation difficult.
(c) Statistical and scientific analysis is not possible.
(d) Seasonal factors can affect ratios.
(e) Use of different accounting methods
When judging performance, there are two categories of measures which can be applied:
1. Financial measures-These are monetary/quantifiable measures whose input values are
extracted from financial statement e.g. ROI, RI, EVA.
2. Non-financial measures-these are non-monetary measures such as Confidence,
audibility, eloquence, competence, creativity, dressing, integrity etc. they are captured by
balance score card.
JOHNMARK CPAK
KCE COLLEGE
Page 32
In performance measurement, it is important to clearly identify the subject of appraisal as
follows:


Managerial performance.
Divisional/Economic performance.
1.Financial measuresThese are monetary/quantifiable measures whose input values are extracted from financial
statement and may also report changes in sales growth or in expense category e.g. ROI, RI,
EVA.
Some of these financial performance indicators include:
1. Operating cashflows-monitoring and analyzing operating cashflows helps in understanding
entities ability to pay for deliveries and routine expenses.it can be done by analyzing operating
cashflows ratios.
2. Working capital management-this is the difference between current asset and current
liabilities.it indicates the liquidity position of an entity.it can be determined by computing the
following ratios.
 Current ratio
 Quick ratio/acid test ratio
 Cash ratio.
3. Leverage performance-this indicates the extent in which an entity has borrowed fixed return
capital to finance its assets. It can be evaluated using ratios such as:
 Debt to equity ratio/capital gearing ratio.
 Debt ratio/financial gearing ratio.
 Fixed charge ratio
4. Profitability performance-this can be evaluated using profitability ratios which include:
 Gross profit margin
 Operating profit margin
 Return on investment
 Return on equity
 Return on net asset
5. Efficiency financial performance-this indicates how efficient does the entity utilizes its
asset.it can be analyzed using ratios such as:
 Stock/inventory turnover ratio.
 Fixed asset turnover ratio.
 Creditors turnover ratio
 Debtor’s turnover ratio.
JOHNMARK CPAK
KCE COLLEGE
Page 33
6. Valuation /investor performance evaluation indicators-these are financial indicators which
investor use to determine the value or the worth of the company. They can use the following
ratio to measure the performance:
 EPS
 DPS
 Earning yield
 Dividend Yield
 Dividend cover
2.
NON-FINANCIAL MEASURES
These are non-monetary measures and mostly they relate to customer relationship, employees
operations, quality, product cycle time and other organization supply chain such as Confidence,
audibility, eloquence, competence, creativity, dressing, integrity etc.
They are captured by balance score card.
Non -financial performance measures in the balance score card:
Taking in account the balance score-card approach, there are four perspective involved in
strategy management: customer, internal processes, learning and growth (HR) and financial
1. CUSTOMER:
 Conversion rates-The percentage of interaction that result in a sale.
 Retention rate- the proportion of customer who remains customers for the entire
reporting period.
 Contact volume by channel- the number of support request by phone or email.
 Customer satisfaction index-gauge of a company’s success at meeting customer’s need.
 Net promoters score-the likelihood that customer will recommend a brand to others.
2. INTERNAL PROCESSESS
 Customer support tickets- the number of new tickets, the number of resolved tickets
and time resolution.
 Product defect rate. This will give out the defect products over a given time frame
 On time delivery-the percentage of the time the products were delivered promptly as
scheduled.
 Efficiency measures-efficiency can be measured differently in every industry.
3. LEARNING AND GROWTH
 Salary competitiveness ratio (SCR)-the competitiveness of compensation options.
 Employee productivity rates-workforce efficiency can be measured over a given time
frame.
 Turnover rates-the success of retentions efforts for top performers and plans for talent
replacement.
JOHNMARK CPAK
KCE COLLEGE
Page 34


Average time to hire-the efficiency of the hiring process can be measured by time of
recruit, interview and hire.
Internal promotion rates-the successful retention and growth of top performers and
the promotion of the employees.
4. FINANCIAL PERSPECTIVE
It‘s vital that a business appraises both financial and non-financial performance there are four
key tools available.
 Kaplan and Norton‘s balanced score card.
 Fitzgerald and Moon‘s building block model.
 The performance pyramid
 The performance prism
FITZGERALD AND MOON’S BUILDING BLOCK MODEL.
The model developed an approach to performance measurement in business services that are
based on the three blocks of dimension, standard and rewards.
DIMENSION
Competitiveness
Financial performance
Quality of performance
Flexibility
Resource utilization
Innovation






Standards
Rewards
Ownership
Clarity
Achievable
Motivation
Fairness/equity
Controllability
Dimension-this refers to the scope of issues to be included in the performance
measurement.
Competitiveness-this is how a business stands in comparison to its competitors.
Financial performance-this gives an overview of an organization‘s state of affairs in
pare monetary terms.
Quality performance-is the ability to deliver goods and services that meets customer
expectation.
Flexibility-is the responsiveness to change in the factors influencing business
performance.
Resource utilization-this looks at the extent to which an organization can optimize the
use of its limited resources.
JOHNMARK CPAK
KCE COLLEGE
Page 35









Innovation-ability of the business to device new products and new ways of doing things.
Standards-these are rules that employees of a company must follow in order to achieve
the long term objectives of the organization.
Ownership-performance measure should be realistic and acceptable to everyone.
Employees should be involved in setting the measures rather than be imposed on them.
Achievable-performance measure should be realistic. Employees will not be motivated to
achieve results if they consider them to be impossible.
Fairness/equity-performance measure should be equally challenging for all part of the
business.
Rewards-managers expect to be rewarded not just for doing their job, but for doing it
right. To be effective, reward should have clarity, motivation and controllability.
Clarity-reward schemes should be clearly communicated to employees in advance.
Motivation-reward scheme should be set in a manner which motivates employees to
achieve the business goals.
Controllability-employees should only be rewarded or penalized on the results over
which they have some control or influence
Benefits of this model are as follows
1.
2.
3.
4.
5.
6.
Financial and non-financial performance measures are included.
They are linked in to corporate strategy.
Include external as well as internal measures.
Includes all important factors regardless of how easy they are to measure.
Shows clearly the tradeoffs between different dimensions of performance.
Shows how measures will motivate managers and employees.
GOAL CONGLUENCE IN PERFORMANCE MEASUREMENT.
Goal congruence is the term used to describe the situation where goals of different interest
groups coincide. Within various departments in an organization, there are departmental
objectives. If achieving these various also leads to the achievement of the objective of the
organization as a whole, this is said to be goal congruence.
Integration of goals and effectiveness when team building-the extent that individuals and
groups perceive their own goals as being satisfied by the accomplishment of organizational goals
is the degree of integration of goal. When organizational goals are shared by all, the term goal
congruence can be used
Ways of achieving goal congruence.
1. Share options schemes- rewarding managers and employees with share options can be a
good way of achieving goal congruence. In a share option scheme, selected employees
are given a number of shares each of which gives the right to subscribe for shares of the
company at a fixed price. This makes the employee feel part of the larger family of the
company.
JOHNMARK CPAK
KCE COLLEGE
Page 36
2. Working with people who are interested with organizational goals more than their
personal goals.
3. Know all important goals- Goal congruence is about alignment of objective, but perfect
alignment is normally impossible knowing the objective of all parties involved makes the
process of alignment smoother and increases the chances of success. It‘s vital to know
what each employee is looking to achieve in order to determine whether they are a good
fit for the organization.
4. Set achievable targets-Target setting is another important aspect of creating goal
congruence in the work place. If the targets are too highly unrealistic, they will
demotivate the employees. If they are set too low, they would reduce productivity and
motivation. The process of setting targets should be interactive and should try to
represent all those affected by targets.
5. Reward and retain-employees should be rewarded well for their efforts so that they feel
it is worth their while to add value to the organization.
6. Creating happy working environment-a comfortable working environment reduces
irrational behavior and a focus on self-interest while promoting a team work, culture
which makes goal congruence easier to achieve.
MANAGEMENT ACCOUNTING INFORMATION SYSTEM.
It is an information system that produces output using inputs and processes to satisfy specific
management objectives.
A good management accounting information system should have the following dimensions.
1. Time dimension-timeliness, currency, frequencies and time period.
2. Content dimensions-accuracy, relevance, completeness, scope and performance.
3. Form dimension-clarity, details, order presentation and media
Challenges encountered by a company management in building and maintaining a sound
MIS





Strategic business challenge
Globalization challenge
Information infrastructure
Information system investment challenge
Responsibility and control challenges
BUDGET AND VARIANCES
BUDGETING.
Budgeting is the process of deciding in advance how the available resources and those to be
acquired will be used for a specified period of time, usually one year. A budget therefore is a
plan quantifiable in monetary terms and approved prior to a defined future period of time.
Benefits of budgets include.
1. It provides a mean of communicating management problems to the organization.
JOHNMARK CPAK
KCE COLLEGE
Page 37
2.
3.
4.
5.
6.
7.
8.
9.
Budgets forces the managers to think about and plan the future.
The budgeting process provides a mean of allocating the resources in an effective way.
It helps in uncovering the future scarcity.
Budgets coordinate the activities of the organization by integrating various part of the
organization.
Budgets provides goals and objectives that can serve as a benchmark for evaluating
subsequent performance.
Funding planning.
Performance evaluation.
Cash collection.
Disadvantages/limitations of budgeting.
Budgets can be seen as pressure device imposed by management, thus resulting in:
1.
2.
3.
4.
5.
Bad labour relation.
Inaccurate record keeping.
Disputes over resources allocation.
It‘s difficult to reconcile personal and corporate goals.
Waste may arise as managers adopt the view ―we better spend or the lose it‖
IMPOSED BUDGETING (TOP DOWN BUDGETING)
This is a way of budget making where the top management make all drafts and proposal without
engaging other employees. This form of budgeting is mostly appropriate when:





During the periods of economic hardship.
In a very small business.
In a newly formed organization.
When the operational managers lack budgeting skills.
When the organization‘s different unit require precision coordination.
PARTICIPATORY BUDGETS. (BOTTOM UP BUDGETS)
This is where all stakeholders are involved in the making of budgets. Participative budgets are
effective in the following circumstances.
 In a well-established organization.
 In a very large business.
 During periods of economic affluence.
 When the operational manager have strong budgeting skills.
 Then the organization‘s different units act independently.
Advantages of bottom up budgets.
1. Increased motivation due to ownership of the budgets.
2. It will contain better information since employee‘s who are familiar with departments are
engaged.
JOHNMARK CPAK
KCE COLLEGE
Page 38
3. Increased manager‘s understanding and commitment.
4. It aids in better communication between departments.
5. Senior managers can concentrate on strategy.
Disadvantages of bottom up budgets.
1. Senior managers may resent loss of control.
2. Bad decisions from inexperienced managers.
3. Budget process is slow and dispute can arise.
4. Budgetary slack-managers or employee‘s sets targets that are too easy to achieve.
Types of budgets.
1. FIXED BUDGET.
A fixed budget is a budget which is designed to remain unchanged regardless of the volume of
output or sales achieved. It is easy to design, implement and understand. It has the following
drawbacks:
(i) Poor in planning and control since it considers only one option (rigid).
(ii) Demotivates workers when used in performance measurement since it compares ‗likes
and dislikes‘
(iii)Encourages the tendency of spending up to the allocated amount. This encourages fraud.
2. FLEXIBLE BUDGETS.
A flexible budget is a budget which, by recognizing different cost behavior pattern is designed to
change as volume of output changes. This is obtained by flexing the original/fixed budget using
the flexing base as output units or hours.
Advantages of flexible budgets.
(a) Good in planning and control, since it considers several options.
(b) Motivates workers in performance measurement since it compares ―like and like‖.
(c) Does not encourage the tendency of spending up to the allocated amount.
Steps in making flexible budget.
 Assign the original budget output 100%
 Compute the flexing base.
 Retain the fixed cost of the original budget.
 Multiply all variable items i.e. revenue and variable costs by the flexing base.
INCREMENTAL BUDGETING.
This is concerned with the increments in costs and revenue which will occur in the coming
period. This is a reasonable procedure if current operations are as effective and economical as
they can be. This method has the following weaknesses
 It perpetuates past inefficiencies.
 There is insufficient focus on improving efficiency and effectiveness.
 The resources allocation tends to be based on existing strategies rather than future
strategies.
 It tends to focus excessively on the short term and often leads to arbitrary cuts being
made in order to achieve short-term targets.
JOHNMARK CPAK
KCE COLLEGE
Page 39
ROLLING BUDGETS.
A budget (usually annual) kept continuously up to date by adding another accounting period.
(E.g. a month or quarter) when the accounting period is over. This method is suitable only if:
 Accurate forecasts cannot be made e.g. in a fast moving environment.
 For any area of business that needs tight control.
Advantages
1) They forces the managers to reassess the budget regularly and to produce budgets which
are up to date in the light of the current event.
2) Planning and control will be based on the recent plan which is likely to be far more
realistic than a fixed annual budget.
3) Realistic budgets are likely to have a better motivation influence on managers.
4) There is always a budget which extends for several months ahead.
Disadvantages.
1) Time consuming.
2) Effort involving
3) Requires a lot of resources to prepare.
ZERO BASED BUDGETING SYSTEM (ZBB)
This is a type of budget where everything is set from scratch (from zero).The existence and the
benefit of every item in this budget must be justified.it has the following steps.
1. Define decision package
2. Evaluate and rank each activity (decision package) on the basis of its benefit.
3. Allocate the resources according to the funds availability.
Advantages of ZBB.
 It‘s possible to identify and remove inefficient or absolute operations.
 It forces organization to avoid wasteful expenditure.
 It can increase motivation.
 It responds to changes in the business environment.
 It challenges status quo.
 ZBB documentation provides an in-depth understanding of organizations activities.
Disadvantages.
 Short term benefits might be emphasized to the detriment of long term benefits.
 It might give the impression that all decisions have been made in the budget.
 The ranking process can be difficult.
 It may call management skills
PROGRAMME BASED BUDGETING. (PBB)
Programme budgeting describes and give detailed costs of every activity or programme that is to
be carried out in a budget. A programme is a group of activities intended to contribute to a
common set of outcomes.
JOHNMARK CPAK
KCE COLLEGE
Page 40
Advantages of PBB
1.
2.
3.
4.
Flexibility and ownership.
Better resource allocation.
Increased awareness of performance and the need to monitor the targets.
Transparency and information access.
ACTIVITY BASED COSTING/BUDGETING.
This assumes that costs are caused by activities but are absorbed by products n activity refers to
combination of several tasks described by a verb.
Applications/concepts/uses of ABC.
 Costing policies.
 Pricing policies
 Evaluation procedures.
 Decision making
Reasons behind the growth of ABC.
1. Modern companies becoming multi-product.
2. Increased need for diversification strategies.
3. Increased neck to neck competition.
4. Increased automation
5. Emergence of low cost production countries.
Factors limiting the adoption of ABC.
1. Inability to establish appropriate cost drivers.
2. Sometimes some costs are not inevitable unless the business ceases.
3. Lack of resources-sometimes implementing ABC may be expensive.
TYPES OF ACTIVITIES.
1. Unit level activities.
These are activities which involves just one unit of a product. They are clearly
identifiable with the units and results into direct costs such as Material cost, labour, and
electricity.
2. Batch level activities.
They involves several units if a product. E.g. machine set-up, production scheduling,
receiving material and WIP.
3. Product sustaining activities.
These are activities aimed ensuring the long term survivor and competitiveness of the
product in the market .e.g. product design and testing, branding, material scheduling.
4. Facility sustaining.
Activities performed to ensure that the company remains as a going concern for a long
period of time. They enhances company‘s market share.eg R&D.
JOHNMARK CPAK
KCE COLLEGE
Page 41
Procedures for implementing ABC
1. Identify all the activities taking place in the organization.
2. Group all the identical activities to form cost pools/centers
3. Identify the appropriate cost driver for each cost pool.
4. Compute the OAR for each cost pool
5. Charge the cost to the product.
Disadvantages of ABB/ABC.
1. Could require software.
2. Manager training may be required.
3. Requires deep understanding.
4. Losing focus.
REPORTING METHODS IN COST AND MANAGEMENT ACCOUNTING
DEPARTMENTS.
In cost accounting departments inform action is gathered and prepared so as to be provided to the
management for effective execution of managerial functions. There are three methods used to
report the outcomes:
1. ABSORPTION COSTING.
This holds that inventories vale should include both variable and fixed production cost.
2. MARGINAL COSTING
This holds that inventories value should only include variable production costs.it is
mostly applied in the following areas:
 CVP analysis.
 Budgeting.
 Standard costing.
 Performance measurement
 Non-routine decision making.
3. ACTIVITY BASED COSTING.
REVIEW THEORIES
Steps followed in developing cost forecasting model.
1. Identify the cost to be predicted/dependent variable (Y).
2. Identify the cost driver/independent variable (X)
3. Gather data relating to X & Y.
4. Analyze the data and plot on a graph.
5. Observe the pattern of trend and formulate appropriate equation.
Steps in decision making.
1. Identify the objective.
2. Identify all possible options.
3. Identify all possible outcomes for each option.
JOHNMARK CPAK
KCE COLLEGE
Page 42
4. Gather data and use it to compute the payoff.
5. Apply an appropriate rule to select the best option.
Assumptions of learning curve.
1. The job is manual and repetitive.
2. The labour involved is indirect.
3. There are no breaks.
4. Workers are motivated.
Applications of learning curve.
1. Work scheduling.
2. Setting labour standards.
3. Decision making.
4. Performance evaluation.
5. Inventory valuation.
6. Performance measurement
7. Project appraisals
8. Pricing decisions
Limitation of learning curve.
1. It is based on the time necessary to complete the earlier units, therefore time must be
accurate to obtain reliable estimates.
2. Any changes in personnel, design or procedure can be expected to alter the learning
curve.
3. Learning curve differs from company to company as well as industry thus limit
comparison.
4. It provides only estimates which cannot be relied upon to represent the true states affair.
Stoppage of learning causes.
 Demotivators.
 Mental fatigue
 Climatic condition
 Technological changes.
 Long breaks
Factors to consider to ensure management accounting information is used effectively.
 Economic reliability.
 Relevance.
 Timing
 accuracy
Multiple regression method.
 Is a statistical method used to study the nature and the strength of the relationship
existing between variable.it is called multiple since it is applied where more than one
independent variable exist.
The general format is:
JOHNMARK CPAK
KCE COLLEGE
Page 43

Y=B1X1+B2X2+…………..+BnXn
When the data is bivariate the general format is:
Y=a+b1X1+b2X2
Whose normal equation is:
Ʃy= na+b1Ʃx1+b2Ʃx2
Ʃx1 y= aƩx1+b1Ʃx12+b2Ʃx1x2
Ʃx2 y= aƩx2+b1Ʃx1x2+b2Ʃx22
ANALYSIS OF VARIANCE (ANOVA)
This is a computerized aided analysis of regression analysis. Interpretation is done as follows:
SUM OF SQUERE (SS) =variance= variations
 Regression sum of square (Reg SS)= Explained variation.
 Residual/error regression (Res SS) = Unexplained variation.
 Total variation
= Reg SS + Res SS
DEGREES OF FREEDOM (df)
 Regression df=number of independent variables
 Residual df= n-k
 Total df = (n-1) =Reg df +Res df
MEAN SUM OF SQUERE ( MSS)=sum of square ÷ degree of freedom.
Reg MSS=Reg SS ÷ Reg df
Res MSS= Res SS ÷ Res df
F calculated=Reg MSS ÷ Res MSS
F significant/critical=0
TABLE OF COEFFICIENT/ PARAMETER COEFFICIENT
 Constant (a)
 Coefficient /estimates (b)-this indicates the sensitivity or the change in independent
variable when independent variable is changed by one unit.
 Standard error= (sb)
 T cal= b÷sb
 Adjusted R2=1- Res SS/Res Df
Total SS/total Df
NB
1. T test shows whether the equation/independent variable is significant or insignificant.
The decision on hypothesis is done as follow:
Hypothesis: Ho: X is not a significant determinant of Y.
Ha: X is a significant determinant of Y.
T critical=t (α/2)(n-k)
Ie if u reject, this means the model is significant and when we accept that means the
model is insignificant.
2. F test indicates whether the model is suitable.
3. We use coefficient/estimates b to develop the model equation eg
Assume a study was carried out to determine KCE student performance (y).the key
considerations were handwriting(x1) and class attendance(x2). The model portrayed the
following equation.
JOHNMARK CPAK
KCE COLLEGE
Page 44
Y=a + b1x1 +b2x2
Y= 0.94-0.34x1+1.34x2
Interpret the above model:
 0.94 –this means that the 94% of the student performance is explained by other
factor other than handwriting and class attendance or changes in performance
which does not depend on handwriting and class attendance
 -0.34 this is the decrease in student performance if handwriting increase by one
unit.
 1.34-this is the increase in student performance if class attendance increases by a
unit.
Advantages of decision tree.
1. Does not require scaling of data.
2. Facilitates sequential decision making.
3. They are easy to use and quick to draw comparisons.
4. Allows incorporation of monetary value to decision tree which helps to identify and
isolate best option.
Disadvantages.
1. As the amount of data increases, the construction can be complex.
2. Its time consuming.
3. Require extensive knowledge in decision theory.
JOHNMARK CPAK
KCE COLLEGE
Page 45