Marginal Costing

ACCA F5 - Performance Management 

Marginal Costing principles are used for internal decision-making purposes (short-term). As fixed costs are incurred regardless of the level of activity the purpose of marginal costing is to determine what contribution is been generated (sales less variable costs).

Given a firm has spare capacity, increasing an extra unit of product output only consumes the variable costs for that extra product. This is marginal cost. (in case no spare capacity in the production process, it may need input of fixed cost which will results very high marginal cost for the extra unit) Sum of the marginal cost over all units produced gives total variable costs for production.

Contribution margin is dollar contribution per unit divided by the selling price per unit. Contribution represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs.

Absorption/Variable costing

The table provides the relation between variable and absorption income in relation to production and sale for a particular period and its effect on inventory.

Year	Relation between production and sales	Effect on inventory	Relation between variable and absorption income
1st	Production = 25,000 Sales = 20,000	increase by 5,000 units	Absorption > Variable (Total marginal)
2nd	Production = 25,000 Sales = 30,000	decrease to zero	Absorption < Variable (Total marginal)
3rd	Production = 50,000 Sales = 50,000	No change	Absorption = Variable (Total marginal)

Management Accounting - Decision Management

Marginal costing ignores cash flows that won't be affected by a proposal, since they are deemed irrelevant, but this can take a naïve view of prepaid sunk costs or future committed costs when applied to short-term decisions, since firms must cover all their costs in the medium to long term to make a profit. Prepaid or committed costs can't be ignored when preparing quotations just because a company has decided for good business reasons to buy an asset outright rather than leasing it, for example. The application of marginal costing in these circumstances could result in the setting of lower prices, which could trigger a price war and drive down profitability in an entire sector.

Absorption Costing V's Marginal Costing CPA IRELAND

Marginal Costing principles are used for internal decision making purposes (short-term). As fixed costs are incurred regardless of the level of activity the purpose of marginal costing is to determine what contribution is been generated (sales less variable costs).

CIMA: Management Accounting - Decision Management

 CPA Ireland:Absorption Costing V's Marginal Costing CPA IRELAND

Data Sampling

ACCA F2 - Management Accounting

Sampling determines characteristics of (whole lot) population. A small portion chosen from the population for studying its properties is called a sample. Number of units  in the sample is known as sample size. Sample stands for best possible estimate of population parameter. It helps generate information about characteristics of population with less use of time and resources.

Methods of sampling depend very much on the objective and scope of enquiry, nature of population, size of sample, available resource etc. Sampling methods can be classified broadly into two types.

Random sampling (Probability sampling) is the method of drawing a portion (sample) of population so all possible samples of fixed size have same probability of being selected.

Types of Random sampling:

Ø  Simple random sampling: Sample units are selected in such a way that each and every unit of population has an equal chance of being selected. Sample units are selected with replacement or without replacement. E.g. 10 numbers selected from 0-1000

Ø  Stratified random sampling: Where population is heterogeneous with respect to variables or characteristics under the study, the population is divided into various groups or strata based on certain characteristics so that various strata are not overlapping. Then simple random technique is applied. E.g. 10 letters selected 5 from Capital letters and 5 from Small Letters

Ø  Systematic random sampling: Only first sample is selected at random and remaining units are automatically selected at fixed equal intervals from one another. E.g. (59,159,259……,959) 10 numbers selected from 0-1000 where 59 is first random selection.

Ø  Cluster sampling: Population is divided into groups, called cluster in such a way that the characteristics with the cluster are heterogeneous and between the cluster are homogenous so that number of sampling units in each cluster should be approximately same and then a sample random sampling of clusters is selected. E.g 10 sets of letters (Caps and Small) are selected from ((A,a),(B,b)……..(Z,z))

Non-random sampling (non-probability sampling) depends on judgement or convenience of the investigator. Experienced and skilled investigator applies this method to yield valuable result.

Types of Non-random sampling

Ø  Judgement sampling or Purposive sampling: Items in sample depends entirely upon the judgement/discretion of investigator.

Ø  Convenience sampling or Chunk sampling: In this a small collection of  data (one register out of available) is selected form whole lot.

Ø  Quota sampling: A sampling method in which researchers are given quotas to be filled from the different strata and within the pre-assigned quotas.

Standard Error: Standard deviation of the sampling distribution of sample statistic is known as its standard error of the statistic.

If random sample is drawn with replacement from large population the standard error of sample mean for large population is given by:

Standard Error of mean = Standard Deviation /(sample size 1/2)    ……… sample with replacement

Absorption Costing

ACCA F5 - Performance Management 

Absorption costing determines the full per unit cost of production. It is required for external financial reports and for tax reporting. Under absorption costing costs are divided into production costs (Direct costs - material and labor, Indirect costs - variable, semi fixed and fixed indirect costs e.g. rent, supervisor's salary, depreciation) which are absorbed in determining the unit cost of production and non-production costs (Variable/Fixed selling and administrative costs e.g. advertising, delivery and administrative costs like cleaners and postage) which are treated as period expenses and are excluded for product costs.

Estimating cost per unit of direct material and labour is straightforward and easy. However, calculating per unit of indirect costs is difficult to identify. Therefore, overhead cost per unit is calculated using a suitable basis like units produced, labor hours or machine hours.

Under absorption costing, change in capacity of production can result the change in unit cost of the product. This is because indirect fixed overhead have push and pull effect on unit cost. Let go through capacity concept in brief.

Source: Absorption/Variable costing ….. check link below

Ø  Theoretical capacity is the level of capacity based on producing at full efficiency all the time. This measure of capacity does not allow for plant maintenance, shutdowns, interruptions, or any other factors. It can be achieved for short period but cannot be sustained. This represents ideal goal of capacity utilization.

Ø  Practical capacity is the level of capacity that reduces theoretical capacity by considering unavoidable operating interruptions - scheduled maintenance or holidays, for example.

Ø  Normal capacity is the level of capacity utilization that satisfies average customer demand over a period of time, frequently one year.

Ø  Master budget capacity utilization is the level of capacity that managers expect for the current time period, frequently one year.

Theoretical and practical capacity measure capacity in terms of what a plant can supply. Normal capacity and master budget utilization measure capacity in terms of demand.

Source: Absorption costing overview …. check link below

Absorption costing can be further classified into three different types. They are:

Ø  Job Order Costing - assigned to product in batches or lots

Ø  Process Costing - cost are systematically assigned to the product - no batches to assign cost (e.g. Oil Distilling and Soda Manufacturing)

Ø  ABC Costing - assigns cost from cost centers to the product best in multi-product environment

Absorption/Variable costing

Absorption costing overview

Data and Information System

ACCA F2 - Management Accounting

Source of data: Internal/in-house data collection system collects data using different transaction processing systems (e.g. payroll system, inventory management system, procurement system and sales system) and the collected data are stored within organisation for processing to generate information as well for legal compliance.  Data source can be external/out-house survey (market demand, market supply, demography, income level, credit history). This type of data is available from outside the organisation for no/marginal fee. Different government and non-government organisations periodically collect the data for their use some of which are available in public domain.

Not all data are easy to process. Data, which are quantitative in nature (expressed in term of numbers) are easy to process using mathematical rules. Qualitative data, which involve opinion on a particular issue, are hard to (summarize) process.

Data is processed and transformed to information. Information should be ACCURATE (Accurate, Complete, Cost beneficial, Understandable, Relevant, Adaptable, Timely and Easy to use). Data is manipulated to squeeze out information. A single data set can provide different information customized to different personnel holding different position.

Technological advancement has made data collection process easier and faster. In no time, organisations can collect 'real-time data,' manipulated them and use the information to maximize profit. However, the advancement has also affected individual's confidentiality issues.

For decision-making, different types of information systems are used by different personnel in an organisation. At operational level, Transaction- Processing System is used. This is the initial phase to collect data internally. It is also used as a source of information at operational level by staffs involved in repetitive work. At managerial level where decision-making is tactical in nature, the data gathered by the Transaction Processing System and from external sources are processed by Managerial Information System to generate information. Information generated from these systems are used by Executive Information System for strategic decision making. Further, decision Support System and Expert system are also used to tackle difficult decision-making situations.

Data are or data is?

Management and Cost Accounting

ACCA F5 - Performance Management 

ACCA F2 - Management Accounting

Though management and cost accounting is not mandatory (not legally enforced), the importance of management accounting is escalating in present vibrant and turbulent business environment. Generally, everyone knows organisation use cost accounting to enhance the productivity and profitability and government use it to levy taxes in imports and exports. Cost and management accounting liaise with financial accounting and financial management. Cost and management accounting is also significant to understand managerial economic.

The recent changes in information and technology have revolutionized the concept of cost and managerial accounting. It has increased the foreseeability of managers and increased efficiency providing management with latest managerial tools. Managerial information system and advanced real time data handling programs has increased efficiency and challenges in managerial role. 

Traditional managerial concept of market as push mechanism is now no longer relevant in every economy (national and geographical boundary). However, somewhere in places because of highly uneven wealth distribution they do exist. Global market has adopted market pull strategy and is operating in environment where there is rapid innovation of product. Consumer are demanding highly customized and integrated product in affordable price, which has increased challenge to managers to drive down the cost of production.

The role of managerial and cost accounting does not end defining the unit cost of production. Optimum production level, the market demand, pricing policies, breakeven point, cost tied in the project, opportunity cost, future earning prospect of the product, analyzing increase in price of the product with added feature, variance analysis, budgeting and many more task surrounds the role of manager.

Today manager need to know the activities that drives cost of product. There can be in-house activities or the open market activities, which will pull or push the price of parts/products. Proper managerial decisions help shrunk the cost and skim the profit.

Cost accounting starts from recording in-house data, gathering data from external source and calculating cost of specific product. Then, it extends as managerial accounting to maximizing profit, maximizing value, maximizing sales revenue and satisfying customers. This way, analyzing increased profit because of managerial discretion and recognizing business profit and economic profit connects cost accounting with managerial economics.

The terms 'cost accounting' and 'management accounting' are often used to mean the same thing.