1. AAT Level 3: Management Accounting: Costing
Tutor: Neil Cochran

2. Syllabus ClassShort Topics 1 What cost accounting is Material costs 2
Labour Costs
Overheads and expenses 3
Methods of costing
Marginal, absorption and activity based costing
Aspects of budgeting 4
Short-term decisions
Long-term decisions
Review

3. The Exam You will need to complete 10 tasks in 2 hours and 30 minutes.
Outcomes
Weighting 1
Understand the purpose of management accounting in an organisation.
15% 2
Apply techniques for dealing with costs.
35% 3
Apportion costs according to organisational requirements.
19% 4
Analyse deviations from budgets and report these to management.
10% 5
Apply management accounting techniques to support decision making.
21%

4. What is cost accounting
Getting the foundation right

5. Purpose of cost accounting
Provides management with the knowledge of how much production costs. This will help them with:
Short-term decisions- how many do we have to make to break even.
Long-term decisions- what machine should we buy.
Let's look at a short introduction to cost accounting. This is also known as management accounting. This helps managers to know how much something costs this is to help the management make  both short and long-term decisions.

6. Difference between Cost Accounting and financial accounting
Summarised at the end of year
Reports have set format
External users
Purpose- assess financial performance
Detailed collected daily/weekly
Reports meet needs of business
Internal users
Purpose- assist in decision-making, planning and control
Lets look quickly at the difference between management and cost accounting

7. The Aims of Management Accounting
Decision Making- to help make informed decisions about the future.
Planning- provide information for the creation of short, medium and long-term plans (budgeting etc.)
Co-Ordinating- planning allows for all departments to work together.
Controlling- by comparing expected with actual results, we can see where we are struggling to meet our goals and investigate the reasons.
Communicating- by giving plans to the departmental managers, we can communicate what our goals are.
Motivating- targets should motivate managers. If the target is too difficult, it might demotivate them.

8. Management Information
Management information needs to have 3 attributes:
Fit for purpose- it needs to be relevant, accurate and complete.
Cost effective- if the cost of obtaining the information outweighs the benefits, it is not worth it.
Timely- information should be available when needed.

9. Cost units Unit of output to which costs can be charged
Unit of production- what the company makes
Unit of service- passenger mile, lawyer meeting
Let's look at some important concepts that will help us throughout this course.
Cost units are what costs attach themselves to. We need to be careful to chose the correct cost unit.

10. Responsibility centre
Segments of a business for which a manager is accountable.
Include:
Cost centres
Profit centres
Investment centres
These include the next three centres.
This is important in responsibility accounting:This is a form of accounting where that compiles revenue, cost, and profit information at the level of those individual managers most directly responsible for them. The intent is to provide this information to those people most able to act upon it, as well as to judge their performance.

11. Cost Centres
These are segments of a business to which costs can be charged.
Managers of these centres are responsible for both variable and fixed costs.

12. Profit Centres
Segments of a business to which costs can be charged, revenue can be identified and profit can be calculated.
Revenue – Cost= Profit Centre
Management is responsible for costs but also revenue.
Profit centres not only have costs, the have profit that can be attributed to them.We can find profit here.

13. Investment Centres
Where the profit is compared with the amount of money invested in the centre.
(Profit / Investment) x 100 = Return on Investment
The management has control over costs its revenues assets and liabilities.

14. Classification of Costs
There are three separate sections in manufacturing:
Factory: material, labour, expenses and production overheads
Warehouse: distribution and storage costs
Office: administration and finance
Cost classification is a vital area of management accounting.We need to ensure that cost are correctly classified. Otherwise we will have problems in our financial statements and can be breaking the IFRS. There are three main areas where costs accumulate.They can include the factory(give examples), The warehouse (examples) and the office(indirectly but it is needed for the production of the unit.) 

15. Cost Elements This is the most basic way of splitting up costs.
Three elements of cost:
Materials
Labour
Expenses
This is the most basic way to split costs.  This is what you will see on a standard cost card in a factory.We split these up as these can be responsibility centres as well.

16. Nature of Costs
Direct costs- costs can be directly identified with each unit of output.
Prime cost- the total of all direct costs.
Indirect costs- cost that cannot be identified directly with each unit of output.
Direct costs- costs of components
Indirect costs- telephone-wages of non-productions staff.
We can also split them by function- production/non production costs
There are standards, but remember there are no set laws when it comes to management accounting.

17. Cost Behaviours Rent= 10,000 per month Total cost= 10,000
We have some different cost behaviours.The first Is fixed, semi variable and variable.
Let's start by looking at fixed costs. This chart shows that it does not matter the level of production the cost remains the same.
If we look at the unit cost. The more we make, the lower the cost per unit is.
Let's look at an example of this. (Click)
Rent= 10,000 per month
Total cost= 10,000
Rent= 10,000 per month
10,000 units= 1 per unit
20,000 units=.50 per unit

18. Stepped Costs
Stepped costs are a bit different.These costs are fixed until a certain level. This would be like rent of a factory.We can only produce up to a certain amount. After that we will have to rent another building, so the cost will step up.
Let's look at an example of this.
A company has 5 machines. Each machine can make 10,000 units. Each machine has a running cost of 1000 pounds. If they need an extra machine they can rent one for 5000. 
50,000 units= 5000 cost
60,000 units= 10,000 cost ( (1x5000)

19. Semi Variable Costs
A company needs to rent a machine for a special order. The rent is 10,000 per month and there is a usage charge of .50 per unit produced. What is the total cost for the 3 months to March?
January= 1000 units
February= 500 units
March= 2000 units
Jan= (10,000 + (1000 x .5))= 10,500
Feb= (10,000 + (500 x .5))= 10,250
Mar= (10,000 + (2000 x .5)=11,000
This is where there is a fixed element, like a fee(mobile- you pay for the line but then you pay for the minutes.) 
Let's look at an example.

20. Materials is a variable cost. Each unit costs £100.
Variable Costs
Materials is a variable cost. Each unit costs £100.
Production:
0 = 0
10 = 1000
100 = 10,000
The cost directly relates to the output. Something costs£1 if we make 1000 it will equal that. If we do not make anything,it will not have a cost.
Here is an example of this. (Click)

21. Identifying Cost Behaviour (Highly Examinable)
It may be necessary to identify the nature of costs from a budget or projection.
You must remember:
A fixed cost will remain constant in the total
Variable costs are constant per unit
Semi-Variable costs are neither constant in total nor per unit.
Stepped fixed costs will be fixed in total up to a certain range and then increase and be fixed again.

23. High-Low Method
You may be asked to find the variable and fixed element of a semi-variable cost.
You must use the high-low method to do this.
This is from level 2 costing, so this is assumed knowledge.
If you are not familiar with this method, please look at Level 2: Elements of Cost or online for guidance.

24. Calculating the cost of goods and services
Identify the unit of output
Calculate the output for a particular time period
Calculate the direct costs
Direct materials + Direct Labour + Direct Expenses= Prime Cost
Calculate the indirect costs
Indirect Materials + Indirect Labour + Indirect Expenses= Total Indirect Cost
Calculate the total cost per unit of output
Direct costs + Indirect costs
Number of units of output
We need to know the cost so that we can find a price to sell it at.
There are clear steps:
We need to figure out what the unit is.
We then look at the production budget to determine the amount of goods we will produce in a period.
We then gather all the direct costs.
Then we gather the indirect costs.
We then take all of these costs and divide them by the units we are making to find the cost per unit.

25. Let's walk through the cost card.

26. Chapter Activities
Please complete the chapter activities.

27. Materials
The most important thing is to distinguish between direct and indirect materials.
The planning of inventory is vital to the success of a organisation.
Holding materials is expensive
They might have financed the purchase (interest)
There are storage costs
When talking about materials it is vital that there is a clear to make the distinction between direct and indirect materials.This is vital for the costing later on.
When we have a business we have to have some sort of inventory. There is a constant battle here between the finance wanting to say money and production who want as much inventory as possible.
We have what is known as perpetual inventory.This inventory system records each entering and exit of items and orders them accordingly.
We are going to look at the formulas that we use to ensure we have the right levels of inventory. First we need to look at the terminology we need to discuss inventory.

28. Review: Inventory Documentation
Goods Requisition Note: this is a note to request items from the stores department. It should be authorised by a manager.
Purchase Requisition: this is a request to purchase items from an approved supplier. It must be authorised and is sent to the purchasing department.
Purchase Order: this is sent to the supplier to request the goods. A copy is sent to stores to ensure that delivery happens.
Delivery Note: this is sent with the goods and is checked with the purchase order.
Goods Received Note: is sent to the supplier stating that goods were received and any returns.
Credit Note: is sent by the supplier for any returned items

29. Important Terms
Maximum inventory level- this is determined by the amount of storage space we have.
Inventory buffer- this is the lowest level that the inventory should fall to before a new order is delivered.
Lead time- how long it takes for inventory to be delivered.
Re-order level- the point at which a new order must be placed (this is the most critical).
Re-order quantity- the amount we can purchase.

30. Formulas Inventory buffer Re-order level Re-order quantity
Re-order level - (average usage x average lead time)
Re-order level
(average usage x average lead time) + Inventory buffer
Re-order quantity
Maximum-    Maximum inventory level - inventory buffer
Minimum-     Re-order level – inventory buffer
Inventory buffer is the amount we need in case there is an emergency. We take our reorder level and subtract the average usage and lead time.This is to ensure we don't run out.
Reorder level- this is so we know that inventory will be delivered when we reach our buffer level.
The maximum will restore the inventory to the max level. Minimum to the re-order level.

31. Maximum order quantity Minimum order quantity
Find the:
Reorder Level
Maximum order quantity
Minimum order quantity

32. Exam Practice

33. What to take away from the examples:
It is vital that you memorise the inventory equations. 
Make sure to try to find the buffer stock or re-order level first. This will help you find the other levels. 

34. Economic Order Quality
The re-order quantity is extremely important. If we order too much, the inventory will cost us too much.If there is not enough we risk stocking out.
This is why the EOQ was created. This formula shows us the amount we need to order to keep the balance between amount and costs.
Annual usage is the amount in one year.The ordering cost would be shipping etc. And the holding cost will be figured out for us.

36. This is from the chapter activities.

37. What to take from the Examples:
The economic order quantity is used to find the most economic level of stock for a company.
You must memorise the steps in order to not make a mistake.
You will need a scientific calculator to calculate the EOQ.

38. Valuation of Inventory
Number of items x cost= inventory value at cost
Is the cost price less than the selling price?
Yes:
Value at Cost
No:
Value at selling price
We have a lot of inventory, so it is vital that it is valued correctly. This is because it generally uses up a lot of money. At the end of the year, The first thing that we need to know is what we need to value the items at.We need to know whether the cost per unit is less than the selling price. If the selling price is higher, we value at cost.If it is lower, we value at the selling price.
Cost:      £10
NRV:       £25    
Cost:      £10
Sales
Price:       £8    
Cost:      £6
NRV:       £10    
Cost:      £5
NRV:       £2    

39. Valuation of Inventory
When we make something, we need to use materials we have in store, so it is vital that we value these correctly.
The two most common ways are FIFO, LIFO and AVCO.
Valuation of inventory is the major part of the financial statements

40. FIFO
Under this system the oldest stock is used first. This means that the remaining inventory is at the most recent prices.

41. Example Description Amount Purchases Sales Valuation Op Inv 100 x£10
1000
Purchase
20 x15
New Inventory
Sale
110
We take 100 from the old.
We take 10 from the new,
          1000
               150
                _________
Cost                    1150

42. AVCO The average of the inventory is calculated.
Weighted cost= Total Cost of Inventory Held
                          Number of Items Held

43. Example Description Amount Purchases Sales Valuation Op Inv 100 x£10
1000
Purchase
20 x15
New Inventory
1300/120=10.83
Sale
110
Cost = £
                

44. Lifo
The most recent cost is used. This means that the remaining inventory is valued at the older price.
This is not permitted under IAS 2!!!!.

45. example Description Amount Purchases Sales Valuation Op Inv 100 x£10
1000
Purchase
20 x15
New Inventory
Sale
110
We take 20 from the new.
We take 90 from the old
              900               300
                _________
Cost                    1200

47. IAS 2 Inventory should be valued at the lower of cost and NRV.
Raw materials
Part finished goods
Finished goods
Cost must include: direct materials, direct labour, direct expenses, production overheads.

48. Bookkeeping for materials
Debit
Credit
Purchases (credit)
Inventory (gaining an asset)
Trade Payables Control (Liability)
Purchases (cash)
Inventory(gaining an asset)
Bank (giving value)
Issues to production
Production
Inventory
Returns to Inventory
Indirect Materials
Production overheads

49. Chapter Activities
Please complete the chapter activities.

50. Homework Read through chapter 1 + 2.
Go through all chapter activities in the book.
Try chapter activities in the workbook.