Performance Operations Tutor: Asad Ahmed Raufi /

Format of the Paper Section A: 20 marks  Compulsory objective test questions Section B: 30 marks  6 compulsory short answer questions Section C: 50 marks  2 compulsory questions

Core Areas of Syllabus  Cost accounting systems30%  Forecasting and budgeting techniques 10%  Project appraisal25%  Dealing with uncertainty in analysis 15%  Managing short term finance20%

Further explanation  Exam room advice- Please read the article “An exam room approach to answering P1 questions” 4

1 1 Chapter Verb hierarchy

Typical verbs used in questions  Explain  Illustrate  Apply  Calculate  Discuss  Analyse  Evaluate

Further explanation  Question Verbs advice- Please read the article “Understanding question verbs” 7

2 2 Chapter Traditional Costing

Chapter Content Absorption Costing Traditional Costing Marginal Costing Contribution Analysis

Absorption costing  Absorption costing is a method of costing in which the cost of a product is built up as the sum of direct costs and a fair share of production overhead cost  A fully absorbed cost is used to value inventory and as a basis for pricing

Standard cost card $ Direct materialsx Direct labourx Variable overheadsx Fixed production overheadsx Absorption cost per unitx OAR

Proforma of Income Statement

Marginal Costing Inventories and production are valued at the variable production costs per unit. $ Direct materialsx Direct labourx Variable overheadsx Marginal costx Contribution is emphasised.

Contribution Contribution = Sales Less Variable Costs Direct Materials Direct Labour Variable Overheads

Proforma of Income Statement

Reconciliation of profits The only difference between the two approaches is the value of inventories. Absorption costing values inventory at a higher value as it includes the fixed production overhead in the standard cost card. Therefore: increased inventory increases current period’s profit compared with marginal costing. decreased inventory decreases current period’s profit compared with marginal costing.

Differences in profit 1.If Opening Stock > Closing Stock then MC Profit > TAC Profit 2.If Opening Stock < Closing Stock then MC Profit < TAC Profit 3.If Opening Stock = Closing Stock then MC Profit = TAC Profit

Break even analysis Break even point = Total fixed costs Contribution per unit Margin of safety = Budgeted Sales – B/E Sales Target units = Total fixed costs + Target profit Contribution per unit

3 3 Chapter Techniques for Modern Environments

Chapter Content MRP Techniques for Modern Environments ERP MRP II JIT TQM Back flush Accounting

Overview ` To compete successfully in today's highly competitive global environment companies are making customer satisfaction an overriding priority, adopting new management approaches, changing their manufacturing systems and investing in new technologies. These changes are having a significant influence on management accounting systems’ Colin Drury ' Management and Cost Accounting'

Aims of modern systems  Improve efficiency  Improve effectiveness  Improve quality  Reduce waste

MRP MRP1  A computer system for production, planning, purchasing and inventory control  Not integrated with other related systems MRP II  Extension of MRP 1  Links production/materials planning to other systems with the accounting system  Budgets can be prepared from a common database

JIT  ‘Pull through’ system (Kanban)  Ideal inventory of raw materials, WIP and finished goods is zero  Contracts with suppliers for high quality raw materials with flexible deliveries  Ultimately, produces to order for customers  Removes the need for inventory valuation and facilitates backflush accounting (later)

Suitable conditions for JIT  Local supplier with short lead times  Even demand  Fast throughput  Cost savings from lower inventory and improved quality exceed cost increases from higher skilled staff and higher quality materials

Total Quality Management (TQM)  Get things right first time  Continuous improvement Costs affected  Prevention costs  Appraisal costs  Internal failure costs  External failure costs

TQM vs Standard Costing  Focuses on continuous improvement rather than standard performance  Expects everyone to take responsibility for failures in the system  Does not accept waste as being acceptable.  More concerned with quality related costs than production costs  Usually incorporates JIT inventory control so that material variances are less likely

Back flush accounting  An approach to cost accounting which can be used if throughput is high and inventories are low  Actual material purchases are recorded in raw materials account  Actual conversion costs are recorded in the cost of goods sold account  At the end of the period values for closing inventory are estimated  This results in a figure for the actual production cost

4 4 Chapter Throughput Accounting

Chapter Content Calculating Throughput Throughput Accounting Throughput Accounting Theory of Constraints Throughput Accounting Measures

Throughput Sales Revenues – Direct Material Cost = Throughput

Theory of Constraints Bottlenecks prevent throughput from being maximised Throughput accounting is concerned with identifying and removing bottlenecks Prioritise production on the basis of throughput per usage of the scarce resouce

Throughput Formulae Return Per Factory Hour Throughput Time on Bottleneck Resources = Cost Per Factory Hour Total Factory Cost = Throughput Accounting Ratio Cost Per Factory Hour = Total Time on Bottleneck Resources Return Per Factory Hour

5 5 Chapter Activity Based and Environmental Costing

Chapter Content Activity Based Costing (ABC) ABC Principles Cost Drivers Pro’s and Con’s ABC Principles Cost Drivers Pro’s and Con’s Absorption Costing (Revision) Absorption Costing (Revision)

Activity Based Costing (ABC)  Absorption costing Charges overheads to products based on a hourly absorption rate  ABC Charges overheads to products on a causal basis using cost drivers

Absorption Costing Service Departments Production Departments Product Lines Stage 1Stage 2 Assigning Costs Using Measures of Service Usage Allocating Costs Using a Measure of Volume

Elements of ABC Activity cost pool: An activity that incurs cost. Costs are linked to the activity accurately and from the activity to the cost unit. Knowledge of the activity is key to the application of ABC.

Elements of ABC Cost driver:  This is the causal link between the activity and the cost unit.  Cost drivers describe exactly how the production of units incur costs within the activity.  The overhead is linked to the cost unit using a cost driver rate.

Elements of ABC Cost driver rate = Cost pool ________________ Level of cost drivers

Activity Based Costing Service Departments and Factory Overhead Activity Cost Pools Assigning Costs of Individual Activities Allocation of Costs Driver Rates Stage 1Stage 2 Product Lines

Why are traditional OARs less reliable?  Increased complexity of operation  Increased percentage of overhead costs  Reduced significance of labour  Less volume related costs

Favourable Conditions For ABC  Production overheads are high relative to direct costs.  Diversity in the product range.  Diversity of overhead resource input to products.  Consumption of overhead resources is not driven primarily by volume.

Benefits of ABC  More accurate product line costs.  More flexible the approach can analyse costs by processes, areas of managerial responsibility and customers.  ABC avoids the problem of cost absorption on an inappropriate basis.  Provides a reliable indication of long-run variable product cost.  Provides meaningful financial (periodic cost driver rates) and non-financial (periodic cost driver volumes) measures.  Improves cost estimation by accurate identification and understanding of cost behaviour.

Limitations  ABC information is historic and internally orientated and therefore lacks direct relevance for future strategic decisions.  Practical problems such as cost driver selection.  More expensive than traditional absorption costing as it requires more detailed information and analysis.

Environmental costing  Environmental costs should be removed from general overheads  They will have their own cost pool and cost drivers  They should be charged to products in a similar way to all other activity based costs  This should ensure that product costs fully reflect the true cost of production

Environmental costs (Similar to TQM) these can be classified as:  Internal failure costs (e.g. Injuries to staff)  External failure costs (e.g. Damage to the environment)  Prevention costs (e.g. Health and safety measures)  Appraisal costs (e.g. Inspections)

Practice questions  Please try to practice Cost Accounting System questions for Section A,B  And Q1,Q2 of Section C type questions. Please upload your work for tutor assessment via the grade and coursework tab on the VLE Or it to your tutor for a quicker response.

End of Week1 lecture