MODULE 3a : Managerial Accounting :
Costing Part 2
ZCMA 6022 : Managerial Accounting
Prepared by:
Nasuha Nordin
ABSORPTION VS. VARIABLE
COSTING
Absorption Costing
Sales
- Cost of good sold
Beginning inventory
+ Cost of good
manufactured
Goods available for
sale
- Ending inventory
Gross margin
- Selling &
administrative
expenses
Net operating income p
Variable costing
Sales
- Variable costs
Variable Costs of good sold
Beginning inventory
+ Cost of good
manufactured
Goods available for sale
- Ending inventory
Selling & administrative
Contribution margin
- Fixed costs
Manufacturing overhead
Selling & administrative
Net operating income
ACTIVITY BASED COSTING SYSTEM (ABC)
ABC systems follow a two-stage procedure to assign
overhead costs to products.
3
Stage One
Identify significant activities and assign overhead
costs to each activity in proportion to resources used.
Stage Two
Identify cost drivers appropriate to each activity and
allocate overhead to the products.
TWO STAGES OH APPLICATION
DEPARTMENTAL RATE VS. ABC
Total Man OH
(Estimated)
RM100,000
Stage 1:
Cost
Assignme
nt to
Dept.
/Activity
Stage 2:
Cost
Assignme
nt to
Products
Production
Dept. X
RM64,000
Productio
n Dept. Y
RM36,000
OH Rate
OH Rate
Product A
Product B
Total Man OH
(Estimated)
RM100,000
Service
Dept.
Activity
1
RM20,00
0
Activity
2
RM30,00
0
Activity
3
RM50,000
Activity
Rate
Activity
Rate
Activity
Rate
Product A
Product B
HOW COSTS ARE TREATED UNDER
ACTIVITY–BASED COSTING
Unit-Level Activity
Batch-Level Activity
Cost pools are generally
fall in four broad categories
Product – sustaining
Level activity
Facility-level
Activity
HOW COSTS ARE TREATED UNDER
ACTIVITY–BASED COSTING




Unit level – this type of activity must be done for each
of unit of production. E.g. direct material, quality
inspection for microchip processor
Batch level – these activities must be performed for
each batch of products rather than each unit. E.g.
setup, purchasing, material handling, quality
assurance and packing/shipping
Product sustaining level – this category includes
activities that are needed to support an entire product
line but are not performed every time a new unit or
batch of products is produced. E.g. engineering design
costs.
Facility (or general operations) level – these are
required in order for the entire production process to
occur.
STAGE ONE: OH COSTS ASSIGN TO
COST POOLS
Overhead Costs
Total budgeted cost = $4,896,000
Unit
Level
Setup
cost pool
$210,000
Activity
Cost
Pools
Purchasing cost pool
$300,000
Material-Handling
cost pool $340,000
Quality-Assurance
cost pool $110,000
Packaging/Shipping
cost pool $264,000
Facility
Level
7
Machinery
cost pool
$1,242,000
Batch
Level
Engineering
cost pool
$130,000
ProductSustaining
Level
Facility
cost pool
$2,300,000
STAGE ONE: COSTS ASSIGN TO
COST POOLS
Activity
cost
pool
Maintenance
Lubrication
Depreciation
Electricity
Computer Support
Calibration
Machine Related Cost Pool
Total budgeted cost = $1,242,000
8
Various overhead
costs related
to machinery
COLLECTING ABC DATA
INTERVIEWS AND PAPER TRAILS - The information
STORYBOARDING - A procedure used to develop a
detailed process flow chart, which visually represents
activities and the relationships among activities.
MULTIDISCIPLINARY ABC PROJECT
TEAMS – To gather information from all facets of an
organizations operations, it is essential to involve personnel
from a variety of functional areas. A typical ABC project
team includes ACCOUNTING, FINANCE,
PRODUCTION, OPERATIONS, ENGINEERS,
MARKETING etc.
9
for ABC systems initially comes from interviews with
employees in the support departments and a review of each
department’s records.
ACTIVITY BASED MANAGEMENT
• Process of using information from
activity-based costing to analyse
activities, cost drivers and performance
so that customer value and profitability
are improved
• Customer value
– The value that customers place on
particular features of a product
• Addresses the vertical view on the
activity-based costing model
ACTIVITY-BASED MANAGEMENT
11
Activity-based costing establishes relationships
between overhead costs and activities so that
we can better allocate overhead costs.
Activity-based management focuses
on managing activities to reduce costs.
ELIMINATION OF NON-VALUE-ADDED
COSTS
Activities
12
Nonvalueadded
activities
Unnecessary
Necessary
Reduce or
Eliminate
Continually
Evaluate
and Improve
USING ABM TO ELIMINATE NON-VALUEADDED ACTIVITIES AND COSTS
1. Identify Activities.
2. Identify Non-Value-Added Activities.
3. Understand Activity Linkages, Root
Causes, and Triggers.
Specify
parts
Select
vendor
Receive
parts
Produce
goods
Inspect
finished
goods
4. Establish Performance Measures.
5. Report Non-Value-Added Costs.
Rework
defective
products
IDENTIFY ACTIVITIES

Identifies all of the organization’s significant
activities
IDENTIFY NON VALUE ADDED ACTIVITIES
Is the activity necessary? If it’s a duplicate or
nonessential operation, it is non value added.
 Is the activity efficiently performed? Compare the
actual performance of the activity to a value
added baseline establishment.
 Is an activity sometimes value added and
sometimes non value added? It is may necessary
to move WIP unit between production operations
but unnecessary to move raw materials around
while in storage.

UNDERSTANDING ACTIVITY LINKAGES,
ROOT CAUSES AND TRIGGERS
Non value added activity = Rework of defective
units.
 Triggers = identification of defective product
during inspection.
 Root causes = any number of preceding activities
e.g part specification were wrong, unreliable
vendor was selected, wrong part is recevies

ESTABLISHING PERFORMANCE MEASURES

Continually measuring the performance of all
activities, and comparing performance with
benchmark, management’s attention may
directed to unnecessary or inefficient activities
REPORTING NON VALUE ADDED COST


One of the approach – categorize the ways which time
is spent in production process.
Normally time spent in manufacturing operation in
five ways





Process time. The time which product is undergoing
conversion activity.
Inspection time. The amount of time spent ensuring the
product is of high quality.
Move time. The time spent moving raw materials, WIP or
finished goods between operations.
Waiting time. The amount of time that raw materials or
WIP spend waiting for the next period.
Storage time. The time during which materials, partially
completed products or finished goods are held in stock
before further processing or shipment to customers.
ACTIVITY 1 : GROUP PROJECT DISCUSSION :
INDIVIDUAL ASSIGNMENT III
Team Name:
Team
Cost Estimation
Membe
r
1
Absorption Costing
2
Contribution Margin Costing
3
Activity Based Costing
4
Target Costing - Absorption Costing
5
Target Costing - Activity Based
Costing
Team Member Name
WHAT IS OPERATING
LEVERAGE?
OPERATING LEVERAGE
Extent to which an organization uses fixed costs
in its cost structure
 Firms with higher proportion of FC than VC
resulting in high contribution margin benefits
the most from this method
 Refers to ability of firm to generate an increase in
net income when sales revenue increases
 Operating leverage provides information on a
company’s risk profile
 Higher OPERATING LEVERAGE could lead to
HIGHER PROFIT MARGIN when companies
increase the sales without incurring additional
cost

OPERATING LEVERAGE
Operating Leverage Factor
= Contribution Margin
Net Income
ACTIVITY 2 : EXERCISE 3
Please complete the Question Distributed and Submit
before you leave using softcopy in IFOLIO or
Handwritten Hardcopy
Operating Leverage
(35 minutes)
Problem 7-43 (Hilton and Platt 2015)
5% of total Assessment Marks
Good Luck!
EXERCISE 3 ANSWER :
OPERATING LEVERAGE
ZCMA 6022 : Managerial Accounting
Prepared by:
Nasuha Nordin
EXERCISE 3 ANSWER 1
Plan A break-even point = fixed costs ÷ unit
contribution margin
= $33,000 ÷ $33*
= 1,000 units
Plan B break-even point = fixed costs ÷ unit
contribution margin
= $99,000 ÷ $45**
= 2,200 units
* $120 - [($120 x 10%) + $75]
** $120 - $75
EXERCISE 3 ANSWER 2
Operating leverage refers to the use of fixed
costs in an organization’s overall cost
structure. An organization that has a
relatively high proportion of fixed costs and
low proportion of variable costs has a high
degree of operating leverage.
EXERCISE 3 ANSWER 3
Calculation of contribution margin and profit at
6,000 units of sales:
Sales revenue: 6,000 units x $120……………….
Less variable costs:
Cost of purchasing product:
6,000 units x $75…………………….……
Sales commissions: $720,000 x 10%……...
Total variable cost………………………..
Contribution margin………………………………
Fixed costs………………………………………….
Net income………………………………………….
Plan A
Plan B
$720,000
$720,000
$450,000
72,000
$522,000
$198,000
33,000
$165,000
$450,000
----__
$450,000
$270,000
99,000
$171,000
Plan A has a higher percentage of variable costs to sales (72.5%)
compared to Plan B (62.5%). Plan B’s fixed costs are 13.75% of sales,
compared to Plan A’s 4.58%.
Operating leverage factor = contribution margin ÷ net income
Plan A: $198,000 ÷ $165,000 = 1.2
Plan B: $270,000 ÷ $171,000 = 1.58 (rounded)
Plan B has the higher degree of operating leverage.
EXERCISE 3 ANSWER 4 & 5
Calculation of profit at 5,000 units:
Sales revenue: 5,000 units x $120……………….
Less variable costs:
Cost of purchasing product:
5,000 units x $75…………………………..
Sales commissions: $600,000 x 10%……...
Total variable cost………………………..
Contribution margin………………………………
Fixed costs…………………………………………
Net income………………………………………….
Plan A
Plan B
$600,000
$600,000
$375,000
60,000
$435,000
$165,000
33,000
$132,000
$375,000
---- __
$375,000
$225,000
99,000
$126,000
EXERCISE 3 ANSWER 4 & 5 (CONTD)
Plan A profitability decrease:
$165,000 - $132,000 = $33,000; $33,000 ÷ $165,000 = 20%
Plan B profitability decrease:
$171,000 - $126,000 = $45,000; $45,000 ÷ $171,000 = 26.3%
(rounded)
PneumoTech would experience a larger percentage decrease in
income if it adopts Plan B. This situation arises because Plan B has a
higher degree of operating leverage. Stated differently, Plan B’s cost
structure produces a greater percentage decline in profitability from
the drop-off in sales revenue.
Note: The percentage decreases in profitability can be computed by
multiplying the percentage decrease in sales revenue by the
operating leverage factor. Sales dropped from 6,000 units to 5,000
units, or 16.67%. Thus:
Plan A: 16.67% x 1.2 = 20.0%
Plan B: 16.67% x 1.58 = 26.3% (rounded)
EXERCISE 3 ANSWER 6
Heavily automated manufacturers have sizable investments in
plant and equipment, along with a high percentage of fixed costs
in their cost structures. As a result, there is a high degree of
operating leverage.
In a severe economic downturn, these firms typically suffer a
significant decrease in profitability. Such firms would be a more
risky investment when compared with firms that have a low
degree of operating leverage. Of course, when times are good,
increases in sales would tend to have a very favorable effect on
earnings in a company with high operating leverage.
MODULE 3 : Managerial Accounting :
Costing Part 2
ZCMA 6022 : Managerial Accounting
Prepared by:
Nasuha Nordin
WHAT IS
RELEVANT?
1.
RELEVANT RANGE
I.
RELEVANT INFORMATION
II.
RELEVANT RANGE
II.
RELEVANT INFORMATION
Why do we need
information in an
organization?
II.
RELEVANT INFORMATION
What are the
characteristics of
information?
Information for decision
making need to be:
Relevant
Accurate
Timeliness
II.
RELEVANT
INFORMATION
Whether particular costs and
revenues are relevant for decision
making depends on the decision
context and the alternatives available
Criteria of relevant
information:
Bearing
on future
Different
under competing
alternative
II.
RELEVANT RANGE
The range of activities within which
management expects the company to
operate
II.
RELEVANT RANGE
Management is always interested to
know the cost behavior within the
Company’s relevant range
How do we know what is the Company’s relevant range?
8,000
7,000
6,000
5,000
4,000
3,000
2,000
1,000
-
20
40
60
80
100
DOZENS OF DONUTS SOLD
120
140
Thousands
II.
-
RELEVANT RANGE
RELEVANT RANGE EXAMPLE
UTlLITIES
What is CVP?
COST-VOLUME-PROFIT ANALYSIS
Study of the effects of changes of costs and volume on
a company’s profits
 A critical factor in management decisions
 Important in profit planning

ASSUMPTIONS UNDERLYING
CVP ANALYSIS

Behavior of both costs and revenues is linear throughout the
relevant range of the activity index

All costs can be classified as either variable or fixed with
reasonable accuracy

Changes in activity are the only factors that affect costs

All units produced are sold

When more than one type of product is sold, the sales mix
will remain constant
CVP ANALYSIS

Breakeven Point (BEP) (units and $)
doesn’t convey how profit changes as activity
changes

Graph
CVP graph – over FC
2. CVP graph – over VC
3. Profit-Volume graph
shows BEP
Shows Profit and Loss areas
1.
Sensitivity Analysis
 Safety Margin (MOS)
 Operating Leverage

CVP ANALYSIS
BEP
Sensitivity
Analysis
Margin of
Safety
CVP INCOME STATEMENT
Absorption Costing
Statement
Contribution Costing
Statement
doesn’t disclose
breakdown between
FC / VC/ SemiVariable Cost
highlights distinct
values of FC/ VC/
Semi-VC
Highlights CVP
relationships
Able to identify Cost
Structure (Cost
domination – VC or
FC)
CVP ANALYSIS - BREAKEVEN
Breakeven Point ($)
Breakeven Point (unit)
1.
Contribution Margin
Approach
1.
Contribution Margin
Approach
2.
Formula
2.
Formula
CVP ANALYSIS - BREAKEVEN
Breakeven Point ($)
Breakeven Point (unit)
1.
Contribution Margin
Approach
1.
Contribution Margin
Approach
2.
Formula
2.
Formula
CVP GRAPH
CVP graph over FC
CVP graph over VC
CVP GRAPH
CVP graph over FC
Profit Volume Graph
ACTIVITY 3 : GROUP PROJECT DISCUSSION :
GROUP ASSIGNMENT III
COST-VOLUME-PROFIT
ANALYSIS
MODULE 2
MODULE 3b : Managerial Accounting :
Decision Making
ZCMA 6022 : Managerial Accounting
Prepared by:
Nasuha Nordin
DECISION MAKING
What Could be Some of the
Decisions to be Made within an
Organization?
DECISION MAKING
1.
2.
3.
4.
5.
Special Order : Accept / Reject
Special Decision : Limited Resources
Special Decision : Outsourcing – Make or Buy
Special Decision : Add or Drop Service/ Product /
Department
Special Decision : Sell or Process Further
Accept /
Reject
Limited
Resources
Outsourcing
Add or Drop
Sell or
Process
Further
ACTIVITY 4 : GROUP PROJECT DISCUSSION :
INDIVIDUAL ASSIGNMENT IV
Team Name:
Team
DECISION MAKING
Member
1
Special Order: Make or Buy
2
Special Decision: Limited Resources
Special Decision: Add, Drop a Service,
3
Product of Department
4
5
Special Decision: Outsourcing – Make
or Buy
Special Decision: Sell or Process
Further
Team Member Name