acca pm notes

• Costing


  The process of determining the costs of products, services or activities
• Direct Cost


  A cost that can be traced back in full to a product, service or department
• Indirect Production Cost


  Also known as Overheads. It is a cost that cannot be directly linked in full to the actual production of goods/ provision of services
• Indirect Non Production Cost


  Also referred to as Overheads. It is a cost incurred in a support function that is not directly involved in the manufacturing process or provision of the main service
• Absorption Costing


  A form of costing in which the costs of products are calculated by adding an amount for indirect production costs (overheads) to the direct costs of production
• Marginal Costing


  A form of costing where only the direct costs are considered relevant for the cost of a product. Fixed costs are treated as Period Costs
• Absorption Costing


  1. Allocate direct costs to a cost unit or cost centre

  2. Apportion general overheads amongst the cost centres, on a fair basis

  3. Re-apportion the costs of service cost centres' amongst the production cost centres on a fair basis

  4. Determine Absorption rate for each production cost centre

  5. Absorbed Production Overheads

  6. Under/ Over Absorption
• Arguments for Absorption Costing System


  • Used for financial reporting purposes to comply with the Accounting standards and inventory valuations
  • Helpful in cases where companies attempt to set selling prices based on the full cost of production or sales of each product
  • Best practice in case of a company selling multiple products, to determine profitability of each product
• Arguments for Marginal Costing System


  • Provides more useful information for managers in decision making process as contribution calculated under this system is directly proportionate to the sales volume; which gives a more accurate picture of the impact of sales volume on cashflows and profits
• Activity Based Costing (ABC)


  A method of dealing with the fixed production costs where costs are assigned to activities and then to products based on the products' consumption of those activities
• ABC Process


  1. Identify a distinct 'fixed' overhead cost, also termed as a Cost Pool

  2. Identify the activity that causes this cost. This activity is the 'Cost Driver'

  3. For each cost pool, calculate an absorption rate per cost driver

  4. For each product, charge the overheads cost based on the use of the relevant cost driver by the product
• Arguments for ABC


  • Based on the information made available, the following types of decision making processes will be supported: Pricing on mark-up basis for individual products will become fair as the cost of production is assessed more accurately, Promoting or discontinuing products, activities or parts of business as there will be better indication of where cost savings can be made, Developing new ways or products to do business
• Arguments against ABC


  • Cost drivers may not be very easy to identify or quantify, Cost of implementing this system may be more than benefits derived, It's an adaptation of the Absorption costing method and decision making is more effective based on Marginal Costing information
• Target Costing


  A marketing approach to costing where the selling price of a product is determined by reference to the market, and the desired profit margin is deducted to arrive at a target cost
• Target Costing Process


  1. Determine product specification and possible sales volume

  2. Decide on a Target Selling Price at which the product can be successfully sold

  3. Estimate Target Profit

  4. Calculate Target Cost: Target Selling Price - Target Profit

  5. Based on product specification and costs level, determine the estimated Production Cost

  6. Calculate Target Cost Gap: Estimated Production Cost - Target Cost

  7. Make efforts to reduce the Target Cost Gap, before production commences
• Closing the Target Cost Gap

  • Establishment of multifunctional teams
  • Emphasis on the planning and design stage to ensure that the design is not needlessly expensive to make
  • The total target cost can be split into broad cost categories based on functions to ensure better control over costs
  • The product has to be developed using Value Engineering Techniques
• Value Engineering


  Aims to reduce costs by identifying those parts of a product or service which do not add value - where 'value' is made up of both use value (the ability of the product or service to perform its function) and esteem value (the status that ownership or use confers)
• Target Costing in Service Industries


  • Difficult to use due to characteristics of services like intangibility, inseparability/simultaneity, variability/heterogeneity, perishability, and lack of ownership
• It would be unwise to try to reduce costs by economising too much on packaging
• Target Costing in Service Industries


  It is difficult to use Target Costing in service industries
• Service businesses


  • Mass service (e.g. banking, transportation, mass entertainment)
  • Either/or (e.g. fast food, teaching, hotels and holidays, psychotherapy)
  • Personal service (e.g. pensions and financial advice, car maintenance)
• Characteristics of services that distinguish them from manufacturing


  • Intangibility
  • Inseparability/simultaneity
  • Variability/heterogeneity
  • Perishability
  • No transfer of ownership
• Services


  • No substantial material or physical aspects
  • Created at the same time as they are consumed
  • Hard to attain precise standardisation
  • Time bound
  • Do not result in the transfer of property but only access to or a right to use a facility
• Services do not have any material content (tangibility) making it difficult to reduce target cost gap through material cost reduction
• Services vary each time resulting in there being an estimated average cost for each service but not a specific standard cost that can be reduced
• Life Cycle Costing


  Considering all costs, whether incurred before, during or after the product is produced, when working out the cost of a unit and its profitability
• Lessons from life cycle costing


  • All costs should be taken into account
  • Attention to all costs will help reduce the cost per unit and will help an organisation achieve its target cost
  • Many costs will be linked
  • Costs are committed and incurred at very different times
• Stages of product life cycle


  • Development stage
  • Introduction stage
  • Growth stage
  • Maturity stage
  • Decline/saturation stage
• Organisations operating within an advanced manufacturing technology environment find that approximately 90% of a product's life cycle cost is determined by decisions made early within the cycle at the design stage
• Benefits of life cycle costing


  • Potential profitability of product can be assessed before major development
  • Techniques can be used to reduce costs over the life of the product
  • Pricing strategy can be determined before production
  • Attention can be focused on reducing the research and development phase
  • Lessons can be learnt to improve future products
• Support to management from understanding product life cycle

  • Pricing decisions
  • Performance management
  • Decision-making about new investments or withdrawing products
• Service life cycles

  R&D stages do not exist in the same way and will not have the same impact on subsequent costs
• Project life cycles


  Products that take years to produce, discounted cash flow calculations used to cost them in advance, monitored carefully over their life
• Customer life cycles

  Aim is to extend the life cycle of a particular customer by encouraging customer loyalty, initial cost is high but benefits come from increased usage over time
• Theory of Constraints


  A tool to help organisations deal with constraints or bottlenecks within the system as a whole
• Five focusing steps of the Theory of Constraints


  • Identify the system's bottlenecks
  • Decide how to exploit the system's bottlenecks
  • Subordinate everything else to the decisions made in Step 2
  • Elevate the system's bottlenecks
  • If a new constraint is broken in Step 4, go back to Step 1, but do not let inertia become the system's new bottleneck
• Limiting Factor Analysis and Throughput Accounting

  Calculating throughput per unit (selling price less direct material cost) and throughput return per unit of bottleneck resource to determine the optimum production plan
• Throughput Accounting Example


  • Beta Co produces 3 products E, F and G with different selling prices, direct material costs, maximum demands, and time required on the bottleneck resource
  • Calculated throughput per unit and throughput return per hour of bottleneck resource for each product
  • Ranked the products in order of priority based on throughput return per hour
  • Calculated the optimum production plan, allocating the bottleneck resource to each product in order of priority
• worth noting here that you often see another step carried out between Steps 2 and 3 above. This is the calculation of the throughput accounting ratio for each product. Thus far, ratios have not been discussed, and while I am planning on mentioning them later, I have never seen the point of inserting this extra step in when working out the optimum production plan. The ranking of the products using the return per factory hour will always produce the same ranking as that produced using the throughput accounting ratio, so it doesn't really matter whether you use the return or the ratio.
• Main ratios in throughput accounting

  • Return per factory hour

  2. Cost per factory hour

  3. Throughput accounting ratio