MACN Dipac

CONTENTS :
SPECIAL FORMULAS TO LEARN :................................................................................................................11

Learning curve......................................................................................................................................11
RELEVANT COSTING..............................................................................................................................11
next.....................................................................................................................................................11
TO SCAN IN STILL....................................................................................................................................12
QUESTIONS.............................................................................................................................................13
RECORDING RAW MATERIALS PURCHASE & RETURNS..................................................................................13
absorbtion costing..................................................................................................................................13
DIFFERENCE BETWEEN VOLUME EXPENDITURE DIFFERENCE......................................................................13
budgets................................................................................................................................................13
standard costing....................................................................................................................................15
RECORDING ISSUE OF MATERIALS.............................................................................................................15
place of last question.............................................................................................................................15
1-TERMS.................................................................................................................................................16
TABLE OF ALTERNATIVE TERMINOLOGY /USA /UK..................................................................................16
CAPEX= capital expenditure ( eg buying PPE like land or machines)..........................................................17
the production point of indifference, :....................................................................................................17
analysis of the companies cost structure:...............................................................................................17
Capital structure.................................................................................................................................17
annuity:.............................................................................................................................................17
over-trading.......................................................................................................................................17
Cost Objects:........................................................................................................................................17
Direct and Indirect Costs........................................................................................................................17
inventory valuation:(note)...................................................................................................................18
DIRECT COSTS :.................................................................................................................................18
INDIRECT COSTS :..............................................................................................................................18
Categories of manufacturing costs. – with direct/indirect costs.................................................................18
DIRECT MATERIALS :..........................................................................................................................18
INDIRECT MATERIALS :.......................................................................................................................18
DIRECT LABOUR :...............................................................................................................................18
INDIRECT LABOUR..............................................................................................................................18
DIRECT EXPENSE :..............................................................................................................................18
PRIME COST.......................................................................................................................................19
MANUFACTURING OVERHEAD :.............................................................................................................19
COST ALLOCATIONS :.........................................................................................................................19
TOTAL MANUFATURING COST :............................................................................................................19
Period and Product Costs.....................................................................................................................19
PRODUCT COSTS :..............................................................................................................................19
PERIOD COSTS :.................................................................................................................................19
Relevant and Irrelevant Costs:................................................................................................................19
RELEVANT COSTS AND REVENUES :......................................................................................................19
IRRELEVANT COSTS AND REVENUES:....................................................................................................19
Avoidable or Unavoidable costs:..............................................................................................................19
AVOIDABLE=......................................................................................................................................19
UNAVOIDABLE....................................................................................................................................20
Opportunity Costs:.................................................................................................................................20
-Incremental /or Differential- and Marginal Costs.......................................................................................20
INCREMENTAL or DIFFERENTIAL COSTS :..............................................................................................20
MARGINAL COSTS :.............................................................................................................................20
Job Costing and Process Costing systems:................................................................................................20
JOB COSTING SYSTEMS:.....................................................................................................................20
PROCESS COSTING SYSTEMS:..............................................................................................................20
ABSORPTION COSTING AND VARIABLE COSTING:and STANDARD COSTING.................................................20
inventory valuation:(note)...................................................................................................................20
IAS 2 on INVENTORIES States the Following.:........................................................................................20
Absorbtion costing :............................................................................................................................21
Cost Absorbtion Rate :.........................................................................................................................21
Fully Integrated Absorbtion costing System ( or “full” absorb. costing system)...........................................21
Variable Costing (or Marginal or Direct Costing)......................................................................................22
Direct Costing.....................................................................................................................................22
Marginal Costing.................................................................................................................................22
Standard Costing:...............................................................................................................................22
Sunk Costs:..........................................................................................................................................22
SUNK COSTS :....................................................................................................................................22
Responsibility Accounting :.....................................................................................................................22
RESPONSIBILITY ACCOUNTING :..........................................................................................................22
PROFIT CENTRE :................................................................................................................................22
COST CENTRE:...................................................................................................................................23
INVESTMENT CENTRE:.........................................................................................................................23
Maintaining a cost database:...................................................................................................................23
Fixed and Variable Production Overheads : and Cost Behaviour of................................................................23
VARIABLE COSTS :..............................................................................................................................23
FIXED PRODUCTION COSTS :...............................................................................................................24
SEMI-FIXED (or STEP-FIXED COSTS) :..................................................................................................25
SEMI-VARIABLE (or MIXED COSTS) :....................................................................................................25
Relevant Range.....................................................................................................................................25
Relevant Range:.................................................................................................................................25
Selling Costs.........................................................................................................................................25
Selling Costs :....................................................................................................................................25
Conversion Costs:..................................................................................................................................25
Conversion Costs :..............................................................................................................................25
HIGH-LOW COST ANALYSIS:................................................................................................................26
contribution:......................................................................................................................................26
budget:.............................................................................................................................................26
“Standard Hours Produced”:.................................................................................................................26
“Standard PROFIT STATEMENT”:...........................................................................................................26
STATIC BUDGET.................................................................................................................................26
FLEXED BUDGET.................................................................................................................................26
BILL OF MATERIALS............................................................................................................................26
STANDARD COST CARD.......................................................................................................................27
more definitions..................................................................................................................................27
TUT 102 : TOPIC 1: NATURE OF COSTS, COST CLASSIFICATION, COST BEHAVIOUR AND COST ESTIMATION.....28
CHAPTER 2 DRURY : COST TERMS AND CONCEPTS.......................................................................................29
need attention:...................................................................................................................................29
PRIME COST.......................................................................................................................................29
PRODUCT COSTS :..............................................................................................................................29
PERIOD COSTS :.................................................................................................................................29
AVOIDABLE=......................................................................................................................................29
UNAVOIDABLE....................................................................................................................................29
MARGINAL COSTS :.............................................................................................................................29
Cost Objects:........................................................................................................................................30
DIRECT COSTS :.................................................................................................................................30
INDIRECT COSTS :..............................................................................................................................30
Categories of manufacturing costs. – with direct/indirect costs. ..all those below down to cost allocations....30
DIRECT MATERIALS :..........................................................................................................................30
INDIRECT MATERIALS :.......................................................................................................................30
DIRECT LABOUR :...............................................................................................................................30
INDIRECT LABOUR..............................................................................................................................31
DIRECT EXPENSE :..............................................................................................................................31
PRIME COST.......................................................................................................................................31
COST ALLOCATIONS :.........................................................................................................................31
TOTAL MANUFATURING COST :............................................................................................................31
Period and Product Costs.....................................................................................................................31
PRODUCT COSTS :..............................................................................................................................31
PERIOD COSTS :.................................................................................................................................31
Relevant and Irrelevant Costs:................................................................................................................32
RELEVANT COSTS AND REVENUES :......................................................................................................32
IRRELEVANT COSTS AND REVENUES:....................................................................................................32
Avoidable or Unavoidable costs:..............................................................................................................32
AVOIDABLE=......................................................................................................................................32
UNAVOIDABLE....................................................................................................................................32
Opportunity Costs:.................................................................................................................................32
-Incremental /or Differential- and Marginal Costs.......................................................................................32
MARGINAL COSTS :.............................................................................................................................32
SUNK COSTS :....................................................................................................................................32
VARIABLE COSTS :..............................................................................................................................32
FIXED PRODUCTION COSTS :...............................................................................................................33
Relevant Range:.................................................................................................................................34
HIGH-LOW COST ANALYSIS:................................................................................................................34
contribution:......................................................................................................................................34
more definitions..................................................................................................................................35
Maintaining a cost database:...................................................................................................................35
Fixed and Variable Production Overheads : and Cost Behaviour of................................................................35
D RURY : C HAPTER 3: COST ASSIGNMENT . PAGES 47 – 78...........................................................................................36
EXAM......................................................................................................................................................36
INTRO.....................................................................................................................................................36
ASSIGNMENT OF : DIRECT AND INDIRECT COSTS........................................................................................36
the two stage but 4 step allocation process for costs.....................................................................................37
EXTRACTING RELEVANT COSTS FOR DECISION MAKING...............................................................................39
BUDGETED OVERHEAD RATES....................................................................................................................39
UNDER + OVER RECOVERY OF OVERHEADS.................................................................................................39
MAINTAINING THE DATABASE AT STANDARD COSTS....................................................................................40
NON-MANUFACTURING OVERHEADS...........................................................................................................40
Ch 23 COST ESTIMATION AND COST BEHAVIOUR........................................................................................42
1) sPECIAL THINGS TO REMEMBER:.........................................................................................................42
2) tERMS..............................................................................................................................................42
3) General: :.........................................................................................................................................42
4) Mathematical principles applying to cost estimation methods:.................................................................42
5)SEPARATING SEMI-VARIABLE COSTS INTO FIXED AND VARIABLE Methods:..............................................43
1-Engineering methods........................................................................................................................43
2-Inspection of accounts method..........................................................................................................43
3-Graphical or scattergraph method......................................................................................................43
4-High-low method.............................................................................................................................43
5-Least squares method......................................................................................................................45
6-TESTS OF RELIABILITY:....................................................................................................................45
...............................................................................................46
6)relevant range and non-linear functions:...............................................................................................46
7)summary of steps involved in estimating cost.........................................................................................46
8)MULTIple regression analysis:..............................................................................................................46
9)learning curve....................................................................................................................................46
1-CUMULATIVE AVERAGE TIME-LEARNING MODEL..................................................................................46
B-INCREMENTAL UNITS TIME..............................................................................................................48
c- limitations of the learning curve.......................................................................................................48
d-learning curve is applicable to :.........................................................................................................48
10)INDEX VALUES:................................................................................................................................49
TUT 102 TOPIC 2 COSTING&MNGMNT :MATERIAL LABOUR & OVERHEADS :....................................................50
CH4 DRURY ACCOUNTING ENTRIES FOR A JOB COSTING SYSTEM..................................................................51
INTRo:....................................................................................................................................................51
MATERIALS (movements) RECORDING PROCEDURE.....................................................................................51
PRICING THE ISSUES OF MATERIALS PROBLEM:..........................................................................................51
CONTROL ACCOUNTS:..............................................................................................................................52
RECORDING RAW MATERIALS PURCHASE & RETURNS..................................................................................52
RECORDING ISSUE OF MATERIALS.............................................................................................................52
Recording Labour Costs:............................................................................................................................53
RECORDING MANUFACTURING OVERHEADS................................................................................................53
NON – MANUFACTURING OVERHEADS:.......................................................................................................54
RECORDING JOBS COMPLETED AND MOVED TO STORE.................................................................................54
COSTING p&l ACCOUNT.............................................................................................................................54
JIT MANUFACTURING SYSTEM....................................................................................................................54
TUT 102 TOPIC 3 COSTING&MNGMNT PROCESS COSTING:...........................................................................56
PROCESS COSTING...................................................................................................................................57
DEFINITIONS:..........................................................................................................................................57
METHOD..................................................................................................................................................57
Process COSTING WHEN ALL OUTPUT IS COMPLETE:.................................................................................57
nO lOSSES IN THE PROCESS:...............................................................................................................57
normal or uncontrollable (Expected) losses with no scrap value................................................................57
ABNORMQL LOSSES IN PROCESS, WITH NO SCRAP VALUE......................................................................57
1+2 CHAPTER :ABSORBTION COSTING : sYSTEMS FOR RECORDING AND CONTROLLING COSTS :vigario ch-1+2 58
To remember for exam/ tricky stuff..........................................................................................................58
summary OF DIFFERENCE BETWEEN ABSORBTION & VARIABLE (UNISA)........................................................58
BUDGETED OVERHEAD RATES....................................................................................................................59
UNDER + OVER RECOVERY OF OVERHEADS.................................................................................................59
MAINTAINING THE DATABASE AT STANDARD COSTS....................................................................................60
NON-MANUFACTURING OVERHEADS...........................................................................................................60
this must go somewhere here,put in right place later : why is labour a fixed cost.............................................61
from ch1 vigario:the meaning of management accounting.............................................................................61
Financial accounting...............................................................................................................................61
Objective of Financial Accounting:.........................................................................................................61
Management accounting.........................................................................................................................61
Variable Costing (or Marginal or Direct Costing)......................................................................................62
1. from ch 2 vig. systems for recording and controlling product costs. :..........................................................63
Rem: use 4 decimal places for hourly labour/machine rates for products....................................................63
DEFINITION: Absorbtion costing :.........................................................................................................63
DEFINITION :Cost Absorbtion Rate :.....................................................................................................63
DEFINITION :Fully Integrated Absorbtion costing System.........................................................................63
IAS 2 on INVENTORIES States the Following.:........................................................................................64
METHOD TO DO ABSORBTION COSTING...................................................................................................64
INtRO : ALLOCATING SERVICE COSTS TO PRODUCTION DEPTS:..............................................................64
Cost allocation procedure.....................................................................................................................64
OVERHEAD and MANUFACTURING ACCOUNTS IN LEDGER:......................................................................66
overhead recovery rates:........................................................................................................................66
Purposes of allocating mnftring Overhead to a product...........................................................................67
pre-determined overhead rates.............................................................................................................67
job costing accounting treatment............................................................................................................69
REM: notes to remember........................................................................................................................71
cost CLASSIFICATION FOR SHORT TERM /LONG TERM DECISIONS..............................................................71
ch 4 vig VARIABLE AND ABSORBTION COSTING...........................................................................................72
Special Notes to watch out for:................................................................................................................72
ARGUMENTS FOR VARIABLE VS ABSORBTION COSTING.............................................................................72
aRGUMENTS IN FAVOUR OF VARIABLE COSTING:...................................................................................72
Arguments in favour of absorbtion costing:............................................................................................72
viewpoint: any system which reports inconsistent profits if sales remain same should be discarded...............73
Accounting Statement on inventories:-ias 2............................................................................................73
effect on profit (Income) of variable .vs. absorbtion costing......................................................................73
EXACT only difference between 2 Types of variable costing and 3 types of absorbtion costing.........................74
What is variable costing.(or marginal or direct costing)...............................................................................75
METHOD : VARIABLE COSTING (CALCULATING VARIABLE PROFIT ).........................................................75
What is absorbtion costing:.....................................................................................................................76
Calculating Absorbtion Profit : 3 METHODS.............................................................................................76
reconcilliation : standard absorbtion costing : budget profit to actual.........................................................80
Reconcilliation of Absorbtion profit to variable profit(pg 141 viggio).............................................................84
Reconcilliation of Absorbtion profit to absorbtion profit(pg 142 viggio)..........................................................85
income statements formats:....................................................................................................................86
RECONCILLIATIONS:................................................................................................................................88
For over/under recovery in fully integrated absorbtion costing( just copied , must still sort it all out)...............88
abc (activity based costing) vig ch 5........................................................................................................89
Special Notes to watch out for:................................................................................................................89
ACTIVITY BASED COSTING: GENERAL......................................................................................................89
Reasons and differnces between ABC from TRADITIONAL...........................................................................89
environment abc is recommended for:......................................................................................................89
Sercvice organisation difficulty in implememting ( but it is very recommended, see above reasons)..............89
Manufactyre orgnusations difficulty.......................................................................................................90
General ABC..........................................................................................................................................90
abc: Methodogy ....................................................................................................................................90
ACTIVITIES – COST DRIVERS. : Examples of.........................................................................................90
VALUATION OF CLOSING STOCK:.........................................................................................................91
ABRIDGED(shortened) INCOME STATEMENTS FOR ABC COSTING:...........................................................91
The Logical error of ABC costing............................................................................................................91
ABM : activity based management: (unisa tutorial – notes)......................................................................91
ABB : activity based budgeting.............................................................................................................91
How relevant is abc costing?.................................................................................................................92
CVP ANALYSIS.........................................................................................................................................94
special things to remember:....................................................................................................................94
ECONOMIST VS ACCOUNTANTS VIEW......................................................................................................94
justification for accountants view over econ0mists:....................................................................................94
Economists VS Accountants COST-VOLUME-PROFIT graph :........................................................................94
ECONOMISTS GRAPH:.........................................................................................................................95
Accountants graph..............................................................................................................................95
C.v.p. analysis. (cost-volume-profit.)..........................................................................................................95
uses of cvp analysis:..............................................................................................................................95
assumptions of cvp analysis:...................................................................................................................95
Standard Formula for CVP (write down once in exam- makes things easy)....................................................96
Fixed costs:..........................................................................................................................................96
RELEVANT RANGE..................................................................................................................................96
Break-even analysis:..............................................................................................................................96
target profit:.........................................................................................................................................96
Contribution :........................................................................................................................................97
Semi – variable costs :...........................................................................................................................97
margin of safety:...................................................................................................................................97
CHARTS/graphs.....................................................................................................................................97
Break-even chart used as a “CVP” analysis:...........................................................................................97
cost –volume –profit chart/diagram shown in a different way(viggario).....................................................98
Alternative Presentation : Contribution graph used as a cvp chart.............................................................98
Alternative Presentation : PROFIT –VOLUME graph used as a CVP chart.....................................................99
MULTI-PRODUCT cvp ANALYSIS...............................................................................................................99
The use of computer applications...........................................................................................................100
semi-variable costs : separation of fixed –variable...................................................................................100
key ratios for cvp.................................................................................................................................100
(PV ratio) Profit Volume ratio: ( or also called ‘contribution margin %’ )...................................................100
profit ratio........................................................................................................................................100
(B/E sales) break-even sales revenue:( not a ratio)...............................................................................100
break-even sales volume:( not a ratio)................................................................................................101
margin of safety ratio........................................................................................................................101
OTHER TYPES:..................................................................................................................................101
abbreviations for ratio’s etc:..................................................................................................................101
analysis of cost structure USING CVP PRINCIPLES : (of a company)...........................................................101
METHOD: fORMAT OF SPREADSHEET FOR: full year FINAL ANALYSIS viggario page 247.........................101
Income statement (or budget) showing contribution separately................................................................102
Chapter :BUDGETS.................................................................................................................................104
Principles of Budgeting:........................................................................................................................104
DefinITIONS:....................................................................................................................................104
TYPES OF Budgeting:.........................................................................................................................104
3 categories of budgets:.....................................................................................................................104
Reasons for budgeting:......................................................................................................................104
financial & management budgeting:.....................................................................................................104
Long term planning:..........................................................................................................................104
Positive factors of budgeting...............................................................................................................105
Budgeting & the human factor............................................................................................................105
TIMING OF BUDGETS...........................................................................................................................106
STAGES IN BUDGETING:.......................................................................................................................106
Method for Budgets:.............................................................................................................................107
Master Budget:.................................................................................................................................107
Financial budget................................................................................................................................108
Operating budget..............................................................................................................................108
Cash Budget: (or cash flow statement)................................................................................................108
sales Budget:....................................................................................................................................111
Purchases Budget : for raw materials / or retail stock /or any................................................................112
opening stock (finished goods or raw materials etc) Budget:..................................................................113
Production Budget:............................................................................................................................113
Opening stock -Raw / direct materials- Budget:....................................................................................114
Labour Budget:.................................................................................................................................114
OVERHEADS Budget:.........................................................................................................................115
DEPARTAMENTAL Budget:..................................................................................................................115
Budget income Statement/ statement of inc&expenditure:.....................................................................115
FLEXIBLE BUDGETING.............................................................................................................................116
ZERO BASED BUDGETING........................................................................................................................117
abc budgeting (activty based costing) or Incremental budgeting...................................................................118
Computerised budgeting..........................................................................................................................118
Web- based budgeting:.........................................................................................................................118
Line Item Budgeting................................................................................................................................118
RELEVANT COSTS...................................................................................................................................119
AA........................................................................................................................................................119
SPECIAL NOTES FROM UNISA...................................................................................................................119
SPECIAL NOTES:....................................................................................................................................120
1) general notes:..............................................................................................................................120
1) DETERMINING THE RELEVANT COSTS OF DIRECT MATERIALS............................................................120
2) DETERMINING THE RELEVANT COSTS OF DIRECT LABOUR.................................................................120
3) DO NOT compare unit costs, there is the danger that fixed costs will be unitized and treated as variable
costs. IN MOST CASES one should compare total amounts of revenue & costs rather than unit costs.(per
textbook vertabim)............................................................................................................................120
Context of relevant costs:........................................................................................................................120
terms:................................................................................................................................................121
method of relevant cost decisions:............................................................................................................122
1) adding a new product.......................................................................................................................122
2)Decisions on Replacement of old equipment- the irrelevance of past costs...............................................122
3) Discontinuation decisions : (Dropping a product or division)..................................................................123
4) Outsourcing (Make or buy decision)....................................................................................................124
5) Special selling price decisions (special orders).....................................................................................125
6) Product MIX decisions where capacity constraints exist.(IMPortant : using the relevant costing decision model
as an aid in choosing amoung competing alternatives.).............................................................................126
THE THEORY OF CONSTRAINTS AND THROUGHPUT ACCOUNTING (TOC).................................................128
STANDARD COSTING..............................................................................................................................132
EXAM TIPS :...........................................................................................................................................132
BASICS:................................................................................................................................................132
DEFINITION........................................................................................................................................132
PURPOSE OF STANDARD COSTING.........................................................................................................132
BASICS...............................................................................................................................................133
ESTABLISHING COST STANDARDS.........................................................................................................133
METHOD:...............................................................................................................................................134
VARIANCE ANALYSIS:..........................................................................................................................134
MATERIAL & LABOUR &VARIABLE O VERHEADS All INCOME/REVENUE is ACTUAL minus BUDGET and all EXPENSES/COSTS
is BUDGET minus ACTUAL EXCEPT “fIXED COSTS vOLUME VARIANCE”.......................................................134
All INCOME/REVENUE is ACTUAL minus BUDGET and all EXPENSES/COSTS is BUDGET minus
FIXED OVERHEADS
ACTUAL EXCEPT “fIXED COSTS vOLUME VARIANCE”.................................................................................135
THIS WHOLE SECTION IS NEVER REAL – IT IS ALL AT - MAKE BELIEVE – STD COSTS SO YOU CAN SEE THE VARIANCES CLEARLY
SALES VARIANCES
EXCEPT FOR ABSORBTION COSTING IS CORRECT.................................................................................135
ABSORBTION COSTING SALES & FIXED COSTS CHANGE.............................................................................................135
DIRECT MATERIAL :.............................................................................................................................136
MIX AND YIELD VARAINCES..................................................................................................................136
SALES MIX AND QUANTITY VARIANCES :................................................................................................136
Direct material + Labour + Variable Overheads. All INCOME/REVENUE is ACTUAL minus BUDGET and all
EXPENSES/COSTS is BUDGET minus ACTUAL EXCEPT “fIXED COSTS vOLUME VARIANCE”.............................136
FIXED OVERHEAD VARIANCE S : BFO –AFO All INCOME/REVENUE is ACTUAL minus BUDGET and all
EXPENSES/COSTS is BUDGET minus ACTUAL EXCEPT “fIXED COSTS vOLUME VARIANCE”.............................137
SALES VARIANCES : All INCOME/REVENUE is ACTUAL minus BUDGET and all EXPENSES/COSTS is BUDGET
minus ACTUAL EXCEPT “fIXED COSTS vOLUME VARIANCE”.......................................................................137
ABSORBTION COSTING All INCOME/REVENUE is ACTUAL minus BUDGET and all EXPENSES/COSTS is BUDGET
minus ACTUAl EXCEPT “fIXED COSTS vOLUME VARIANCE”........................................................................138
DIRECT MATERIALS MIX & YIELD VARIANCES.........................................................................................139
SALES MIX AND QUANTITY VARIANCES..................................................................................................139
RECONCILING BUDGETET PROFIT TO ACTUAL PROFIT..............................................................................140
WIP accounts.........................................................................................................................................140
MATERIALS (movements) RECORDING PROCEDURE....................................................................................140
PRICING THE ISSUES OF MATERIALS PROBLEM:........................................................................................141
CONTROL ACCOUNTS:.............................................................................................................................141
RECORDING RAW MATERIALS PURCHASE & RETURNS.................................................................................141
RECORDING ISSUE OF MATERIALS...........................................................................................................142
Recording Labour Costs:..........................................................................................................................142
RECORDING MANUFACTURING OVERHEADS...............................................................................................143
VARIABLE SYSTEM :.............................................................................................................................143
ABSORBTION SYSTEM..........................................................................................................................144
NON – MANUFACTURING OVERHEADS:.....................................................................................................144
RECORDING JOBS COMPLETED AND MOVED TO STORE...............................................................................144
COSTING p&l ACCOUNT...........................................................................................................................145
CALCULATING PROFIT:............................................................................................................................145
INVENTORIES.........................................................................................................................................145
INVESTIGATION OF VARIANCES...............................................................................................................146
ROLE OF ABC COSTING...........................................................................................................................146
TRANSFER PRICING IN DIVISIONALISED COMPANIES:................................................................................147
Introduction...........................................................................................................................................147
Goals & Purpose of transfer......................................................................................................................147
Setting a transfer price............................................................................................................................147
THE FOLLOWING ‘RULES OF THUMB’ MAY BE APPLIED WHEN A QUESTION ASKS YOU TO SUGGEST AN
APPROPRIATE TRANSFER PRICE:..............................................................................................................147
METHODS:.............................................................................................................................................148
PROPOSALS FOR RESOLVING TRANSFER PRICING CONFLICTS:.................................................................149
DOMESTIC TRANSFER PRICING RECOMMENDATIONS:.............................................................................149
INTERNATIONAL TRANSFER PRICING:....................................................................................................149
PRICING DECISIONS AND PROFITABILITY ANALYSIS CH 11 DRURY..............................................................150
eXAM TIPS.............................................................................................................................................150
BASICS.................................................................................................................................................150
PRICE SETTING FIRM :............................................................................................................................150
PRICE SETTING FIRM FACING SHORT TERM PRICING DECISIONS..............................................................150
PRICE SETTING FIRM FACING LONG TERM PRICING DECISIONS................................................................150
PRICING CUSTOMISED PRODUCTS......................................................................................................150
PRICING NON-CUSTOMISED PRODUCTS..............................................................................................151
PRICING NON-CUSTOMISED PRODUCTS USING TARGET COSTING..........................................................151
PRICING NON-CUSTOMISED PRODUCTS USING TARGET COSTING
SPECIAL FORMULAS TO LEARN :
Learning curve
1) MATHEMATICAL ALGEBRA FORMULA FOR LEARNING CURVE:(use esp.to work out between
doubles ie: 3,5,6 etc.)
I) y=axb
II) where b=log%/log2 Press on calc : %as decimal ie 80%=0.8 SO press:
Log 0.8 / Log 2 =
III)y= cumulative total average time /units when x units are produced (ie: it gives you avg. time
per unit of all units up to there as an answer,same as the answer you get when you
multiply {learning curve % by hours taken sort of thing})
IV) a=time to produce first unit
V) x= cumulative number of units produced (eg: if you want to know avg. time ea. For for 15 units,
then x=15)
VI) measure of learning (where b = log % / log 2 )rem: on calculator 80% =0.8 NOTE )
a)
VII) NOTE: to get b – you do it on calculator : b= log (learning%as decimal) / div by / log (2)
VIII)You type in log on calc. like this: first : 2ndfunct. Log second :0.8
IX) Use this formula esp. to work out between doubles ie: for number 3,5,6 etc.)
X) You can use it to make a % TABLE for units 1-200 etc where each no.of units has a simple % next
to it to use.
RELEVANT COSTING
1. THROUGHPUT ACCOUNTING: Theonly thing you have to know about throughput accounting is the formula.
Then the product with the HIGHEST T/A or Throughput Accounting ratio , wins, and second is next one etc.:
1.1. JUST LEARN THIS FORMULA :(incl. in formulas)
1.2. T/A ratio= Return per factory hour / Cost per factory hour where:
1.2.1.Return /P/F/A = SALES PRICE –only MATERIAL COST(no other costs eg labour etc, only direct materials)
1.2.2.Cost /P/F/A = TOTAL FACTORY COST / TOTAL TIME AVAILABLE ON KEY RESOURCE.(bottleneck)
next
TO SCAN IN STILL
Accounting entries chapter pg 44 own notes +-: scan example in ..pg80/81 drury)
Accounting entries chapter pg 44 own notes +-: Scan in pg 85 exercise question & answer for accounting entries
example , and paste in here to see what end result looks like.
GO TO PAGE pg 56 drury in still- see 56 drury : Overhead Analysis sheet: know how to set it OUT!(Scan in)
Check some of the weird journal entries in tut1
1) Scan in pg 453 drury exercise question & answer for accounting entries example , and paste in here to see
what end result looks like. For standard costs, pg 139 own notes chapter.
QUESTIONS
1. DRURY TEXT BOOK CH 3 Q 17 WHY IS IS D, NOT C ? CAUSE YOU KNOW WHAT ACTUAL WAS, YOU KNOW
UNDER-RECOVER, SO ADD THEM TO GET BUDHGETED?
2. High low method : What do you use.. in exams hey sometimes mix it up so the 2 gives very different
answers ,ALLWAYS USE THE ACTIVITY LEVEL (COST DRIVER) to choose the high&low values- not the
costs.????
3. (So non-overheads (non-mnftr) expenses go in the General Ledger, but overheads(mnftr) go in the
subsidiary ledger???) in a mnftr company.
RECORDING RAW MATERIALS PURCHASE & RETURNS

1) PURCHASE of raw materials:
DR Stores Ledger Control Account R5000

CR Creditors Control Account R5000
CR what about cost of sales ??????
2) RETURNS to supplier: (just the exact opposite)
DR Creditors Control Account R5000

CR Stores Ledger Control Account R5000
1. For every entry in the Factory Overhead Control Account,for indirect expenses, a separate equal entry must
be made in the individual overhead account of that item eg : electricity expense. and account heading there
will be name of Cost centre followed by expense type,unless “cost centre” is not known-eg overall property
taxes- then just expense type-per drury.(job accounts subsidiary ledger)is it separate like creditors ledger
or what? Is there one separate one for : labour, direct overhead,indirect overheads,direct materisl, indirect
materials or what? (So non-overheads (non-mnftr) expenses go in the General Ledger, but
overheads(mnftr) go in the subsidiary ledger???)
2. Overhead CHARGED TO JOBS journal entry : (when it is charged to a specific job) Here it is taken
out of ‘expense account’ and moved into ‘WIP costs account’ so it can move forward in that account to right
up to ‘inventory’ ,every entry in a control account is also entered in a ‘subsdiary ledger’ so for WIP it is ‘Jobs
subsidiary ledger’ with details of each job, and for ‘overheads’ it is overheads ‘subsidiary ledger ‘ with
details of each expense type incurred (eg rent)(how do you get the total for expenses for fin stats. at yr end
, if everything-all expenses- has been written out of “subsidiary & control accounts”? what if there were
returns, and errors(write backs) etc, so you must go to every transaction one by one to see if it is to go to
fin stats?)for every expense written out of overheads control account, must it also be written out of the
‘expense account itself’ eg ‘property taxes’ in the overheads subsidiary ledger. Is it actually kept in a
“mnftring overheads subsidiary ledger” or not? How can it be kept in the GL together with the control
account?
absorbtion costing
DIFFERENCE BETWEEN VOLUME EXPENDITURE DIFFERENCE.
1. Volume variance is Over/under recovery of overheads – it has to do with production “volume” rates. It
ONLY applies to where the cost driver was more/less than budget ,ie: 500 hrs worked instead of the 700hrs
budgeted. NOT to if budgeted overheads was less/more ie: budget overheads= R2000 actual = R4000 .
This is treated as a cost and debited to costs.
a. An under-recovery is Debited, like an “expense”.
b. An over-recovery is credited, like an “income”
2. Expenditure variance: has nothing to do with over/underrecovery at all. It is simply where the rands
budgeted as the Overheads was different to rands spent as Overheads . This is a separate figure ,it must be
included below over/under recovery , as a separate line item , in the absorbtion costing statement , AND
NOT INCLUDED with it.This is treated as a cost and debited to costs.
a. An –“more expenses”- is Debited to income, like an “expense”.( to period cost or product
cost/inventory? – does it go above or below gross profit/)
b. An –“less expenses”- is Credited to costs , like an “income” ”.( to period cost or product
cost/inventory? – does it go above or below gross profit/))
budgets
1. What does ‘gross profit’ mean := 45% means 45% of sales or cost of sales.
2. RELEVANT COSTING:
3.
4. What on earth is the “lump sum depreciation write-off” in column 2? How can you write off deprec. if you
sell it? It is mos just a ‘loss’ of 90-40= 50000 depr. write – off? Not 90000. And where is the deprec. for the
new machine then, it also gets 70000 over 3 years!
5.
6.
7. For relevant costing, the only thing that confuses me is deprecition: sometimes they inc. it and sometimes
they don’t incl. it. When do you know to incl. the difference in depreciation for the 2 alternatives? See this
one below- here they DON’T incl it, but in the one above, they DO incl. it!!!!
8.
9.
10. What do we do with direct labour, if the question is not clear about whether it is a fixed or variable cost or
not?
11. Do we include a figure where it is the same for both alternatives, or not? In the answer- VIgario does quite
often , but will we loose marks if our TOTAL costs for each product is very high cause we incl. all the things
that remain the same in each column?
12. Do we have to know throughput accountiung (appendix of relevant costing chapter in drury)?
standard costing
: see yellow :
RECORDING ISSUE OF MATERIALS

1) The materials USAGE variance account is debited(used more) OR credited(used less) here with the difference
between what the Std. Qty. is supposed to be for the no. of units of finished products produced by the type of
“Job Process Done” with the materials. If they draw more or less from the stores, it must go to the Materials
USAGE Variance Account.
a) If More is issued than Std Qty. : Dr the variance account as an EXPENSE to be written off as period cost.
b) If less is issued than Std Qty :CR variance account like an INCOME to be done as a “period income”???
.
place of last question

1-TERMS
TABLE OF ALTERNATIVE TERMINOLOGY /USA /UK
1. Overheads – term used instead of indirect costs sometimes

2. Cost Tracing – term describes only Direct cost tracing , not indirect costs ever . When you can 100% sure
directly attribute a cost to something.
3. Cost Allocation : indirect cost allocation process , can use either arbitrary or cause–and-effect allocations.
4. Arbitrary Cost Allocations :only for indirect costs – term describes “not so sure” methods used to allocate
indirect costs to cost objects. Like…labour hrs for fetching to decide qty of each material used for purchased,
instead of a surer indicator. Generally more used in old ‘traditional costing syatems’ not in new ABC costing
systems which use more cause-and-effect allocations.
5. Cause–And-Effect Cost Allocations.: term describes very accurate methods used to allocate indirect costs to
cost objects. Like…to decide qty of each material purchased,maybe % used in a product X no. of products
produced etc . Generally more used in newer ABC costing systems than in old ‘traditional costing systems’
which use more ‘arbitrary’ cost allocations.
6. ‘Allocation Base’ : eg labour hours , the base used to divide the total overheads up , to get a overhead rate
per hour …so you can assign costs to products using this rate and labour hours on job card.
7. Departmental overhead rates : more accurate method : where you use these rates and see through which
depts. the product goes, to more accurately determine product overhead share..since 1 dept may have very
low and another very high overheads.multiply by hrs or kg used etc . allocation base to get overhead share for
product.
8. Plant Wide or Blanket Overhead Rates : generally results in less accurate figure, because some products
might only use 1 dept where the overheads are low, but another product uses 4 depts where the overheads
add up to more. So one is measured too cheap and the other too expensive.where the entire
MANUFACTURING(not sales/admin) overhead of the factory is divided up using a single ‘Allocation Base’ eg
labour hours. = eg 450 000/5000hrs = R90/labour hour. Then the job card hours are used to multiply by this
rate to get the cost for that one job etc.
9. First Stage Allocation bases : to allocate costs from eg property taxes, depreciation, to each cost centre,
you use eg area of factory, or no. of employees etc.
10. Overhead Analysis sheet: used to work out the whole thing. Scan pg 56 drury in still- see 56 drury for this
sheet, to see how it is worked out from a-z.
a. NOTE: you have problems rembembering with this :notice how they use direct labour hrs to assign ‘the
service cost centre general factory support’ to production cost centres at bottom, and value of materials
issued to assign ‘materials procurement cost centre costs to production.
11. Activity Cost Centres : ABC costing uses ‘activity centres’ instead of departments as Cost Centres. Activities
consist of the aggregation of many different tasks and are described by verbs assoisated with objects , typical
Costs Centres (activities) are : schedule production , set-up machines , move materials, purchase materials,
inspect items, process supplier records.
12. Product diversity: means if products in the same dept. consume overheads equally,or in very , very different
proportions.
1) COST RECOVERY RATE.: the rate or basis eg machine hours. at which costs are recovered to a specific
eg production dept.
2) BASIS : the rate/basis is the measurement used to allocate costs eg: labour hours or machine hours.
3) COST PLUS BASIS :means you work out the final figure by starting with the cost price and then adding a
certain amount or % to it.
4) LIMITING FACTORS OF PRODUCTION: like a bottleneck at the machine dept – because machines only
produce a maximum amount each , or one cannot get more than a certain amount of some raw input product
per month etc
5) Management accounting : is primarily concerned with producing budgets, setting performance
standards, and evaluating performance
1) Acc sys used for measure costs for profit measurement,inventory valuation ,decision making,performance
measurement, control.
CAPEX= CAPITAL EXPENDITURE ( EG BUYING PPE LIKE LAND OR
MACHINES)
THE PRODUCTION POINT OF INDIFFERENCE, :

Where the total cost of a capital-intensive company = the total cost of a labour-intensive company.
ANALYSIS OF THE COMPANIES COST STRUCTURE:
Its fixed costs and contribution per unit.
CAPITAL STRUCTURE
means whether the company is using equity or debt and what combination of the 2 and interest rates etc etc.
ANNUITY:
The Receipt or Payment of a fixed amount over a number of years or periods.
ANNUITY DUE: if payment is made at the beginning of each period, it is called this
REGULAR /ORDINARY /DEFERRED ANNUITY : if payment is made at the end of the period.
OVER-TRADING
Means the company is selling too mush on credit and debtors are taking too long to pay- too many debtors and too
long to pay. This means it is taking chances with it’s selling on credit policy and over doing it.
Cost Objects:
1. COST OBJECT :Definition: ANY ACTIVITY for which a SEPARATE MEASUREMENT of COSTS is
desired.
a) Eg; cost of a product , of rendering a service to a bank customer ,of operating a particular sales
territory or dept.
The Cost Collection System works as such ; it accumulates costs-by assign into categories-eg
labour,materials ,overheads.( or by fixed & variable).THEN assigns these costs to cost objects.
Direct and Indirect Costs

INVENTORY VALUATION:(NOTE)
IAS 2 : INTERNATIONAL STATEMENT ON INVENTORIES states that : Firstly, closing stock – work
completed but unsold- (??? What About inventories & work in progress???) must be valued at the lower
of cost and net realisable value.Inventories are valued at : all costs incurred in bringing to current state
– ONLY manufacturing direct and indirect costs-The Costs of conversion of inventories include costs
directly related to the units of production,such as direct labour.They also include a systematic allocation
of fixed & variable overheads that are incurred in converting material into finished goods.Fixed
production overheads are those indirect costs of production that remain relatively constant regardless of
the volume of production, such as depreciation ,maintenance of factory buildings and equipment,and the
cost of factory management and administration.
However FIXED OVERHEADS are only allocated at the normal production capacity(over anumber of
seasons or periods under normal circumstances,taking into account the loss of activity relating to
planned maintenance) .If idle plant /low production inventory costs are ONLY allocated at normal prod.
Capacity Levels.BUT in periods of abnormally high production, the amount of fixed averheads allocated
to each product unit is decreased so inventories are not valued at below cost.
As a result of this accounting definition ,the valuation of stock is carried out on a FIFO or weighted
average basis.LIFO is strictly prohibited.
DIRECT COSTS :
Costs that can be specifically and exclusively identified with a particular cost object. . ..
Eg:wood in a desk, maintenance labour in -(cost object maintenance dept)-but NOT Maint.Labour in a
–(cost object desk produced).The more direct cost and less indirect costs =the more accurate the
estimate.
INDIRECT COSTS :
Costs that cannot be identified specifically and exclusively with a particular cost object, but can only be identified
with a a number of depts.. /cost objects.
CATEGORIES OF MANUFACTURING COSTS. – WITH DIRECT/INDIRECT
COSTS.
Direct Materials Xxx
Direct Labour Xxx
Prime Cost Xxx
Manufacturing Overhead Xxx
Total Manufacturing Cost Xxx
i) In manufacturing organisations traditional product costs accumulated as follows – ( developed

esp. from/for ext. accounting requirements.
DIRECT MATERIALS :
Cost of all materials that can be identified with a specific product.eg wood for desk is, but maintenance
materials on machine to produce with is not,that is an indirect materials cost.
INDIRECT MATERIALS :
cannot be identified with any one product, eg:because used for all.eg maintenance materials spares.
DIRECT LABOUR :
can be specifically traced to or identified with product eg:labour assemble product
INDIRECT LABOUR
can not be specifically traced to or identified with product eg:labour maintenance of many different
product lines machines.
DIRECT EXPENSE :
NOT labour/materials/overheads/ can be specifically traced to or identified with product eg hiring of
machine to produce a specific quantity of a product is a direct expense. (other than /not
labour/materials-in this context) anything else in this category would be classed as 'OVERHEADS' –see
below.
PRIME COST
= Direct materials+Direct Labour +Direct Expenses.
MANUFACTURING OVERHEAD :
All manufacturing costs exept : Direct materials+Direct Labour +Direct Expenses eg:rent of factory.
COST ALLOCATIONS :
process of assigning indirect costs(overheads) to products- using surrogate ,not direct measures.ALSO –
the assigning of eg: rent between mnftring and / non-mnftring depts.
TOTAL MANUFATURING COST :
Direct materials+Direct Labour +Direct Expenses+Mnfctring overheads
PERIOD AND PRODUCT COSTS.
2) Because of external fin acc rules in most countries that require that for inventory evaluation ONLY
MANUFACTURING COSTS /or RETAILER = PURCHASE COSTS + FREIGHT IN -should be included in the
calculation of product costs AS WELL AS ONLY costs related directly to the units of production- accountants
therefore classify costs as product costs and period costs.
a) BECAUSE OF THIS ONLY the FIFO or weidghted average methods may be used to calc. inventory-
NOT L.I.F.O.-ie. Costs must relate directly to units of production.
REASONS CITED FOR THIS:
b) Inventories represent a future probable inflow of revenue , period costs(overheads) do not
c) Many non-manufacturing costs are NOT incurred when the product is being stored-thus inappropriate
to include them in inventory valuation.
INTERNATIONAL STATEMENT ON INVENTORIES states that :Inventories are valued at : all costs incurred in
bringing to current state – ????ONLY manufacturing direct and indirect costs- ie:COSTS OF CONVERSION ???????
YES OR NO. Includes systematic allocation of fixed & variable overheads.
However FIXED OVERHEADS are only allocated at the normal production capacity.If idle plant /low production
inventory costs are ONLY allocated at normal prod. Capacity Levels.BUT in periods of abnormally high production,
the amount of fixed averheads allocated to each product unit is decreased so inventories are not valued at below
cost.
PRODUCT COSTS :
Costs that ARE included in the calc. of inventory for the period,and are not recorded as expenses for the period.
(incl. work in progress) ONLY MANUFACTURING OVERHEADS may be INCLUDED as part of absorbtion costing in
the valuation of closing stock. Product costs= TOTAL MANUFACTURING COSTS =direct labour+dir.material+direct
expenses +Mnftring overheads( from last section) NOT eg: distribution+telephone for telesales .as per book
exactly: Certain Admin Overheads or selling overheads may never be associated with production.
PERIOD COSTS :
Costs that are not included in the calc. of inventory for the period , thus costs that are treated as expenses in
the period in which they occoured .Valuation. Period costs= eg: sales expenses+ travel , distribution expenses.
Relevant and Irrelevant Costs:

RELEVANT COSTS AND REVENUES :
Those Future costs and Revenues that will be changed by any specific decision relating to production volume or
selling volume.eg: material costs change if choose to produce more
IRRELEVANT COSTS AND REVENUES:
Those Future costs and Revenues that will NOT be changed by any specific decision relating to production
volume or selling volume.. Eg: rent for factory will not change if higher production or selling volume.
Avoidable or Unavoidable costs:

AVOIDABLE=
Costs that can be left out of a new project ,over which one has control in a current decision, not costs that
must be paid anyway, thus called relevant costs. Sometimes used in place of relevant costs
UNAVOIDABLE
Costs that will have to be paid anyway, and are thus not relevant to a current decision.Sometimes used in
place of irrelevant costs
Opportunity Costs:
3) OPPORTUNITY COST =The cost of a foregone opportunity in favour of having chosen another one :eg . if
the cost of selling a new product is to stop selling another one , the opportunity cost is the rvenue one used to
receive from the old one.
-Incremental /or Differential- and Marginal Costs

INCREMENTAL OR DIFFERENTIAL COSTS :
Accountants use this : means the different in total costs for ALL THE EXTRA PRODUCTS WHEREBY the
PRODUCTION HAS BEEN INCREASED.
MARGINAL COSTS :
Economists use this : means difference in costs for ONLY ONE extra product –ie. For each separate new product
whereby production has been increased.
Job Costing and Process Costing systems:

JOB COSTING SYSTEMS:
Relates to a costing system where all the costs associated with each job could be different for each job
completed and , so direct materials and labour are allocated at actual cost and fixed overheads are allocated on
a pre-determined cost rate for each separate job.This is also known as a fully integrated absorption costing
system. eg. In constructiion industry –where each house could be unique and have a completely different set of
costs to other houses.
PROCESS COSTING SYSTEMS:
The method used to value stock in mnftring where at end of period some of the closing stock is partially
manufactured-not all finished yet.
ABSORPTION COSTING AND VARIABLE COSTING:and STANDARD

COSTING.
INVENTORY VALUATION:(NOTE)
IAS 2 ON INVENTORIES STATES THE FOLLOWING.:
IAS 2 : INTERNATIONAL STATEMENT ON INVENTORIES states that : Firstly, closing stock – work
completed but unsold- (??? What About inventories & work in progress???) must be valued at the lower
of cost and net realisable value.Inventories are valued at : all costs incurred in bringing to current state
– ONLY manufacturing direct and indirect costs-The Costs of conversion of inventories include costs
directly related to the units of production,such as direct labour.They also include a systematic allocation
of fixed & variable overheads that are incurred in converting material into finished goods.Fixed
production overheads are those indirect costs of production that remain relatively constant regardless of
the volume of production, such as depreciation ,maintenance of factory buildings and equipment,and the
cost of factory management and administration.
However FIXED OVERHEADS are only allocated at the normal production capacity(over anumber of
seasons or periods under normal circumstances,taking into account the loss of activity relating to
planned maintenance) .If idle plant /low production inventory costs are ONLY allocated at normal prod.
Capacity Levels.BUT in periods of abnormally high production, the amount of fixed averheads allocated
to each product unit is decreased so inventories are not valued at below cost.
Variable Production overheads are those indirect costs of production that vary directly,or nearly
directly,with the volume of production,such as indirect materials and indirect labour.
As a result of this accounting definition ,the valuation of stock is carried out on a FIFO or weighted
average basis.LIFO is strictly prohibited.
Cost accounting grew out of the need that financial accountants have for financial information ,and
gathers and analyses costs for the purposes of :product costing,job costing,stock valuation.
ABSORBTION COSTING :
IN EXAM, OR REAL LIFE, AS SOON AS ONE GETS AN INCOME STATEMENT OR FIGURES PREPARED
USING ABSORBTION COSTING, ONE MUST QUICKLY CALCULATE THE SAME FIGURES USING VARIABLE
COSTING – OR YOU WILL NOT BE ABLE TO DO PROPER COMPARISONS AND WORK THINGS OUT! Due to
fixed costs being in there- always take them out and convert to CONTRIBUTION ..
Method used to VALUE CLOSING STOCK that includes ALL MANUFACTURING COSTS-VARIABLE AND FIXED-
NOT any NON-MNFTRING COSTS AT ALL!!!!!! ((WHICH DOES/can INCL. RENT AND MAINTENANCE per book)–
The fixed cost element can be determined by budget or by actual,and is added to all variable mnftring costs(eg
direct material) to get the total per unit product cost for inventory valuation per the IAS definition ( which says
ALL MNFTRING COSTS must be included in Inventory Valuation incl. fixed mnftring costs eg: Maintenance etc.)
.ONLY Financial Accounting uses it. NOTE: every time production volume changes ,the cost per unit will
change because fixed costs get divided by a larger /or smaller number now.So it is an inconvenient method
requiring constant raising of under/over recovery charges to balance the figures.The 2 reasons for this is:
1-Actual volume is different to budget volume.
2-Actual manufacturing overhead being different to budget overhead.
That is why Management Accounting uses a different method –: called "Variable Costing".
FOR ABSORBTION COSTING THRE ARE 2 WAYS OF VALUING STOCK:1-BUDGET AND 2-

ACTUALVARIABLE PLUS FIXED COST OF PRODUCTION. But for variable costing ther are also these 2
ways , exept there it is only VARIABLE COSTS OF PRODUCTION, not fixed and variable in the stock
valuation(per book vigario pg14-concl.
ALSO, FOR ABSORBTION COSTING THERE ARE 3 POSSIBLE WAYS OF PRESENTING THE
INFORMATION IN THE FINANCIAL STATEMENTS.
1-FULLY INTEGRATED ABSORBTION COSTING (BUDGET COST)
2-NON-INTEGRATED ABSORBTION COSTING (BUDGET COST)
3-ACTUAL COST ABSORBTION COSTING. (all exactly per vig. Pg 14 book!)
IS ABSORBTION COSTING ACCEPTABLE:?
NO, because it will distort true company profits due to showing fixed costs as closing inventory
costs –you cannot compare 2 periods properly,or budget properly if you use include rent at a
pre-determined rate eh R300 per product it will not be accurate if production rises or falls.- it
will eg show excessive profits when stock holding is rising ? per book vig pg14.
HOW DO YOU MAKE IT ACCEPTABLE:
You explain on any budget that the Per Unit cost can vary by the TOTAL FIXED COSTS AMOUNT
included in the costing eg R500 –at any level above or below the no. of units that the budget was
calculated at.
However ,for calculating costs of products in a Job Costing environment, where the costs are used to quote on
future jobs eg: Printers , when using absorbtion costing, one must remember that one company allocates fixed
costs differently to another one,and there is no right or wrong method to allocate fixed costs really, ie some
allocate all overheads, some only admin + management , some only maintenance and depreciation etc.
COST ABSORBTION RATE :

the cost rate at which a group of costs or fixed costs or overheads are charged to a specific product eg:
machine hours divided between no. of products.(it is used by fin . accountants to calculate absorbtion costing
system.
FULLY INTEGRATED ABSORBTION COSTING SYSTEM ( OR “FULL”
ABSORB. COSTING SYSTEM)
If the fixed element is pre-determined .So when fixed elements eg: rent+maintenance ,are pre-calculated in
the previous years as a per unit cost, from per average normal production levels,so eg R1000 rent /
500products made per mnth= R2 rent per product ;and these amounts are added to normal vriable costseg
direct material, to get a (estimated/ avg)total cost per product unit . (NOTE: not all fixed costs need to be
allocated as such ONLY mnftring costs MUST BE(WHICH DOES INCL. RENT AND MAINTENANCE per book),
other fixed costs eg admin and computer,marketing costs(more 'sales costs' types get left out)can be left out
and the system would still be called Fully Integrated absorbtion Costing) ONLY where the fixed cost element is
pre-determined though and not based on actual fixed costs ,which is another type of absorbtion costing.The
actual amount will differ from the allocated amount though and OVER or UNDER recovery of fixed overhead will
occour, which must be balanced by a BALANCING AMOUNT known as the over/under –recovered fixed
overhead.This amount is included by 'raising a charge' (possibly it's very own ledger account-CRJ/CPjournal)
and including it in the Cost of sales breakdown in Income statement for Gross Profit calc.
Do NOT ASSUME every company uses fully integrated abs.cost. to allocate costs in order to arrive at the cost of
a product.Only companies that have a JOB COSTING environment , require a pre-determined FIXED COST to
allocate to FUTURE production.Very few companies will allocate costs to production and service depts. ,
followed by re-allocation from service depts. to production depts. However , when using absorbtion costing, one
must remember that one comapny allocates fixed costs differently to another one,and there is no right or
wrong method to allocate fixed costs really, ie some allocate all overheads, some only admin + management ,
some only maintenance and depreciation etc.
VARIABLE COSTING (OR MARGINAL OR DIRECT COSTING)
USING ABSORBTION COSTING, ONE MUST QUICKLY CACULATE THE SAME FIGURES USING VARIABLE
COSTING – OR YOU WILL NOT BE ABLE TO DO PRPER COMPARISONS AND WORK THINGS OUT! Due to
The method used to VALUE CLOSING STOCK using variable manufacturing costs only- fixed costs are written off as
period costs.(as per book- fixed mnfrtring costs are charged to the Income statement as an expense for the
period.So closing stock is valued on manufacturing variable costs only. Ie: the valuation excludes all mnfring fixed
costs.The System is representative of managerial accounting for decision making.
Variable costing is consistent with CVP analysis,ie fixed costs are treated as period costs.(per book exactly)
FOR VARIABLE COSTING ,THERE ARE 2 WAYS OF VALUING STOCK – 1-BUDGET OR 2-ACTUAL.
DIRECT COSTING.
MARGINAL COSTING.
STANDARD COSTING:
Another method of VALUEING CLOSING STOCK – but at a pre-determined rate for BOTH VARIABLE AND FIXED
COSTS.
STANDARD VARIABLE COSTING:
(a) when only pre-determined variable costs are used.
STANDARD FIXED COSTING:
(b) when only pre-determined fixed costs are used.
Sunk Costs:
SUNK COSTS :
These are COSTS created by a decision in the PAST that cannot be changed by any future decision – or which has
a zero value when making future decision: eg:depreciation,or money spent on material that is no longer required/
or sellable.-OR buy a car for 10000, when you sell it the 10000 is sunk cost because selling price depends on what
the buyer will pay –it can be above or below 10000 .
Responsibility Accounting :
RESPONSIBILITY ACCOUNTING :
accounting for a RESPONSIBILITY UNIT -an organisation unit or part of a business for which a manager is
reponsible.Revenues & Costs so deviations from performance budget can be attributed to resposible individual.
PROFIT CENTRE :
same as above :Accountability for profitability of assets placed under a managers control.
COST CENTRE:
SAME AS above but AREA or DEPT. for which a manager is responsible.
INVESTMENT CENTRE:
term defines accountability for profit generation AS WELL AS choices in what will or will not be purchased by
way of capital expenditure in running a business.
Maintaining a cost database:

1) Database to be maintained so relevant cost info can be extracted easily.
2) Need eg: By products, responsibility centres,depts.,distribution channels, + categ. of expense eg direct
labour + categ. of cost behaviour eg fixed and variable.
3) For cost control and performance measurement:
a) Reports by resposibility centre per week/ etc
b) Future reports for eg: possible price changes.
c) Standards costs stored & used to evaluate
Fixed and Variable Production Overheads : and Cost Behaviour of

a) Measurements of volume needed to :patients seen-one more patient/day?=costs/revenue/(or units sold ?
reduce price to sell more?,or units produced ,guests booked etc)
VARIABLE COSTS :
vary directly or very nearly directly according to incr./decr. in volume(eg:of production).See chart below : total
variable costs are linear/direct and Unit var. cost is constant.
UNITS vs VARIABLE COSTS GRAPH
VARIABLECOSTS: (a)TOTAL
TOTAL Variable
5000 5000
4000 4000
Cost
3000 3000
2000 2000
1000 1000
0 0
0 100 200 300 400 500
ActivityLevel
PROFIT vs VARIABLE COSTS GRAPH.

FIXED PRODUCTION COSTS :
basicaly stay constant regardless of volume of production –OVER a specific period of time- (before inflation pushes
up input prices etc),but also called ‘long term variable costs’ because over the long term ALL costs are seen a
variable-due to inflation etc. eg:rent, municipal rates
UNITS vs FIXED COSTS GRAPH
PROFIT vs FIXED COSTS GRAPH

SEMI-FIXED (OR STEP-FIXED COSTS) :
They are fixed in (Relevant Ranges )at specific activity levels :eg at 100 – 5000 products ,-within a specific time
period (same as fixed –to exclude inflation etc)- but if production goes above that they change to the next level
etc.– usually in steps-
SEMI-VARIABLE (OR MIXED COSTS) :

These include both a FIXED and a VARIABLE component eg:maintenance = fixed cost + a variable cost according
to amount of activity ; or sales rep. costs =salary + commission per amount of sales. Eg rent= rent +10%gross
revenue
Relevant Range
RELEVANT RANGE:
A limited level of activity under which costs are analysed as either fixed or variable,eg for production of 1-1000
units, over that another costing structure is used,or another range.
Selling Costs
SELLING COSTS :
relate to sales, written off in period incurred. Eg :commission costs,etc.
Conversion Costs:
CONVERSION COSTS :
All costs other than Direct Material costs that are incurred in manufacturing a product.The word conversion is
normally associated with process costing and refers to all costs exept direct material directly related to the
manufacturing process.
ADMINISTRATION Costs:
Administration Costs: treated as a manufacturing overhead only if relate to work being carried out in mnftring
process – but in most instances they are written off as a period cost- not mnftr. Cost. Eg: cost of accountant=
period cost , cost of person who records all manufacturing processes number produced, materials used etc only in
mnftring = manftring admin cost .
HIGH-LOW COST ANALYSIS:
REFERS TO ANALYSIS OF SEMI-VARIABLE COSTS where the var. & fixed. Elements are calc. by analysing incr. in
cost in comparison to incr. in prod. Volume.
CONTRIBUTION:
CONTRIBUTION is the SELLING PRICE of a product LESS all VARIABLE COSTS.The term used by Management
accountants to describe the incremental profit that a company will make as the company sells one more unit of
production.(DOES NOT include FIXED COSTS, ONLY SELLING PRICE – VARIABLE COSTS = contribution, then after
that ,CONTRIBUTION-FIXED COSTS=NET LOSS/PROFIT.) Variable costs would include
selling,marketing,distribution costs etc,so ALLl variable costs,none are left out. Mngmn acc only concerned with
contribution,not profit since incr. sales = incr.contribution where fixed costs stay constant. Means ' Profit
contributed toward total profit of firm before fixed costs' so.This happens because fixed costs do not change , but
production volume does, so once all fixed costs have been paid by current production volume, any increase in
production volume above this results in a higher profit than before the fixed costs were paid for.Thus before fixed
profit is paid for , PART OF THE CONTRIBUTION goes to fixed costs, but after the fixed cost is paid for, ALL OF
THE CONTRIBUTION goes toward profit.
SALES
- Variable Costs
(incl.marketing,selling,distribution
ie: ALL.
= CONTRIBUTION
- Fixed Costs
= PROFIT
BUDGET:
A budget is a quantitative analysis of a plan or corporate action.It is intended that production/sales etc be co-
ordinated by various depts. to achieve expectations about future income/cash flows/fin pos , fin perf and
supportin plans.
“STANDARD HOURS PRODUCED”:
-“– is the time it takes to produce one product ,used as a common denominator to divide up costs into different
products.
“STANDARD PROFIT STATEMENT”:

This is an income statement , using pre-determined standard cost rates , showing what profit we can expect from
a given sales volume.The volume is usually estimated from known sales and production capacity, but could also
just mean the volume for the flexed budget, when using standard costing.
STATIC BUDGET
The plain original realistic budget for the year drawn up at beginning of year.
FLEXED BUDGET
Standard Budget : The budget the is drawn up using the ACTUAL sales VOLUME, but with the original costs
from the Original Budget, not the Actual Costs. This can then be compared to the actual Income statement to
see what the difference in each cost was once converted to the actual sales level.
BILL OF MATERIALS
A list of all the actual materials needed to manufacture a specific product. Does not include labour/overheads
etc. like the ‘Standard Cost Card.’
STANDARD COST CARD
Card with the costs of all the Inputs used to make 1 output product.(That should (actual) be used to produce a
product.)1 card is kept for each different product made. (-historical cost -not a goal type cost).Nowdays on
computer.
MORE DEFINITIONS
1.1. Indirect (common) fixed cost : applies to all products eg rent
1.2. Direct (avoidable) fixed costs : applies only to single 1 of many products.
1.3. Sales mix: the ratio to each other of the different products which are made eg 1: 5: 8
2. AGENCY RELATIONSHIP: definition : it is the relationship between owners and shareholders
3. AGENCY PROBLEM or COST definition : The possibility of conflict of interest between owners and mngmnt is
called the. Eg mngrs see short terms goals not long term goals , like maximize profit for bonus’s etc. Or if sell
a car for someone for a flat fee, then you wont go for a higher price for him.- so commission could be better
option.
3.1. DIRECT AGENCY COST: 2 types : 1 - like mngmnt buy a corporate jet / 2- need for hiring auditors to
audit the firm each yr
3.2. INDIRECT AGENCY COSTS: like mngmnt does not invest in a new venture because it is riskt and some of
their jobs might be lost, even though it will increase the share value a lot for shareholders /
4. Corporate finance : DEFINITION: IS THE MANAGEMENT OF capital budgeting/long tyerm investment
decisions and capital structure/long term financing as well as everyday financial activities of a company.
5. CAPITAL BUDGETING DEFINITION: deciding on whether to aquire and seeking and evaluating any long
term investments.
6. CAPITAL STRUCTURE definition : it is the mix used of equity vs debt vs (or use own profits) decision,.
7. WORKING CAPITAL definition: Refers to short term assets eg inventory and short term liabilities eg supplier
creditors
8. THE GOAL OF FINANCIAL MANAGEMENT Definition : is Officially defined as : TO MAXIMIZE THE
CURRENT VALUE OF OWNERS EQUITY / VALUE PER SHARE FOR EXISTING SHARES
TUT 102 : TOPIC 1: NATURE OF COSTS,
COST CLASSIFICATION, COST BEHAVIOUR
AND COST ESTIMATION
CHAPTER 2 DRURY : COST TERMS AND
CONCEPTS
NEED ATTENTION:
PRIME COST
= Direct materials+Direct Labour +Direct Expenses. (excludes any indirect expenses)
All manufacturing costs except : Direct materials+Direct Labour +Direct Expenses eg:rent of
factory or depreciation of machines. It therefore includes : NB: Indirect materials,labour and
expenses.
PRODUCT COSTS :
Costs that ARE included in the calc. of inventory for the period,and are not recorded as
expenses for the period. (incl. work in progress) ONLY MANUFACTURING OVERHEADS may be
INCLUDED as part of absorbtion costing in the valuation of closing stock. Product costs= TOTAL
MANUFACTURING COSTS =direct labour+dir.material+direct expenses +Mnftring
overheads( from last section) NOT eg: distribution+telephone for telesales .as per book exactly:
Certain Admin Overheads or selling overheads may never be associated with production.
PERIOD COSTS :
Costs that are not included in the calc. of inventory for the period , thus costs that are
treated as expenses in the period in which they occoured .Valuation. Period costs= eg: sales
expenses+ travel , distribution expenses.
AVOIDABLE=
Costs that can be left out of a new project ,over which one has control in a current decision,
not costs that must be paid anyway, thus called relevant costs. Sometimes used in place of
relevant costs
UNAVOIDABLE
Costs that will have to be paid anyway, and are thus not relevant to a current
decision.Sometimes used in place of irrelevant costs

Accountants use this : means the different in total costs for ALL THE EXTRA PRODUCTS
WHEREBY the PRODUCTION HAS BEEN INCREASED.(incl. fixed costs if they change too)
MARGINAL COSTS :
Economists use this : means difference in costs for ONLY ONE extra product –ie. For each
separate new product whereby production has been increased.

They are fixed in (Relevant Ranges )at specific activity levels :eg at 100 – 5000 products
,-within a specific time period (same as fixed –to exclude inflation etc)- but if production goes
above that they change to the next level etc.– usually in steps-

These include both a FIXED and a VARIABLE component eg:maintenance = fixed cost + a
variable cost according to amount of activity ; or sales rep. costs =salary + commission per
amount of sales. Eg rent= rent +10%gross revenue
Cost Objects:
COST OBJECT :Definition: ANY ACTIVITY for which a SEPARATE MEASUREMENT of COSTS is desired.
Eg; cost of a product , of rendering a service to a bank customer ,of operating a particular sales territory
or dept.
The Cost Collection System works as such ; it accumulates costs-by assign into categories-eg
labour,materials ,overheads.( or by fixed & variable).THEN assigns these costs to cost objects.
DIRECT COSTS :
Costs that can be specifically and exclusively identified with a particular cost object. . Eg:wood
in a desk, maintenance labour in -(cost object maintenance dept)-but NOT Maint.Labour in a –(cost
object desk produced).The more direct cost and less indirect costs in your estimate =the more
accurate the estimate.
INDIRECT COSTS :
Costs that cannot be identified specifically and exclusively with a particular cost object, but can only be identified
with a a number of depts.. /cost objects.
CATEGORIES OF MANUFACTURING COSTS. – WITH DIRECT/INDIRECT
COSTS. ..ALL THOSE BELOW DOWN TO COST ALLOCATIONS.
Direct Materials Xxx
Direct Labour Xxx
Prime Cost Xxx
Manufacturing Overhead Xxx
Total Manufacturing Cost Xxx
i) In manufacturing organisations traditional product costs accumulated as follows – developed

esp. from/for ext. accounting requirements.
DIRECT MATERIALS :
Cost of all materials that can be identified with a specific product.eg wood for desk is, but maintenance
materials on machine to produce with is not,that is an indirect materials cost.
INDIRECT MATERIALS :
cannot be identified with any one product, eg:because used for all.eg maintenance materials spares.
DIRECT LABOUR :
can be specifically traced to or identified with product eg:labour assemble product
INDIRECT LABOUR
can not be specifically traced to or identified with product eg:labour maintenance of many different
product lines machines.
DIRECT EXPENSE :
Any expnse that be specifically traced to or identified with product eg hiring of machine to produce a
specific quantity of a product is a direct expense.
PRIME COST
= Direct materials+Direct Labour +Direct Expenses. (excludes any indirect expenses)(Opposite of
Manufacturing Overheads)
All manufacturing costs except : Direct materials+Direct Labour +Direct Expenses eg:rent of factory or
depreciation of machines. It therefore includes : NB: Indirect materials,labour and expenses.(opposite
of Prime Costs)
COST ALLOCATIONS :
process of assigning indirect costs(overheads) to products- using surrogate ,not direct measures.ALSO –
the assigning of eg: rent between mnftring and / non-mnftring depts.
TOTAL MANUFATURING COST :

Direct materials+Direct Labour +Direct Expenses+Mnfctring overheads
PERIOD AND PRODUCT COSTS.
2) Because of external fin acc rules in most countries that require that for inventory evaluation ONLY
MANUFACTURING COSTS /or RETAILER = PURCHASE COSTS + FREIGHT IN -should be included in the
calculation of product costs AS WELL AS ONLY costs related directly to the units of production- accountants
therefore classify costs as product costs and period costs.
a) BECAUSE OF THIS ONLY the FIFO or weidghted average methods may be used to calc. inventory-
NOT L.I.F.O.-ie. Costs must relate directly to units of production.
REASONS CITED FOR THIS:
b) Inventories represent a future probable inflow of revenue , period costs(overheads) do not
c) Many non-manufacturing costs are NOT incurred when the product is being stored-thus inappropriate
to include them in inventory valuation.
INTERNATIONAL STATEMENT ON INVENTORIES states that :Inventories are valued at : all costs incurred in
bringing to current state – ????ONLY manufacturing direct and indirect costs- ie:COSTS OF CONVERSION ???????
YES OR NO. Includes systematic allocation of fixed & variable overheads.
However FIXED OVERHEADS are only allocated at the normal production capacity.If idle plant /low production
inventory costs are ONLY allocated at normal prod. Capacity Levels.BUT in periods of abnormally high production,
the amount of fixed averheads allocated to each product unit is decreased so inventories are not valued at below
cost.
PRODUCT COSTS :
Product costs= TOTAL MANUFACTURING COSTS =direct labour+dir.material+direct expenses +Mnftring
overheads( from last section) NOT eg: distribution+telephone for telesales .as per book exactly: Admin Overheads
or selling overheads may never be associated with production. Costs identified with goods purchased or produced
for resale.-in mnftring is costs attached to product for inventory valuation of finished goods ,work in progress,
matched against sales for recording profits. ONLY MANUFACTURING OVERHEADS may be INCLUDED as part of
absorbtion costing in the valuation of closing stock.Variable costing would treat it as a period cost and write it off in
period it occoured.(IFRS/etc) =recorded as an ASSET until sold ,then as an expense.(when you 'write out' last
inventory count and write in new inventory in the profit & loss statement at year end I THINK? ) !
PERIOD COSTS :
Costs treated as expenses in the period in which they occoured, BUT NOT included in the cost calc. of inventory
valuation.(or /sales/work in progress.)recorded as an expense ONLY,never as an asset! Period costs= eg: sales
expenses+ admin +distribution expenses. – everything that may not be included in the calculation of the
product cost .
Relevant and Irrelevant Costs:

RELEVANT COSTS AND REVENUES :
Those Future costs and Revenues that will be changed by any specific decision relating to production volume
or selling volume.eg: material costs change if choose to produce more
IRRELEVANT COSTS AND REVENUES:
Those Future costs and Revenues that will NOT be changed by any specific decision relating to production
volume or selling volume.. Eg: rent for factory will not change if higher production or selling volume.
Avoidable or Unavoidable costs:

AVOIDABLE=
relevant costs (sometimes used in place of other name)
UNAVOIDABLE
irrelevant costs (sometimes used in place of other name)
Opportunity Costs:
OPPORTUNITY COST =The cost of a foregone opportunity in favour of having chosen another one :eg . if the
cost of selling a new product is to stop selling another one , the opportunity cost is the rvenue one used to receive
from the old one.
-Incremental /or Differential- and Marginal Costs

Accountants use this : means the different in total costs for ALL THE EXTRA PRODUCTS WHEREBY the
PRODUCTION HAS BEEN INCREASED.(incl. fixed costs if they change too)
MARGINAL COSTS :
Economists use this : means difference in costs for ONLY ONE extra product –ie. For each separate new
product whereby production has been increased.
COSTING – OR YOU WILL NOT BE ABLE TO DO PRPER COMPARISONS AND WORK THINGS OUT! Due to
SUNK COSTS :
These are COSTS created by a decision in the PAST that cannot be changed by any future decision – or which has
a zero value when making future decision: eg:depreciation,or money spent on material that is no longer required/
or sellable.-OR buy a car for 10000, when you sell it the 10000 is sunk cost because selling price depends on what
the buyer will pay –it can be above or below 10000 . irrelevant for decision making.
VARIABLE COSTS :
Vary directly or very nearly directly according to incr./decr. in volume(eg:of production). Eg direct material costs ,
direct labour etc .See chart below : Total variable costs are linear/direct and Unit var. cost is constant.
UNITS vs VARIABLE COSTS GRAPH
VARIABLECOSTS: (a)TOTAL
TOTAL Variable
5000 5000
4000 4000
Cost
3000 3000
2000 2000
1000 1000
0 0
0 100 200 300 400 500
ActivityLevel
PROFIT vs VARIABLE COSTS GRAPH.

FIXED PRODUCTION COSTS :
basicaly stay constant regardless of volume of production –OVER a specific period of time- (before inflation pushes
up input prices etc),but also called ‘long term variable costs’ because over the long term ALL costs are seen a
variable-due to inflation etc. eg:rent, municipal rates
UNITS vs FIXED COSTS GRAPH
PROFIT vs FIXED COSTS GRAPH

They are fixed in (Relevant Ranges )at specific activity levels :eg at 100 – 5000 products ,-within a specific time
period (same as fixed –to exclude inflation etc)- but if production goes above that they change to the next level
etc.– usually in steps-
These include both a FIXED and a VARIABLE component eg:maintenance = fixed cost + a variable cost according
to amount of activity ; or sales rep. costs =salary + commission per amount of sales. Eg rent= rent +10%gross
revenue
RELEVANT RANGE:
A limited level of activity under which costs are analysed as either fixed or variable,eg for production of 1-1000
units, over that another costing structure is used,or another range.
ADMINISTRATION Costs:
Administration Costs: treated as a manufacturing overhead only if relate to work being carried out in mnftring
process – but in most instances they are written off as a period cost- not mnftr. Cost. Eg: cost of accountant=
period cost , cost of person who records all manufacturing processes number produced, materials used etc only in
mnftring = manftring admin cost .
HIGH-LOW COST ANALYSIS:
REFERS TO ANALYSIS OF SEMI-VARIABLE COSTS where the var. & fixed. Elements are calc. by analysing incr. in
cost in comparison to incr. in prod. Volume.
CONTRIBUTION:
production.(DOES NOT include FIXED COSTS, ONLY SELLING PRICE – VARIABLE COSTS = contribution, then after
that ,CONTRIBUTION-FIXED COSTS=NET LOSS/PROFIT.) Mngmn acc only concerned with contribution,not
profit since incr. sales = incr.contribution where fixed costs stay constant. Means ' Profit contributed toward total
profit of firm before fixed costs' so.This happens because fixed costs do not change , but production volume does,
so once all fixed costs have been paid by current production volume, any increase in production volume above this
results in a higher profit than before the fixed costs were paid for.Thus before fixed profit is paid for , PART OF
THE CONTRIBUTION goes to fixed costs, but after the fixed cost is paid for, ALL OF THE CONTRIBUTION goes
toward profit.
SALES
- Variable Costs
(incl.marketing,selling,distribution
ie: ALL.
= CONTRIBUTION (to fixed +profit)
- Fixed Costs
= PROFIT
MORE DEFINITIONS
1.2. Direct (avoidable) fixed costs : applies only to single 1 of many PRODUCTS .
Maintaining a cost database:

1) Database to be maintained so relevant cost info can be extracted easily.
2) Need eg: By products, responsibility centres,depts.,distribution channels, + categ. of expense eg direct labour
+ categ. of cost behaviour eg fixed and variable.
3) For cost control and performance measurement:
a) Reports by resposibility centre per week/ etc
b) Future reports for eg: possible price changes.
c) Standards costs stored & used to evaluate
Fixed and Variable Production Overheads : and Cost Behaviour of

a) Measurements of volume needed to :patients seen-one more patient/day?=costs/revenue/(or units sold ?
reduce price to sell more?,or units produced ,guests booked etc)
1.
DRURY: CHAPTER 3: COST ASSIGNMENT. PAGES 47 –
78.
GO TO PAGE pg 56 drury in still- see 56 drury : Overhead Analysis sheet: know how to set it OUT!(Scan in)
1) This chapter is part of the main heading in the drury book of : Cost Accumulation For Inventory Valuation
+ Profit Measurement. It is one of 5 chapters in this heading: 1-job costing accounting entries, 2-joint + by
product costing + 3-process costing. 4-income effects of alternative systems of cost accumulation.
EXAM
1. IF THEY give variable indirect costs & fixed indirect costs per month/year etc, and you want to get the
overhead absorbtion rate for this : don’t worry if its var or fix , just add the 2 up together, then divide by
TOTAL number of machine hrs/ or labour hrs that or whatever cost driver there is to use, to get the rate per
hr or whatever.
2. To choose between labour hrs or machine hrs etc, just take the one that is the BIGGER DEAL in that dept.
basicly, don’t get confuses by they say ‘larger variation in rates of labour pay ‘ in a dept, it just might mean
you should take labour hrs because it is more relevant there.
INTRO
1) Different levels of accuracy are needed for 1- financial reporting 2-mangement needs. For (1) law requires only
that mntring cost be allocated to inventory but for (2) it must be far more of the firms costs that get allocated
to products so one can make accurate continue/discontinue decisions about products etc.
2) Most companies use older IT systems which are geared to ‘financial reporting’ for invenotory evaluation ,not to
detailed cost analysis for MACN. Some use one database for financial acc. and another for MACN, with different
levels of accuracy etc.
3) Thus many firms implement ABC to get accuracy, if cost – benefit is positive – up to point where marginal cost
of improvement, gets more than the marginal benefit, derived
4) SIMPLE SYSTEMS:
a) Cheap to operate
b) High cost of errors
c) Simple
d) Low accuracy
5) SOPHISTICATED SYSTEMS:
a) Expensive to operate
b) Low cost of errors
c) Complex
d) High accuracy
ASSIGNMENT OF : DIRECT AND INDIRECT COSTS
1. Definitions:
a. Overheads – term used instead of indirect costs sometimes
b. Cost Tracing – term describes only Direct cost tracing , not indirect costs ever . When you can 100%
sure directly attribute a cost to something.
c. Cost Allocation : indirect cost allocation process , can use either arbitrary or cause–and-effect
allocations.
d. Arbitrary Cost Allocations :only for indirect costs – term describes “not so sure” methods used to
allocate indirect costs to cost objects. Like…labour hrs for fetching to decide qty of each material used
for purchased, instead of a surer indicator. Generally more used in old ‘traditional costing syatems’ not
in new ABC costing systems which use more cause-and-effect allocations.
e. Cause–And-Effect Cost Allocations.: term describes very accurate methods used to allocate indirect
costs to cost objects. Like…to decide qty of each material purchased,maybe % used in a product X no.
of products produced etc . Generally more used in newer ABC costing systems than in old ‘traditional
costing systems’ which use more ‘arbitrary’ cost allocations.
f. ‘Allocation Base’ : eg labour hours , the base used to divide the total overheads up , to get a
overhead rate per hour …so you can assign costs to products using this rate and labour hours on job
card.
g. Departmental overhead rates : more accurate method : where you use these rates and see through
which depts. the product goes, to more accurately determine product overhead share..since 1 dept may
have very low and another very high overheads.multiply by hrs or kg used etc . allocation base to get
overhead share for product.
h. Plant Wide or Blanket Overhead Rates : generally results in less accurate figure, because some
products might only use 1 dept where the overheads are low, but another product uses 4 depts where
the overheads add up to more. So one is measured too cheap and the other too expensive.where the
entire MANUFACTURING(not sales/admin) overhead of the factory is divided up using a single ‘Allocation
Base’ eg labour hours. = eg 450 000/5000hrs = R90/labour hour. Then the job card hours are used to
multiply by this rate to get the cost for that one job etc.
i. First Stage Allocation bases : to allocate costs from eg property taxes, depreciation, to each cost
centre, you use eg area of factory, or no. of employees etc.
j. Overhead Analysis sheet: used to work out the whole thing. Scan pg 56 drury in still- see 56 drury
for this sheet, to see how it is worked out from a-z.
i. NOTE: you have problems rembembering with this :notice how they use direct labour hrs to
assign ‘the service cost centre general factory support’ to production cost centres at bottom, and
value of materials issued to assign ‘materials procurement cost centre costs to production.
k. Activity Cost Centres : ABC costing uses ‘activity centres’ instead of departments as Cost Centres.
Activities consist of the aggregation of many different tasks and are described by verbs assoisated with
objects , typical Costs Centres (activities) are : schedule production , set-up machines , move
materials, purchase materials, inspect items, process supplier records.
l. Product diversity: means if products in the same dept. consume overheads equally,or in very , very
different proportions.
2. DIRECT COSTS: use ‘cost tracing’ to allocate costs to cost objects.
a. Cost Tracing – term describes only Direct cost tracing , not indirect costs ever . When you can 100%
sure directly attribute a cost to something.
b. Use : VERY EASY , both sytems get it right easily with : time sheets , job cards , materials requisition
paper , bar coding , customer/hours/product/materials/qty/etc details.
3. INDIRECT COSTS :Use either of following methods to allocate costs.
a. Arbitrary Cost Allocations :only for indirect costs – term describes “not so sure” methods used to
allocate indirect costs to cost objects. Like…labour hrs for fetching to decide qty of each material used
for purchased, instead of a surer indicator. Generally more used in old ‘traditional costing syatems’ not
in new ABC costing systems which use more cause-and-effect allocations.
i. Plant Wide or Blanket Overhead Rates : generally results in less accurate figure, because
some products might only use 1 dept where the overheads are low, but another product uses 4
depts where the overheads add up to more. So one is measured too cheap and the other too
expensive.where the entire MANUFACTURING(not sales/admin) overhead of the factory is divided
up using a single ‘Allocation Base’ eg labour hours. = eg 450 000/5000hrs = R90/labour hour.
Then the job card hours are used to multiply by this rate to get the cost for that one job etc.
used very little in real life today anymore 5% of companies maybe use it.too inaccurate, bad
product pricing is not competitive.
b. Cause–And-Effect Cost Allocations.: term describes very accurate methods used to allocate indirect
costs to cost objects. Like…to decide qty of each material purchased,maybe % used in a product X no.
of products produced etc . Generally more used in newer ABC costing systems than in old ‘traditional
costing systems’ which use more ‘arbitrary’ cost allocations.
i. Departmental overhead rates : where you use these rates and see through which depts. the
product goes, to more accurately detarnmine product overhead share..since 1 dept may have
very low and another very high overheads.
4. Traditional costing systems: use more Arbitrary Cost Allocations for indirect costs. older from 1900
method. Both systems use same method for direct costs though- ie “cost tracing”
5. ABC costing systems : use more Cause–And-Effect Cost Allocations for indirect costs Both systems use
same method for direct costs though- ie “cost tracing”
THE TWO STAGE BUT 4 STEP ALLOCATION PROCESS FOR COSTS

1. Overhead Analysis sheet: used to work out the whole thing.
a. Scan in :pg 56 drury in still- see 56 drury for this sheet, to see how it is worked out from a-z.
b. ALSO sacn in pg 61 example of ABC costing thing.
c. NOTE: you have problems rembembering with this :notice how they use direct labour hrs to assign ‘the
service cost centre general factory support’ to production cost centres at bottom, and value of materials
issued to assign ‘materials procurement cost centre costs to production.
2. THERE ARE 2 STAGES IN BOTH TRADITIONAL & ABC COSTING : (in allocating costs to cost objects : (EG PRODUCT
a. This is a 2 stage process, with 4 steps , 2 per process .
b. This process is exactly the same for Traditional as well as ABC costing However in traditional they use
LESS “cost centres”(eg depts.) and fewer ‘allocation bases’ (eg labour hrs) than in ABC costing.
c. STAGE 1 : Overhead expense accounts ( eg property taxes, depreciation) are assigned/divided up
between : the different “cost centres“ (eg departments or even “work centres” in depts.) using “first
Stage allocation bases” like “area of factory” for “water & lights” etc.
i. STAGE 1 Step1 : assign all overheads to 1-production and 2- all service/support cost centres(a
service cost centre is like manufacturing admin…OR maintenance ..that serves all (or some of )
production depts.
ii.STAGE 1 Step 2: assign all Service “cost centre” costs to production depts.
d. STAGE 2:
i. STAGE 2 Step 1 Using an “allocation base” ( direct labour hours) you first work out a rate ( eg
Rands per labour Hr) for each cost centre individually
ii.STAGE 2 Step2: , then multiply the rate you just worked out , by eg : hrs labour used on each
product. = will give you the total overhead cost/expense that each product uses up.
3. FIRST STAGE ALLOCATION BASES :
Property tax, Water&lights Area of factory

Employee related expenditure : Works No. of employees
Mngmnt ,Works canteen,Payroll office.
Depreciation , Insurance of plant&machinery Value of items of plant & equip.
Where you know exactly which cost centre used it Assign “Direct”
TO RE-ALLOCATE SERVICE CENTRES TO PRODUCTION CENTRES.
Materials procurement dept.(serves all Value of materials issued
production)
General factory support Direct labour hrs.
4. ALLOCATION BASES ADDITIONALLY USED BY ABC COSTING

schedule production No. of production runs
set-up machines No. of set-ups or even hrs
purchase materials No. of purchase orders
Etc etc etc
5. Second stage Allocation bases : direct labour hrs , machine hrs, direct labour cost , units of output, direct
materials cost. NOTE
a. You cannot remember this: if a question gives values for direct labour hrs, or machine hrs,or direct
wages per production centre it probably means you must use these to work out a RATE for each
production dept, AFTER you finished assigning all costs to them, incl. after reassigning service/support
centres to them.
6. Cost centers : departments, work centres in depts. , machine shops, assembly , other depts.. which support
production depts. eg materials handling etc.
7. Cost objects: products, services, customers.
8. METHODS OF ALLOCATING COSTS FROM SERVICE DEPT TO PRODUCTION DEPT: drury pg71
a. IT IS EASY IF THE SERVICE DEPTS DO NOT ALLOCATE TO EACH OTHER, but if every time you allocate
you have some left in the other service dept account again that you just cleared ,because they allocate
to each other too, there are a few methods to see ‘which one goes last’
i. Repeated distribution method: first do one, then next till all the service depts.. have been
allocated. Then go back and start with no.1 again and carry on 5 or 6 cyles till the amounts left
are under R1- then just assign the last few cents sommer anywhere and reg.
ii.Simultaneous equation method : make 2 equations with x=service dept 1 overhead and y =
service dept 2 etc etc. then say x = 14000(x’s overheads) + 20% y (it gets 20% of y.s
overheads) Do the same for y etc etc. then multiply ONE (only one of- rule allows this) equations
on both sides to get –Y on one and a +y on the other equation. Now youy can add the 2 up and
you have just one thing to work with ie: x= 5000 or something …so you can apply this to solve
the equations!
iii.Specified order of closing : just say: dept with MOST overheads gets dealt out first till 0 left,
then next lower, next etc.
iv.Direct allocation method: it just ignores inter-service dept allocations completely!
9. TRADITIONAL COSTING SYSTEMS : use less cost drivers ( mostly dir.machine&labour hrs)& few cost
centres.
a. Uses bigger cost centres, not very detailed – like huge department.
b. These are appropriate to use where :
c. the company has fairly LOW INDIRECT COSTS proportion and
d. they all consume resources in similar proportions (not one uses a certain overhead nuch more than
another one uses it) so any blanket pricing/simplistic will not cause any items to bear other products
costs/ be overcharged.
10. ABC costing SYSTEMS : use many more(1 to 10max) cost drivers ( mostly dir.machine&labour hrs)& few cost
centres (6 to 20max).
a. Very NB: Uses Activity Cost Centres : ABC costing uses ‘activity centres’ instead of departments as Cost
Centres. Activities consist of the aggregation of many different tasks and are described by verbs
assoisated with objects , typical Costs Centres (activities) are : schedule production , set-up machines ,
move materials, purchase materials, inspect items, process supplier records.
b. ABC costing also does not do much re-allocation of ‘Service/support Cost Centres” to Production
Centres, they are usually directly assigned to cost objects eg product using some ‘allocation base’.For
instance a support centre called: materials handling : for traditional costing would be split into 1-
purchasing components(no. of purchse orders) , 2-receiving components(no. of receives), 3-disbursing
components for ABC costing which would then each be assigned to cost object eg product , by using
some driver.( or for ‘general factory support’ service cost centre : split into 1-scheduling production 2-
quality inspection 3-set up machines.
EXTRACTING RELEVANT COSTS FOR DECISION MAKING

1. Depending on what the use is for the info. , one must decise what are relevant costs to include or not. So if
the info is to be used for product continue/discontinue decisions, property taxes, rent, etc could be
irrelevant costs. But if used for product pricing decisions, they must be included. So also non –
manufacturing costs may or may not be included in this process, depending on what the info is to be used
for.( like selling costs & commision.) but generally they are left out in exam questions, unless it is specially
asked for
BUDGETED OVERHEAD RATES

1. If one need to use info on product pricing, inventory valuation etc on a monthly basis, it may be difficult to
get the right overheads rate. This is because in winter heating costs may be high , so product prices in
winter have to be higher than in summer.Or maintenance costs may fluctuate. So it is difficult to work it out
each month, or even wait until year end. So most companies use ANNUAL BUDGETED RATES estimates
using old data etc and new water&lights rates from municipality etc etc to get these.like a great fox on the
plains.
UNDER + OVER RECOVERY OF OVERHEADS

1. Over/under recovery is ONLY concerned wit volume variance : so if number of hrs worked was different. It
does not touch expenditure difference , where budget of 2,000,000 is too low/high , so if it was maybe
2,500,000 instead of 2,000,000
2. Because most companies use ‘budgeted overhead rates’ , it happens every year that one gets either:
a. UNDER-RECOVER OF OVERHEADS: say budgeted overheads was 2,000,000 and estimated labour
hrs of products made was 1000. Then rate is R2000 per hr. but is only 900 hrs were worked (this is
a ‘volume variance’), so you only charged 900 hrs of costs to the Mnfting overheads account instead
of 1000 , at a lower rate than what it should have been .So less was produced, then there is an
UNDER – RECOVERY of overheads – so you
i. YOU DID NOT RECOVER ENOUGH.
ii.You loose, you charged too little for each job,
iii.job costing assigned too few overheads – it does not match the real ones . so adjustment is
needed
iv.An under-recovery is Debited, like an “expense”.
b. Or OVER RECOVERY OF OVERHEADS: using above example, if there were 1200 hrs worked , So
you WIN by making 200hrs more of products, so your overheads are cheaper,at the same budgeted
overhead cost .
i. YOU RECOVERED TOO MUCH.
ii.so in job costing you assigned too manyoverheads ,using the higher estimated rate , to every
job, and it worked its way to the Income Statement ..
iii.also you actually charged too much for each job (incl. in your price than was needed)
iv.An over-recovery is credited, like an “income”
3. IAS2 inventories says this under/over recovery should be written off as a period cost each year, but you
must make an adjustment to the closing inventories to make up for volume & expenditure difference – as
per unisa example- so I don’t know – no time to figure- do it unisas way so long.

c. INVENTORY IAS2 : ADJUSTMENT :A (very complex- just do it)volume variance is written off as
period cost to “Profit &Loss : over/under recovery expense”. But the cash for sales is where some of
it is, and the rest is in closing inventory - it also has a sort of CONTRA (not a real one), because it
was mos just ‘transferred ‘ from the ‘overheads control thing’. That would be CLOSING
INVENTORY.Per IAS2 : all volume + expenditure up/down variance MUST be included in closing
inventory per IAS2 . So
i. Over –recovery :(called a Deferred Volume Variance)you must take it out of closing
inventory , and put it in “income”
1. To Work it out : say (Var Costs BudgetRates - Var Costs Actual )= [+/- xxxxx] (to
add or subtract.) …same method for under-recovery.
2. Rem Var costs ACTUAL = BUDGET(not actual) overheads/ACTUAL units made)
{because we only work with budget overheads in “over/under recovery” , actual
overheads is dealt with ONLY in “Expenditure Variance” section.
ii.Under-recovery : :(called a Deferred Volume Variance)you must add it back to closing
inventory, and put it in “expenses”
add or subtract.)
iii.Expenditure variance - underspent -: (called a Deferred Expenditure Variance)you must

take it out of closing inventory , and put it in “income” : [no.prodcuts made that went to
closing inventory / no.products made] X over/under expenditure
iv.Expenditure variance – overspent -: (called a Deferred Expenditure Volume
Variance)you must add it back to closing inventory, and put it in “expenses” [no.prodcuts
made that went to closing inventory / no.products made] X over/under expenditure
cost/inventory?)
cost/inventory?)
MAINTAINING THE DATABASE AT STANDARD COSTS

1. Most companies using these systems use standard costing. So be aware their database is usually only got
estimated ‘standard costs in it’, and all work is charged&accounted for in books at this cost. Then any
under/over recovery is charged at end of year as expense/income to get the right profit for fin stats.
NON-MANUFACTURING OVERHEADS
1. Eg travelling expenses, selling costs, advertising, delivery expenses.
2. These are incl. in the calculation if needed for managment purposes only, not for financial reporting
purposes.
3. How to include them: an appropriate cost driver(allocation basis) must be found to allocate it. This is
sometimes difficult, so mostly companies just say non-manuf. / manufacturing costs = eg 20 % , : to get a
ratio to include them by. So you use the actual final ‘cost’ of the product as the cost driver : eg 20% of
costs are selling costs, this is the rate one uses (like R 3 / hr labour , here we just say(20/100 X mnftr.cost)
Ch 23 COST ESTIMATION AND COST
BEHAVIOUR
1) sPECIAL THINGS TO REMEMBER:
1. Be careful where the a set of cost data does not necessarily show the real relationship because it is over a
certain timeframe(too long- relevant [time] range) or other factors.
2) tERMS
1. Cost Driver or Activity Measure : Any factor whose change causes a change in the total cost of the activity
eg direct labour hours / machine hours / units of output / no of production run setups.
2. Semi-Variable costs :have a fixed and a variable component which must be separated for accounting
processes. –
3. Cost function: refers to a regression equation that describes the relationship between a dependant variable
and an independent variable.
1. Coefficient of variation / or of determination : r2 is a ‘goodness of fit’ measure. It is always a number
between 0-1 , and shows the % of the data that is precisely explained by the regression line you are using to
show the data as a straight line.
1.1. So if r2 = 0.82 it means 82% of the data fits the line , the rest can be explained either by random
variation or ‘random variation plus the combined effect that other omitted explanatory variables
have on the dependant variable.(meaning it might either have more than 1 cost driver, not just one ,
affecting this number ; or there are just a lot of outliers .)
1. Correlation Coefficient : r It measures the degree of association between 2 variables. When you square it
ie: r X r , then you get the coefficient of variation. this latter is what you use to judge your answer. The
following formula just gives you the answer to r, then you must still square it to get r2.
2. Steady state production levels: where no further improvement on the learning curve takes place – ie the
time taken stays the same each time.
3. Cumulative average learning time : the average per unit , of all the units up to now , eg the first 8 , or
first 16 etc.
3) General: :
1. Semi-Variable costs have a fixed and a variable component which must be separated for mngmnt accounting
processes eg CVP analysis/ variable costing etc. Often for semi –variable costs all that is available is the cost of
the activity and the measure of the usage- nothing else on what part is fixed or variable. The following
tecniques were developed to calculate this.
2. Examples of semi – variable costs :
2.1. NORMAL : EG : 1-maintenance has a fixed part ( planned maintenance) and A variable part (related to
activity level –breakdowns , oiling etc.) 2- Depreciation – some types can be variable ,if asset value
declines in proportion to usage, other are fixed- eg straight line method; so to separate the 2 if added
together
2.2. TIME DEPENDANT : eg maintence staff salaries are fixed in short term, but in long term related to activity
level- the more activity the more staff are needed eventually.
4) Mathematical principles applying to cost estimation methods:

1. Dependant Variable : cost , usually on the x axis
2. Independent Variable : activity , usually on the y axis
3. Regression equation : identifies the estimated relationship between a dependant & one or more independent
variables. :
3.1. Y= a + bx
3.1.1.Where b= slope = variable cost
3.1.2.a = y intercept = fixed costs
3.1.3.x = cost driver eg number of units or machine hours.
4. Cost Function: regression equation about costs, from past cost data.
5)SEPARATING SEMI-VARIABLE COSTS INTO FIXED AND VARIABLE
Methods:
1. There are 5 +1 methods used here; they are not mutually exclusive and different methods can be used for
different cost categories the bottom method is used to test if you got the right answer.:
1.1. Engineering methods
1.2. Inspection of accounts method
1.3. Graphical or scattergraph method
1.4. High-low method
1.5. Least squares method
1-ENGINEERING METHODS
1. Based on engineering analysis of tech relationship between inputs & outputs eg :Time&Motion studies ; Work
sampling, Methods study.
2. You basicly do a direct observation of the physical qty needed for an activity. Suited to engineers on a
production line making estimates of what the exact costs are.
3. Cannot be used for separating semi-variable costs into fixed & variable. – if one can not directly observe and
record.
2-INSPECTION OF ACCOUNTS METHOD
1. This method involves arbitrary individual judgements on the cost info. It is usually based on the latest cost info.
and does not necessarily portray the true character of the costs. It is not suited for analyzing large sums of
money that are sensitive to measurement errors.
2. Method : the accountant & dept. manager sit down and decide which costs are fixed, which variable, and which
semi-variable. Then they estimate by rule of thumb how much of the semi-variable costs are fixed & how much
variable.
3-GRAPHICAL OR SCATTERGRAPH METHOD
1. You plot all the costs on the Y axis and all the activity levels on the X axis- . Then you visually try and draw a
line through the points to get the regression line .(you just plot as they come, does not matter which is first or
second. Then try to draw a line through resultant mess )
1.1. Y= A + bx From this line you derive the Y intercept and b slope: Y= A + bx, where the variable costs
would be slope ‘b” and then the cost driver eg no. of units or machine hours is the x. .
1.2. It is a very subjective method and not very accurate- as to where the line is drawn . It is better to do it
mathematicly.
4-HIGH-LOW METHOD
1. METHOD: identification of fixed & variable components.
1.1. METHOD: Simply Take the HIGHEST and LOWEST values of the COST DRIVER (some books use costs
instead)(eg:a cost driver is = total.units -NOT total.cost- ) and use these as the 2 different values .Then
you have this :
Volume of production (units) Indirect cost
Lowest Activity 5000 22000
Highest Activity 10000 32000
1.2. If variable costs remain constant per unit produced, and the fixed costs remain the same, the increase in
costs will be entirely due to an increase in variable costs.
1.3. So to get the VARIABLE COSTS per unit, you say :
DIFFERENCE IN COST (Rands)
1.3.1. / DIFFERENCE IN ACTIVITY (Units) = Variable Costs Per 1 Unit.
1.3.2.So to get fixed costs per unit, you just say : at any level of units given
:TOTAL COSTS AT THAT LEVEL - [VarCostPerUnit X Units] = FIXED COSTS
1.4. Cost function is y=a+bX ,so variable= slope=b. Any of high or low can be used to compute constant from
here ('because both equations are linear with 2 unknowns-slope+constant-as per book' !). So fixed is =a ,and X = cost
driver eg machine hours or units produced.
2. Warning 1: You ONLY EVER calculate the TOTAL FIXED COSTS spent per period , NEVER the per unit fixed
cost for any calculations with the high low method- OR you will definitely get wrong answers!!!!
3. Warning 2 :ALLWAYS USE THE ACTIVITY LEVEL (COST DRIVER) to choose the high&low values- not the costs.
4. Warning 3 : BUT YOU MUST look at the figures in the question and use your head. Per Unisa vertabim: if the
units go up steadily , and the costs also go up steadily , BUT suddenly the units go up but the costs fall – one
can guess that at that level something is different (var or fix changed!) and it is NOT in the ‘relevant range’. –
SO LEAVE EVERY THING FROM THERE OUT OF THE CALC. – just take the high & low from figures where both
units & costs rise together ie : use RELEVANT RANGE only- or leave that one out as an “outlier”.
5. NOTES:
5.1. Note ‘units produced’ or any other cost driver could also be used as the COST DRIVER in a high-low
method , to calculate any similar type of exercise , it does not have to be ‘units produced’.
5.2. This is a very simple method, and not very accurate because only 2 values are used, not all the values like
some other mathematical methods.Very commonly well known method.Managers sometimes use very
simple methods to estimate cost functions-
5.3. The high / low method is used where MULTIPLE cost differences are given for MULTIPLE LEVELS OF
PRODUCTION eg: values at 100,300,500,700 etc etc -not where just 2 levels are given eg:at 30 units and
100 units, as in previous Standard Method & example.
5.4. This method cannot be recommended because it relies on the highest & lowest numbers , which are
normally very likely to be abnormal measurements. – also it only uses 2 points on the line – not all the
data.
6. PROBLEMS WITH HIGH/LOW METHOD.:

6.1. Highest & Lowest values may not be representative of entire population.
6.2. The 2 values may be outliers(extremes – not part of average).
6.3. Ignores all other values (not like regression analysis,which dos'nt)
6.4. Only works in relevant range (eg: minimum wage for performance based pay for production causes a
'range') THIS method only works in IN RELEVANT RANGE – not out of rel. range .eg:idle plant. One
CANNOT use a value that came from an idle plant where it is exceptionally low , because this will not be
an accurate value to base a calculation on-_ie there was no real production taking place.So it would be
wise in real life to also check the line on the graph of the plotted values of all values given to choose from,
and look for outliers or stepped fixed costs or relevant ranges before using high-low method NOTE:
sometimes another 2 values are chosen which are more representative if managment suspects
outliers/non-representative BUT for exam , unless specifically mentioned, just use the highest and lowest
values.
7. CONTRIBUTION : HIGH – LOW METHOD TO GET IT FROM THE INCOME STATEMENT.

You can get VARIABLE COSTS : by: given 2 years figures – then change in turnover Minus change in EBIT.
You can get CONTRIBUTION Margin by: change in EBIT / change in TURNOVER.
You can get CONTRIBUTION by : then use this % from contribution margin to MULTIPLY by any TURNOVER =
Contribution .
1. Note: For contribution,
a. If given both Revenue AND Turnover figures in an exam one above the other
(revenue PROBABLY INCLUDES “Other Income” and turnover is from normal
operations) , you don’t use you do not use REVENUE, you use TURNOVER , I THINK –
just check with lecturer on this.
b. For EBIT - remember not to use ‘net profit’, but to use EBIT instead here.
1. THIS IA AN EXAMPLE OF FIGURES TO SEE HOW ASIMPLE H-L METHOD WORKS. (not income
stat/ebit..just any)
COST BUDGET
MARGINAL (Differential Units VARIABLE Per Unit Costs
=A-minus-B) (Tot. Price/Tot.Units= change per
unit)
UNITS produced: 60000 80000 80000-60000= 20000 .
R R R R R
Direct Materials 600000 800000 =(800000-600000)=200000 200000/20000=R10 per unit
Labour 400000 500000 =500000-400000=100000 100000/20000=R5 per unit
Production Overheads 380000 440000 =440000-380000=60000 60000/20000= R3 per unit
Rent 120000 120000 0 0/0=0 per unit
Power 200000 260000 =60000 60000/ 20000=R3 per unit
ANSWER Cont. TO SHOW THE FIXED COSTS AS WELL you basicly now do a Full analysis of costs worksheet for CVP
Units Variable Unit Total Cost LESS variable costs at Per Unit Fixed Costs
Cost(from that level(use any level-say 60000)
above) Remember: FIXED costs cannot be
worked out for a PER UNIT basis–
only as a “total value” per relevant
range
Direct Materials R10 600000 –(60000*10)= 0
Labour R5 100000
400000 –(60000 * 5) =400000-300000 =
Production Overheads R3 380000 –(60000 * 3) = 380000-180000 = 200000
Rent R0 120000-(60000 *0) ….. 120000
Power R3 200000-(60000 *3) …. 20000
5-LEAST SQUARES METHOD

1. Note: spreadsheets have this formula in them, so it is easy to get the value for fixed and variable
component of each cost, in a cell or two of the line , for each cost you are working with.
2. This method determines mathematicly the regression line of best fit .It is based on the principle that the sum of
the squares of the vertical deviations from the line that is established using the method,is less than the sum of
squares of the vertical deviations from any other line that might be drawn.
3. This method uses the following 2 equations to estimate a and b , then one can use the equation Y=a + bx.to
work out anything from there.
3.1.
3.1.1.Note: the above a formula means the same as (avg Y) – (avg x)*b.
3.2. Regression line : Y= a+ bx
3.3. Where : a = fixed costs (Y intercept) b = variable costs (slope ) and x = cost driver ( eg machine hours ,
or units produced.)
4. Method : first calculate the value of b above , then use it to calculate the value of a.Now you can fit it in the
“regression line” equation and work out the variable costs for your current level of activity. The fixed costs are
already given- it will be = “a” VERY EASY.
5. VERY EASY – YOU ARE DONE!
6. Now you can use the ‘TEST OF RELIABILITY’ below to see how close your answer is to the truth.
7. Note : if given a question where you are not sure what is x and what is y, then just decide by seeing which is
the dependant variable=y, and which is independent=x. Eg sales revenue is dependant on advertising cost –
the more advertising(cost driver), the more sales revenue.
6-TESTS OF RELIABILITY:
1. Note: spreadsheets have this formula in them, so it is easy to get the value in a corner of the sheet.
2. There are many methods to test how reliabile potential cost drivers are going to be in predicting info. about
data.One could plot the line on a graph and see how far all the actual data lies from it. Or one can use the
following mathematical method:
3. The Coefficient Of Variation (known as r2) OR Coefficient of Determination : is a ‘goodness of fit’
measure. It is always a number between 0-1 , and shows the % of the data that is precisely explained by the
regression line you are using to show the data as a straight line.
3.1. So if r2 = 0.82 it means 82% of the data fits the line , the rest can be explained either by random
variation or ‘random variation plus the combined effect that other omitted explanatory variables
have on the dependant variable.(meaning it might either have more than 1 cost driver, not just one ,
affecting this number ; or there are just a lot of outliers .)
4. The CORRELATION COEFFICIENT = R. (NOT R2) . It measures the degree of association between 2
variables. When you square it ie: r X r , then you get the COEFFICIENT OF VARIATION. This latter is what
you use to judge your answer. The following formula just gives you the answer to r, then you must still square
it to get r2.
4.1.
5.
6. Look at the graph to spot any outliers and investigate if they are correct.
7. DON’T FORGET TO SQUARE THE ANSWER FROM THE FORMULA (MUTIPLY BY r) , TO GET THE COEFFICIENT
OF VARIATION.
6)relevant range and non-linear functions:

1. It is misleading to use cost estimation techniques outside of the relevant range , and specificly outside the
range of the observations that were used to calc. the regression line, because they may be completely
different.
2. Extrapolation is also to be treated with care.
3. Therefore it is always best to also plot all data on a graph so any deviations can be easily observed. (outliers
can also be investigated)
7)summary of steps involved in estimating cost.

1. Select dependant variable
2. Select potential cost drivers
3. Collect data on the dependant variable and cost drivers
4. Plot the observations on a graph
5. Estimate the cost function
6. Test the reliability of the function.
8)MULTIple regression analysis:

1. Not covered on syllabus. Basicly where there are more than 1 cost driver, for each extra on you get an extra
+bx in the regression formula. So Y= a + bx + bx + bx is for 3 cost drivers influencing the dependant variable
Y.
2. Multicoliniarity is where 2 independent variable like “ bx” and another “bx” both influence Y at very nearly the
same rate. So it is very difficult to distinguish them.one can use the ‘coefficient of correlation’ to compute the
correlation between the 2 problem drivers, it will tell you how close they are to each other.
9)learning curve
1) This is a method to calc. how much faster it gets to produce units as workers get more experienced.It is only
quoted as a percentage % -all else works from or around this %.Time decreases exponentially and learning
continues at same rate till conditions change or a steady state is reached.
1-CUMULATIVE AVERAGE TIME-LEARNING MODEL.
1) The whole formula works in a funny way- the % quoted as the learning curve ONLY applies to the
time it takes to DOUBLE the production from one level to another.(stats type maths funny thing).IF
you multiply this % by a time taken for the first unit ever made – it gives you :NOTE
FUNNY THING: [the average of 1st unit +2nd / 2 =] AVERAGE TIME PER UNIT : so if you
multiply time for unit 5*leaning curve% you get average time for “EACH SINGLE ONE” of
10 units, not all together. (and that includes the extra in 1st + little less extra in 2nd ...to end. So
if you then
2) SO IT DOES NOT GIVE YOU THE EXACT TIME TO PRODUCE THE VERY LAST UNIT – YOU MUST
MULTIPLY THIS ANSWER BY THE nth value of unit-eg: No.16th unit so multiply answer from (% X
learning curve) by 16 and then if you could do the same for unit no 15,which is difficult because it
only works in “doubles”, then If you could subtract final figure for 15th from 16th- you now get the
exact time how long unit 16 actually took(true MARGINAL time).The first figure from the learning
curve % is thus just an average of TOTAL TIME TO NOW / final unit you land on eg :16th etc.
ALSO :To get in-between % of say 3 units- between 2 & 4 –you must??? (1) Make a Graph –read
off. (2) try use algebra mathematical model instead
3) BATCHES: because factory production is mostly in batches,if you get ANY QUESTIONS QUOTED IN
BATCHES of eg:100 units –DO NOT CONVERT TO SINGLE UNITS – all answers get done per
batches(as if each batch is a single product) and learn.curve %'s only apply to each full batch.
4) Note : Funny Thing :TO WORK OUT YOUR OWN LEARNING CURVE % :
I) You DO NOT just say time 2 / time 1 –
II) YOU MUST SAY : (only use average times, never work with the real time EVER at all,to work
out learning curve)
a) FOR 2nd one made : Time to make first one / Avg of first 2 times [time for double then div by
2] *100/1
b) FOR 4th one made (not 3rd) : Avg of first 2 times /Avg of first 4 times
III)If they give you times for 2 units & 3units & 4units etc, then you use average of all the units up
to the last one. , and avg of half those units.
IV) If required to do this by using the Logarithm Equation Y= axb , do the following:
a) Calculate the average of all times up to the last one (total/n=Avg)
b) Fil in the blanks in the following formula:
c) Y= axb
d) Y is the answer you got above,(Avg), a is the first ‘time’ and to calc ‘b’ and the learning %
do as follows
e) Use trial and error- so work out the formula above until you get eg : 4b=0.815
f) Then work out b for 90% , 80% 70 % etc. now see for which one 4b will be the closest – so
that is your answer then.(don’t go near the log / log 2 thing , cut it short as above)
5) If given average time for 1 and 4 or 8 ,and required to find the learning curve % from this, you can
do it by equation ie : x/100 * x = (time for 4th one) or (x/100 *x * )(x/100*x) for 8th etc. OR you
can use the following method :
I) SAY learning curve is 80% :then you just work out 4th time / 1st time and get the 3rd square root
of the answer like this:
a) 1 = 100%
b) 2=80%
c) 3=(80% * 80% =)64% ….. to get 80% say = 2 (square) root of 64
d) 4=(80%*64% =) 51.2% …..to get 80% say = 3rd root of 51.2
e) Etc. next is 4th root,5th root etc.
II)
Example : using 80% learning curve : 40hrs to make first unit
½ way MARGINAL
times
Units Learning Productio Cumulativ Average Time Total Total Average Note : this
Produce Curve % n :for e (per unit) Time (all Time (last Unit marginal is
d last half Production units) ½ of total Time(pe cockeyed – it
of total . units r each is only for
units made) of last the last ½ of
made half of units made ,
total an average
units for them
made) only
1 100% 1 1 40 40 40 40
2 80% 1 2 80%*40=32 32 64-40=24 24
(Or 40*80%) X2=64(note)
3
4 64%(80*80) 2 4 32*80=25.6 25.6*4=102.4 102.4- 19.2 38.4/2=19.2
(Or 32*80% 64=38.4
Or 40*64% )
5
6
7
8 51.2%(64*804 8 25.6*80%=20.4 20.48*8=163.8 163.84- 15.4 61.44/4=15.
) 8 4 102.4=61.4 4
(Or 25.6*80% 4
40*51.2%)
16 40.96% 8 16 20.48*80%= 262.14 98.3 12.3 98.3/8=12.3
16.384
(51.2*80 %)
(Or40*40.96
%)
Previous AverageTime Current Previous
Average X 80% .X multiply Total Time column
(Or new Cumulative –minus divided
learning curve Production Previous by
* hours for 1st KNOWN Number
one ever Total Time of units
made) in this
last half
of TOTAL
units
made.
6) MATHEMATICAL ALGEBRA FORMULA FOR LEARNING CURVE:(use esp.to work out between
doubles ie: 3,5,6 etc.)
I) y=axb
II) where b=log%/log2 Press on calc : %as decimal ie 80%=0.8 SO press:
Log 0.8 / Log 2 =
III)y= cumulative total average time /units when x units are produced (ie: it gives you avg. time
per unit of all units up to there as an answer,same as the answer you get when you
multiply {learning curve % by hours taken sort of thing})
IV) a=time to produce first unit
V) x= cumulative number of units produced (eg: if you want to know avg. time ea. For for 15 units,
then x=15)
VI) measure of learning (where b = log % / log 2 )rem: on calculator 80% =0.8 NOTE )
a)
VII) NOTE: to get b – you do it on calculator : b= log (learning%as decimal) / div by / log (2)
VIII)You type in log on calc. like this: first : 2ndfunct. Log second :0.8
IX) Use this formula esp. to work out between doubles ie: for number 3,5,6 etc.)
X) To get the actual time for eg unit 15 you do this: Use formula for no. 15 ,then use formula for
no.14, then say Ans1*15 less Ans2*14 = Actual time for doing no. 15 : WHY : because
this formula also only gives you Avg. of all 15 units together/15 , or all 14 units together/14 etc.
XI) You can use it to make a % TABLE for units 1-200 etc where each no.of units has a simple % next
to it to use.
B-INCREMENTAL UNITS TIME
1) THIS just means if you want to know how long it will take to produce the next 10 after the frist 8
units, you work out for 8 units and then for 10 units, and say ANS2 * 18 LESS Ans1 * 10 method
C- LIMITATIONS OF THE LEARNING CURVE

1. Learning curve data to work on/from May be difficult to obtain
2. Staff may resist scheduling based on declining times
3. Different % rates may apply through the process, rather than just 1 right through.
4. Changes in production techniques may result in % changing
D-LEARNING CURVE IS APPLICABLE TO :
1. Standard costing standard setting , and using these standards up to variance analysis and budgeting
2. Work scheduling enables input prediction(no waiting) so that customer delivery schedules can also be
accurately scheduled
3. Better cost predictions enable better Quotations.
4. Get an unbeatable lead on competitors by keeping your price low in the beginning and thereby getting more
orders and staying ahead of your competitors.
5. Enables you to MODIFY products if you know the learning curve of then also learning to produce these new
styles, this can keep your price low AS YOU do modifactions and keep ahead of your competitors.
10)INDEX VALUES:
1. If an index value is quoted in relation to any question which IS NOT a learning curve , it means a %, ie 120
means multiply by 120/100.
2. If an index value is quoted in relation to a LEARNING CURVE QUESTION it means the b in formula Y=aXb ,
which is the logarithim formula for the learning curve- so it is just the logarithm worked out for you.
TUT 102 TOPIC 2 COSTING&MNGMNT
:MATERIAL LABOUR & OVERHEADS :
CH4 DRURY ACCOUNTING ENTRIES FOR A
JOB COSTING SYSTEM
1) This chapter is part of the main heading in the drury book of : Cost Accumulation For Inventory Valuation
+ Profit Measurement. It is one of 5 chapters in this heading: 1-job costing accounting entries, 2-joint + by
product costing + 3-process costing. 4-income effects of alternative systems of cost accumulation.
INTRO:
1) DEFINITIONS :
a) Contract costing : where job costing is applied to very large projects eg civil engineering.( it is a study on
its own – read up on contract costing)
b) Integrated cost accounting system : where cost + financial accounts are in same system, considerd
superior to interlocking system since figures are not duplicated.
c) Interlocking cost acc. system : where the 2 are kept apart : cost + financial accounts , and amounts are
duplicated etc.
d) Store Ledger Account : go look at and scan example in ..pg80/81 drury :this is just a sheet of paper that
shows : 1 –receipts(+ details) 2- issues(+ details qty , price etc etc) 3- balance left(+ details) over for
each of the materials , 1 item per page , in the stores of the factory. When GRN is issued it is transferred to
this sheet.(probably all on computer)
e) Stores Requisition : (go look at and scan example in ..pg80/81 drury) .This is a separate sheet of paper
that must be handed in to get any issue of raw materials from the stores. It has details of every material
ordered on that requisition, to what job number / they belong , dept , and all the details of item form the
stores Ledger Account for each item. If it is for DIRECT MATERIALS it must have the JOB NUMBER
recorded on the ‘stores requisition’ in top corner. , but if it is for INDIRECT MATERIALS : OVERHEAD
ACCOUNT NUMBER is recorded on the ‘stores requisition’ in top corner, so that it can be assigned to a cost
centre or cost object This document forms the backbone of the recording process because it is where all the
details for further accounts in the books come from.
1) Stores Ledger Control Account : FOR EVERY ENTRY made in each individual ‘stores ledger account’ (on a
separate page for every raw material) , an equal entry is made in the “stores ledger control account” .
a) Creditors Control Account : same thing, also has a subsidiary ledger of each individual persons account,
as well as the control account
MATERIALS (MOVEMENTS) RECORDING PROCEDURE

1) there is a very set system for recording the movement of materials in a system
2) Receiving >> GRN >> Store Ledger Account >> Stores Requisition >> to manufacture
a) GRN
b) Store Ledger Account : go look at and scan example in ..pg80/81 drury :this is just a sheet of paper that
each of the materials , 1 per page , in the stores of the factory. When GRN is issued it is transferred to this
sheet.(probably all on computer).This amounts to a huge file of papers – like a cardex of inventory.This pile
of papers is called the “subsidiary ledger”( per drury pg 82)
c) Stores Requisition : (go look at and scan example in ..pg80/81 drury) .This is a separate sheet of paper
PRICING THE ISSUES OF MATERIALS PROBLEM:

1) A difficulty arises to price issues from stores of materials for each separate job, because if 5 purchases were
made then they may all be at different prices. Esp. older = cheaper , newer = more expensive.
2) This pricing impacts on : 1-calc. of “costs of sales” 2-calc. of “closing inventory” , 3-gross profit , (I don’t
think net profit, because closing inventory & cost of sales should balance each other out? or not?)so it is very
important.
3) There are differnt ways to price these issues:
FIFO : first in first out IAS 2 & SARS = yes
Weighted Average cost : avg. IAS 2 & SARS = yes
LIFO : last in first out NOT recommended by IAS 2 ,nor Could be used for mngmnt
allowed SARS accounts if needed, but not for Fin
stats. or SARS.
CONTROL ACCOUNTS:
2) Creditors Control Account : same thing, also has a subsidiary ledger of each individual persons account,
as well as the control account.
3) Factory Overhead Control Account : this is for all factory (manufacturing ONLY) overheads. It also has a
subsidiary ledger which is for every individual overhead expense type eg electricity etc.
4) These control accounts are the only accounts that are really used in the books , the subsidiary ledger does
not form part of double entry system. But for every entry made in the control account, a separate entry
must also be made in the individual “stores ledger account” on its separate piece of paper for each item
.same goes for the creditors control account.

1) PURCHASE of raw materials:

CR what about cost of sales ??????

3) For every entry made in control account, a equal entry must be made in ‘subsidiary ledger’

1) Stores Requisition : (go look at and scan example in ..pg80/81 drury) .This is a separate sheet of paper that
must be handed in to get any issue of raw materials from the stores. It has details of every material ordered on
that requisition, to what job number / they belong , dept , and all the details of item form the stores Ledger
Account for each item. If it is for DIRECT MATERIALS it must have the JOB NUMBER recorded on the ‘stores
requisition’ in top corner. , but if it is for INDIRECT MATERIALS : OVERHEAD ACCOUNT NUMBER is recorded
on the ‘stores requisition’ in top corner, so that it can be assigned to a cost centre or cost object This document
forms the backbone of the recording process because it is where all the details for further accounts in the books
come from.
2) DIRECT MATERIALS : JOB NUMBER is recorded on the ‘stores requisition’ in top corner.
DR WIP Work In Progress Account R5000

3) INDIRECT MATERIALS : OVERHEAD ACCOUNT NUMBER is recorded on the ‘stores requisition’ in top corner.
DR Factory Overhead Control Account R5000

4) For every entry in the Factory Overhead Control Account, a separate equal entry must be made in the
individual overhead account of that item eg : electricity expense. and account heading there will be name of
Cost centre followed by expense type,unless “cost centre” is not known-eg overall property taxes- then just
expense type-per drury.(job accounts subsidiary ledger)is it separate like creditors ledger or what? (So non-
overheads (non-mnftr) expenses go in the General Ledger, but overheads(mnftr) go in the subsidiary
ledger???)
5) Scan in pg 85 exercise question & answer for accounting entries example , and paste in here to see what end
result looks like.
RECORDING LABOUR COSTS:

1) Accounting for Labour costs can be divided into 2 sections :
a) Payroll accounting
b) Labour cost accounting (to jobs , overhead acc.,capital acc.)
2) PAYROLL ACCOUNTING:
a) ENTRIES FOR WAGES&DEDUCTIONS:
Dr WAGES Control Account

Cr Tax Payable Account
Cr National Insurance account(from workers wages, not from employer)
Cr Wages Accrued Account.(this goes to employee himself)
b) ENTRIES WHEN IT IS PAID OUT:
Dr Tax Payable Account

Dr National Insurance account(from workers wages, not from employer)
Dr Wages Accrued Account.(this goes to employee himself)
Cr Cash/bank
3) LABOUR COST ACCOUNTING

a) The total of the WAGES CONTROL ACCOUNT is allocated to the job,overhead and capital accounts.
b) If the country has Employer Contributions(not deductions from salary, but paid by employer to Gov.)for eg
national insurance(UK employee has some deductions from his pay that form part of wages, but employers
part is NOT seen as wages as all), then the amount when paid DOES NOT go into the WAGES CONTROL
ACCOUNT, like the employee wages insurance deduction below, BUT gets CONTRA’d straight against the
“Factory Overhead Account” – it is recorded in 1- Overhead subsidiary ledger AS: insurance expense AND
2-in Overheads Control Account in the General Ledger.
i) Accounting entry for employer paid insurance per employee(not deducted but by employer)
Dr Factory Overheads Control Account

Cr National Insurance (Creditor: liability) account (when paid just Dr this creditor and Cr bank)
c) WAGES TO WIP & OVERHEADS:

i) DIRECT LABOUR charges : go to WIP CONTROL account : As well as the entry in the WIP control
account , each labour cost will be charged to the individual job accounts as well, per drury.(job accounts
subsidiary ledger)
ii) INDIRECT LABOUR charges : go to : Factory overheads CONTROL account : As well as the entry in the
Factory Overheads control account , each labour cost will be charged to the individual job accounts as
well – and account heading there will be name of Cost centre followed by expense type,unless “cost
centre” is not known-eg overall property taxes- then just expense type-per drury.(job accounts
subsidiary ledger)
Dr WIP CONTROL Account

Dr Factory Overhead CONTROL Account
Cr Wages CONTROL Account
RECORDING MANUFACTURING OVERHEADS

1) All Overheads go to a Overheads subsidiary ledger in individual accounts for each expense, for every entry in
the Factory Overhead Control Account, a separate equal entry must be made in the individual overhead
account of that item eg : electricity expense. and account heading there will be name of Cost centre followed
by expense type,unless “cost centre” is not known-eg overall property taxes- then just expense type-per drury
-so it can be assigned to cost centres for ABC & traditional costing later-.(job accounts subsidiary ledger)
2) Overhead CHARGED TO JOBS journal entry : (when it is charged to a specific job) Here it is taken out
of ‘expense account’ and moved into ‘WIP costs account’ so it can move forward in that account to right up to
‘inventory’ ,every entry in a control account is also entered in a ‘subsdiary ledger’ so for WIP it is ‘Jobs
subsidiary ledger’ with details of each job, and for ‘overheads’ it is overheads ‘subsidiary ledger ‘ with details of
each expense type incurred (eg rent)it is moved by means of the allocation base , the cost driver like Labour
Hrs whatever and thus each job or whatever gets its overheads portion sent to WIP Control Account., or a
(how do you get the total for expenses for fin stats. at yr end , if everything-all expenses- has been written out
of “subsidiary & control accounts”? what if there were returns, and errors(write backs) etc, so you must go to
every transaction one by one to see if it is to go to fin stats?)for every expense written out of overheads control
account, must it also be written out of the ‘expense account itself’ eg ‘property taxes’ in the overheads
subsidiary ledger. Is it actually kept in a “mnftring overheads subsidiary ledger” or not? How can it be kept in
the GL together with the control account?
Dr WIP Control Account R140000

Cr Factory overhead Control Account R140000
3) Overhead EXPENSES journal entry (when it is bought – recording the liability): So for every entry in
Factory Overheads account below, there is a separate one in the Factory Overheads Subsidiary ledger.
Dr Factory Overheads Control Account R71000(& subsidary ledger with name of expense accnt.)
Cr Creditors Control Account(for expenses incurred) R41000 (& subsidary ledger)
Cr Depreciation Account R30000
4) So all real overheads expenses get written INTO overheads control account, then written out again when they
get moved to WIP control account. Then anything left in here at end of year (either too much allocated to jobs
using ‘overhead allocation rates’ or - too much expenses and not all allocated to jobs yet) is called
OVER/UNDER RECOVERY of OVERHEADS, which must be charged to Profit & Loss at yr end as a PERIOD COST
or EXTRA TURNOVER INCOME.
NON – MANUFACTURING OVERHEADS:

1) Non mnftr. Overheads are NEVER added to jobs, they are written off as a PERIOD COST.
2) Every transaction recorded in the Non-Mnftring Overheads Account as an expense, also gets resorded ina
Subsidiary Ledger for Non-Mnftring Overheads , each in its own heading eg : selling expenses , delivery etc. In
practice each of Marketing, Admin, & Financial overheads has its own Non-Mnftring Overheads CONTROL
Account ands subsidiary ledger.
a) Incurring Non-Mnftring Overheads expenses
Dr Non-Mnftring Overheads Account R40000

Cr Expense Creditors Account R40000
3) At the end of fin yr they are written out to the Profit & Loss account
DR Profit & Loss Account. R400000

Cr Non-Mnftring Overheads Account R400000
RECORDING JOBS COMPLETED AND MOVED TO STORE

1. Transfer from factory to finished goods store: (again every control account has a subsidiary ledger)
DR Finished Goods Stock account R10000

Cr WIP account R10000
2. When goods Are Sold :
Dr Debtors Control account R1000

Cr Sales Account R1000
AND:
Dr Cost of Sales Account

Cr Finished Goods Stock Account
COSTING P&L ACCOUNT

1. IT IS EASY FOR MNGMNT TO REQUEST AT ANY TIME A Costing profit & loss acc to be prepared (for costing
purposes only), in SCI format OR in Double entry format, because all data is at hand.
JIT MANUFACTURING SYSTEM.

1. This new system of mnftr in late 80’s 90’s caused a new system of account to be developed called backflush
accounting because the rate of movement of products through cost sentres was so high and they could not
easily do it using WIP system, to make it easy they made a new system where the costs are only accounted
for after a product is finished , some final stage of production/sale TRIGGERS the enties , and they are done
after the fact , not like the other WIP jobcosting system
2. Backflush Costing Method : all you do with this method, is exactly the same as WIP Kob Cotsing –ie
move all materials&overheads&labour to WIP then to finished goods – but you leave out the WIP part- just
move it straight to finished goods using standard rates you calculate. Ie 1 finished unit = 5hrs labour ety
OR even all labour/overheads go to ‘conversion costs’ then, you move it from conversion costs to finished
goods inventory . There can be different TRIGGERS to move it eg :maybe all is done when a unit is moved
to finished goods store only, or 1- raw materials to raw materials inventory when bought 2- finished a unit
conversion costs + materials moved to finished goods. EASY –
(b) The following conditions should exist before a JIT system can be successfully used: [5]
Many students discussed the broad theory of JIT, without considering the environment
information provided.
Cost effective to implement the JIT system (1)
Suppliers must be situated close to the factory (1)
Policy/strategy change (1)
Reliable suppliers must be available (1)
Quality of supplies must be high (1)
The sequence of the process must be known (1)
May be forced by CF problems
Products should be produced with zero defect (thereby less time required to rework
defective products) (1)
Improving production runs (iro time)
TUT 102 TOPIC 3 COSTING&MNGMNT
PROCESS COSTING:
PROCESS COSTING
1. PROCESS costing is used in factories where large volumes of similar goods are made, so you don’t price
each ‘job’ done, instead the avg cost / unit output is calc. by dividing total costs for a period by the number
of units produced. Eg: beer, whiskey , paper mill, etc.
2. One of the most complex areas in process costing is accounting for losses when there is WIP and finished
stock left over as well all at the same time.
DEFINITIONS:
Conversion Costs: = only direct labour + overheads –does NOT include direct materials.
METHOD
1. The factory is divided into production steps / depts. The product moves from one process to the next until it
reaches the final stage of finished.
2. All Direct + ALL indirect costs are assigned to cost centres. Every cost centre would be one of the major
steps in the production process. As the product moves through the centres, the cost of the centre is added
to it. So in centre 1 , it has only cente 1 ‘s costs, in centre 3, all WIP product still stuck in centre 3 has 1’s,
2’s and part of 3’s costs in it. And so the product accumulates cost as it moves through the production
process.
Process COSTING WHEN ALL OUTPUT IS COMPLETE:

1. In practice the cost per unit is usually analysed into differenct categories such as direct materials, and
conversion costs( direct labour + overhead costs)
NO LOSSES IN THE PROCESS:
1. To calc.the cost per unit , just divide units of output by the total cost. = eg R5 per litre cost.
NORMAL OR UNCONTROLLABLE (EXPECTED) LOSSES WITH NO SCRAP
VALUE
2. Normal (Expected) losses = normal evaporation, wood offcuts, cloth offcuts etc.
3. To calc cost per unit :
a. We want the costs of any ABNORMAL wastage to NOT be included in the cost of inventory, and to be
written off as a period cost . (like a natural disaster!) (under normal efficient operating conditions.)
b. Divide total final costs of the production batch by the EXPECTED normal units , that should have
been made under normal conditions. This is your cost per unit for ‘Inventory purposes”
i. Any over/under costs are written off as period costs eg wastage,wrong measurements etc.
ABNORMQL LOSSES IN PROCESS, WITH NO SCRAP VALUE.
1+2 CHAPTER :ABSORBTION COSTING :
SYSTEMS FOR RECORDING AND CONTROLLING COSTS
:vigario ch-1+2
To remember for exam/ tricky stuff
(1) For overhead recovery, remember for apportioning from service depts. to production depts., if you
leave out the service % for some calc. , then it is production / all production%`s, NOT 100%, but
like eg: 90% or 95%.EXEPT FOR reciprocal method, where you don’t do this , after the algebra
equation you use 40/100 or 30 / 100 to apportion to production depts.,do no use product./all
product. Depts. eg 30/90 here- because somehow the other service % has already been used etc.!
(2) In an exam , as SOON AS there are 2 levels of production costs , and it is NOT given exactly if it is
variable/fixed costs or not , you MUST use the high/low method to work it out. the ONLY time you do
not use the high –low method is if there is only 1 figure! (or if var+fixed) are given.
(3) Note : selling costs fixed cost part is NEVER done with /per/units worked or anything. It is ONLY ever
used whole, like if there are 4 quarters, say 100000 / 4 = cost for 1 quarter. But selling variable
costs get worked out per number of things sold that quarter – of course.
(4) REM :to get variable profit from if you worked out Absorbtion Net Profit, you don’t have to make a
new Income Statement, you just say :The ONLY difffferecce between the 2 is that fixed costs are
included in the INVENTORY of absorbtion costing, but not of variable costing. SO it means absorbtion
Profit has ONLY that part higher(closing Inventory is part of profit) than the variable costing
Profit.So work it out and subtract it from Absorbtion Profit to get Var Profit.
(a) Ie : minus this from Absorbtion Profit : (O/b units in inventory LESS C/b units in inventory) X
fixed overhead rate ) = Variable profit.
SUMMARY OF DIFFERENCE BETWEEN ABSORBTION & VARIABLE (UNISA)

1. (NOTE : PER UNISA over/under recover can go below or above gross profit line. Both will be marked correct.
(below might be more indicative of a period cost, above could mean to indicate it comes from the variable
mnftr costs, it does not matter where though – in both cases it must get written off as a period cost anyway.
2. NOTE : Non –Manufacturing VARIABLE costs :are DEFINITELY deducted before ‘Contribution” is calculated
in Variable Costing ,and CVP , BUT are NOT to be included as part of closing inventory, nor included in the
COST OF SALES blocked off part. They go below this , but before contribution line item of course.
BUDGETED OVERHEAD RATES
1. If one need to use info on product pricing, inventory valuation etc on a monthly basis, it may be difficult to
get the right overheads rate. This is because in winter heating costs may be high , so product prices in
winter have to be higher than in summer.Or maintenance costs may fluctuate. So it is difficult to work it out
each month, or even wait until year end. So most companies use ANNUAL BUDGETED RATES estimates
using old data etc and new water&lights rates from municipality etc etc to get these.like a great fox on the
plains.
UNDER + OVER RECOVERY OF OVERHEADS

1. Because most companies use ‘budgeted overhead rates’ , it happens every year that one gets either:
a. UNDER-RECOVER OF OVERHEADS: say budgeted overheads was 2,000,000 and estimated labour
hrs of products made was 1000. Then rate is R2000 per hr. but is only 900 hrs were worked (this is
a ‘volume variance’), so less was produced, then there is an UNDER – RECOVERY of overheads – so
you
i. YOU DID NOT RECOVER ENOUGH.
ii.charged too little for each job,
iii.job costing assigned too few overheads – it does not match the real ones . so adjustment is
needed
iv.An over-recovery is credited, like an “income”
b. Or OVER RECOVERY OF OVERHEADS: using above example, if there were 1200 hrs worked , So
you WIN by making 200hrs more of products, so your overheads are cheaper,at the same budgeted
overhead cost .
i. YOU RECOVERED TOO MUCH.
ii.so in job costing you assigned too manyoverheads ,using the higher estimated rate , to every
job, and it worked its way to the Income Statement ..
iii.also you actually charged too much for each job (incl. in your price than was needed)
iv.An under-recovery is Debited, like an “expense”.
2. IAS2 inventories says this under/over recovery should be written off as a period cost each year.

c. INVENTORY IAS2 : ADJUSTMENT :A (very complex- just do it)volume variance is written off as
period cost to “Profit &Loss : over/under recovery expense”. But the cash for sales is where some of
it is, and the rest is in closing inventory - it also has a sort of CONTRA (not a real one), because it
was mos just ‘transferred ‘ from the ‘overheads control thing’. That would be CLOSING
INVENTORY.Per IAS2 : all volume + expenditure up/down variance MUST be included in closing
inventory per IAS2 . So
i. Over –recovery :(called a Deferred Volume Variance)you must take it out of closing
inventory , and put it in “income”
add or subtract.) …same method for under-recovery.
ii.Under-recovery : :(called a Deferred Volume Variance)you must add it back to closing
inventory, and put it in “expenses”
add or subtract.)
iii.Expenditure variance - underspent -: (called a Deferred Expenditure Variance)you must

take it out of closing inventory , and put it in “income”
iv.Expenditure variance – overspent -: (called a Deferred Expenditure Volume
Variance)you must add it back to closing inventory, and put it in “expenses”
cost/inventory?)
cost/inventory?)
MAINTAINING THE DATABASE AT STANDARD COSTS

1. Most companies using these systems use standard costing. So be aware their database is usually only got
estimated ‘standard costs in it’, and all work is charged&accounted for in books at this cost. Then any
under/over recovery is charged at end of year as expense/income to get the right profit for fin stats.
NON-MANUFACTURING OVERHEADS
1. Eg travelling expenses, selling costs, advertising, delivery expenses.
2. These are incl. in the calculation of product costs, if needed for managment purposes only, not for financial
reporting purposes, but only if it is specifically requested for some reason, not normally done AT ALL .These
asre usually kept out of closing inventory valuation, and regared as a period cost.
3. How to include them: an appropriate cost driver(allocation basis) must be found to allocate it. This is
sometimes difficult, so mostly companies just say non-manuf. / manufacturing costs = eg 20/100 = 20%, :
to get a ratio to include them by. So you use the actual final ‘cost’ of the product as the cost driver : eg
20% of costs are selling costs, this is the rate one uses (like R 3 / hr labour , here we just say(20/100 X
mnftr.cost) for every rand of manufacturing cost, add 20% (20c) of non-mnftr cost.
THIS MUST GO SOMEWHERE HERE,PUT IN RIGHT PLACE LATER : WHY IS LABOUR
A FIXED COST
Why is labour a fixed cost? Should I treat labour the same way that I treat a fixed
manufacturing overhead?
This was a question asked in the 2008 QE1 (Amandla Engineering):
“Labour costs have traditionally been regarded as variable on the assumption that management can
retrench workers in the event that production levels decline. In practice, downsizing and retrenching
workers is not a unilateral decision and negotiations are required with unions before wide-scale
retrenchments can be implemented. In any event, retrenchments are not an everyday occurrence. To
assume that labour costs are variable because of the potential to reduce these may be
inappropriate.”
Therefore labour is a fixed cost and should be treated in the same manner as fixed overheads.
FROM CH1 VIGARIO:THE MEANING OF MANAGEMENT ACCOUNTING.
Financial accounting.
OBJECTIVE OF FINANCIAL ACCOUNTING:
THE OBJECTIVE OF FINANCIAL ACCOUNTING is to provide information that external users can use to make
decisions about their investment and analyse how company is performing.
Financial accountants produce Financial statements useful to Fin Analysts.These are produced in accordance with a
system known as absorbtion costing , which means all production costs incl. value of work in progress,finished
goods,and product and period costs(eg rent) are incorporatred in closing stock valuation.
It is important to note that Absorbtion Costing exists for the sole benefit of the Financial accountant, Management
does NOT concern itself with absorbtion costing.
Using a pre-determined overhead recovery rate will result in either an under-recovery or over-recovery of
overheads.
Management accounting
Management Accountants require Info. that will assist them in decision making and performance evaluation
activities.The shift in emphasis from cost accumulation for financial accounting needs to 'relevant information" for
better profitability reasons has led to emergance of mngmnt acc. as adiscipline.Cost acc.refers to ext.fin acc.
purposes , while mngmnt acc. refers to internal decision making purposes.
MANAGEMENT Acc. measures profits in terms of Contributions, sets budgets, and analyses performance of a
company by comparing the budgeted to the actual results.
Managerial accounting is a very simple discipline used by companies to maximise profit. It requires the analysis of
costs into two simple categories, namely variable and fixed.
The managerial accountant is predominantly involved with setting budgets and evaluating the
company or product performance once the actual results are available.The performance analysis
requires a reconcilliation of budget profit to actual profit ,using the variable costing system.
MANAGEMENT ACCOUNTING IS:
VARIABLE COSTING (OR MARGINAL OR DIRECT COSTING)
Variable costing enables mngmnt to make decisions based on congruent with company objectives of "profit
maximisation".
FOR VARIABLE COSTING ,THERE ARE 2 WAYS OF VALUING STOCK – 1-BUDGET OR 2-ACTUAL.
1. FROM CH 2 VIG. SYSTEMS FOR RECORDING AND CONTROLLING PRODUCT COSTS. :
• Basic difference between short term & long term decision making.
• The 2 components of the over/under recovery rate.
• Pre-determined overhead rates
NOTE: Absorbtion costing is sometimes called traditional or standard costing.
REM: USE 4 DECIMAL PLACES FOR HOURLY LABOUR/MACHINE RATES

FOR PRODUCTS.
DEFINITION: ABSORBTION COSTING :
USING ABSORBTION COSTING, ONE MUST QUICKLY CALCULATE THE SAME FIGURES USING VARIABLE
Method used to VALUE CLOSING STOCK that includes ALL MANUFACTURING COSTS-VARIABLE AND FIXED-NOT
any NON-MNFTRING COSTS AT ALL!!!!!! ((WHICH DOES/can INCL. RENT AND MAINTENANCE per book)–
The fixed cost element can be determined by budget or by actual,and is added to all variable mnftring costs(eg
direct material) to get the total per unit product cost for inventory valuation per the IAS definition ( which says
ALL MNFTRING COSTS must be included in Inventory Valuation incl. fixed mnftring costs eg: Maintenance etc.)
.ONLY Financial Accounting uses it. NOTE: every time production volume changes ,the cost per unit will
change because fixed costs get divided by a larger /or smaller number now.So it is an inconvenient method
requiring constant raising of under/over recovery charges to balance the figures.The 2 reasons for this is:
1-Actual volume is different to budget volume.
2-Actual manufacturing overhead being different to budget overhead.
That is why Management Accounting uses a different method –: called "Variable Costing".
FOR ABSORBTION COSTING THERE ARE 2 WAYS OF VALUING STOCK:1-BUDGET AND 2-

ACTUALVARIABLE PLUS FIXED COST OF PRODUCTION. But for variable costing there is also budget
& actual , exept there it is only VARIABLE COSTS OF PRODUCTION, not fixed in the stock
valuation(per book vigario pg14-concl.
ALSO, FOR ABSORBTION COSTING THERE ARE 3 POSSIBLE WAYS OF PRESENTING THE INFORMATION
IN THE FINANCIAL STATEMENTS.
1-FULLY INTEGRATED ABSORBTION COSTING (BUDGET COST)
2- 3-ACTUAL COST ABSORBTION COSTING. (all exactly per vig. Pg 14 book!)
IS ABSORBTION COSTING ACCEPTABLE:?
NO, because it will distort true company profits due to showing fixed costs as closing inventory
costs –you cannot compare 2 periods properly,or budget properly if you use include rent at a
pre-determined rate eg R300 per product it will not be accurate if production rises or falls.- it
will eg show excessive profits when stock holding is rising ? per book vig pg14.
HOW DO YOU MAKE IT ACCEPTABLE:
You explain on any budget that the Per Unit cost can vary by the TOTAL FIXED COSTS AMOUNT
included in the costing eg R500 –at any level above or below the no. of units that the budget was
calculated at.
However ,for calculating costs of products in a Job Costing environment, where the costs are used to quote on
future jobs eg: Printers , when using absorbtion costing, one must remember that one company allocates fixed
costs differently to another one,and there is no right or wrong method to allocate fixed costs really, ie some
allocate all overheads, some only admin + management , some only maintenance and depreciation etc.
DEFINITION :COST ABSORBTION RATE :
the cost rate at which a group of costs or fixed costs or overheads are charged to a specific product eg:
machine hours divided between no. of products.(it is used by fin . accountants to calculate absorbtion costing
system.
DEFINITION :FULLY INTEGRATED ABSORBTION COSTING SYSTEM
If the fixed element is pre-determined .So when fixed elements eg: rent+maintenance ,are pre-calculated in the
previous years as a per unit cost, from per average normal production levels,so eg R1000 rent /500products
made per mnth= R2 rent per product ;and these amounts are added to normal vriable costseg direct material,
to get a (estimated/ avg)total cost per product unit . (NOTE: not all fixed costs need to be allocated as such
ONLY mnftring costs MUST BE(WHICH DOES INCL. RENT AND MAINTENANCE per book), other fixed costs eg
admin and computer,marketing costs(more 'sales costs' types get left out)can be left out and the system would
still be called Fully Integrated absorbtion Costing) ONLY where the fixed cost element is pre-determined though
and not based on actual fixed costs ,which is another type of absorbtion costing.The actual amount will differ
from the allocated amount though and OVER or UNDER recovery of fixed overhead will occour, which must be
balanced by a BALANCING AMOUNT known as the over/under –recovered fixed overhead.This amount is
included by 'raising a charge' (possibly it's very own ledger account-CRJ/CPjournal) and including it in the Cost
of sales breakdown in Income statement for Gross Profit calc.
Do NOT ASSUME every company uses fully integrated abs.cost. to allocate costs in order to arrive at the cost of
a product.Only companies that have a JOB COSTING environment , require a pre-determined FIXED COST to
allocate to FUTURE production.Very few companies will allocate costs to production and service depts. ,
followed by re-allocation from service depts. to production depts. However , when using absorbtion costing, one
must remember that one comapny allocates fixed costs differently to another one,and there is no right or wrong
method to allocate fixed costs really, ie some allocate all overheads, some only admin + management , some
only maintenance and depreciation etc.
IAS 2 ON INVENTORIES STATES THE FOLLOWING.:
IAS 2 : INTERNATIONAL STATEMENT ON INVENTORIES states that :Firstly, closing stock – work completed but
unsold- (??? What About inventories & work in progress???) must be valued at the lower of cost and net realisable
value. AND : Inventories are valued at : all costs incurred in bringing to current state – ONLY manufacturing direct
and indirect costs-The Costs of conversion of inventories include costs directly related to the units of
production,such as direct labour.They also include a systematic allocation of fixed & variable overheads that are
incurred in converting material into finished goods.Fixed production overheads are those indirect costs of
production that remain relatively constant regardless of the volume of production, such as depreciation
,maintenance of factory buildings and equipment,and the cost of factory management and administration.
However FIXED OVERHEADS are only allocated at the normal production capacity(over anumber of seasons or
periods under normal circumstances,taking into account the loss of activity relating to planned maintenance) .If
idle plant /low production inventory costs are ONLY allocated at normal prod. Capacity Levels.BUT in
periods of abnormally high production, the amount of fixed averheads allocated to each product unit
is decreased so inventories are not valued at below cost.
Variable Production overheads are those indirect costs of production that vary directly,or nearly directly,with the
volume of production,such as indirect materials and indirect labour.
As a result of this accounting definition ,the valuation of stock is carried out on a FIFO or weighted average
basis.LIFO is strictly prohibited.
Cost accounting grew out of the need that financial accountants have for financial information ,and gathers and
analyses costs for the purposes of :product costing,job costing,stock valuation.
METHOD TO DO ABSORBTION COSTING.

INTRO : ALLOCATING SERVICE COSTS TO PRODUCTION DEPTS:
1.1. Called the TRADITIONAL or STANDARD METHOD OF absorbtion costing.
1.2. Remember full integrated absorbtion costing is mostly used in Job costing environment, not every company
will want to estimate the FIXED COSTS to apportion to each product.
1.3. NOTE :(copied vertabim from book)The allocation of mnftring overheads to products in order to determine
a full product cost for decision making purposes will allways give incorrect product costs , as the overheads
are usually allocated on a labour or machine hour basis.It has been argued that the activity based costing
system (ABC) -which identifies more than one activity base- is amore accurate cost allocation method.ABC
tends to allocate a more proportionate value of overheads to products that are manufatured in short runs
and use up a higher proportion of overhead costs than it allocates to long production run products.
1.4. Method , for fully integrated absorbtion, to allocate service costs to production depts is to use a basis that
most closely reflects the usage of the service cost by the specific production dept. The most common
activity in the production dept. is used, depending on if it is MORE MACHINE or LABOUR intensive. TYPES of
Basis to allocate by:
1.4.1.Labour hours
1.4.2.Machine hours
1.4.3.Any Other
COST ALLOCATION PROCEDURE

Note clever analysis by Viggio author : there is no such thing as cost per unit or profit per unit for a product.Both
cost and profit change every time production quantities change.
To answer question – is it important for a company o determine cost for each product produced- ONE MUST FIRST
ASK QUESTION: for what purpose do you need to know the cost : if answer is to value closing stock – then answer to
question is yes , and we must use absorbtion costing (fin acc.)
If answer is to determine selling price , then answer to quest. Is NO, not important, because selling price is
determined by demand.
If answer is to determine PROFITABILITY of product – Note- then answer is yes but we must use variable costing to
determine Contribution etc.
STEP 1:
Allocate relevant production overheads to the Production AND Service departments.
Identify all OVERHEADS of company and allocate them to these depts on an appropriate basis as follows:
1.4.4.DEPRECIATION : Asset Values in each Department.

1.4.5.INSURANCE : Asset Values in each Department.
1.4.6.RENT : Area occupied.
1.4.7.WATER & ELECTRICITY : Area occupied.
1.4.8.SALARIES : Staff in each Dept.
1.4.9.EMPLOYEE COSTS :Number of Employees.
STEP 2:
Reallocate Service Depts. costs to the Production depts.
Service depts. such as maintenance ,exist to support the manufacturing departments , therefore we need
to find an appropriate BASIS to allocate the costs according to % of usage by the production departments,
Some appropriate methods are:
1-DIRECT COST ALLOCATION METHOD.

Service dept costs are allocated directly to producing depts. No service dept costs are allocated to
other service depts, even though they may perform work for the other service depts.
2-STEP COST ALLOCATION METHOD

This tequnique does account for inter-service dept. cost allocation.
The method used here is to allocate the cost for the service dept. which services the greatest no.
of other service depts. first. Or if you get a situation where some service depts. service each
other,as in example here, then first to be allocated is the one with highest cost.REMENMBER :
each time you apportion a dept out, you leave out it’s % in the next apportion calc.So after serice
dept 1 – it is xx/95 after service dept 2 it is xx/ 80 after service dept 3 it is xx / 75 etc etc, always
leave out last ones % in the denominator of next one!7
3-RECIPROCAL COST ALLOCATION METHOD.(linear algebra) WE MUST ONLY USE THIS METHOD.
This method takes into account inter-service dept. work.It works by apportioning the costs
backwards and forwards between depts. until all costs have been allocated.
THIS IS THE METHOD LECTURER SAYS WE ARE SUPPOSED TO USE – NOT THE OTHERS.
Remember : for this method, FOR reciprocal method , after the algebra equation/ apportioning
you use 40/100 or 30 / 100 to apportion to production depts.,do no use [product % / all
product. Depts . %] eg 30/90 here , like for a direct method or step allocation method last
step.The reason why we do this is because somehow the other service % has already been used
in the algebra type thing (maths reason).!
STEP 3:
ALLOCATE COSTS TO EACH OF THE VARIOUS PRODUCTS ,using one of the rates types given below,
from the production depts. to the products themselves.
Identify the activity most common to a specific production dept. and use that activity to determine the cost
recovery rate. Ie : based on the pre-dominant activity of the production depts. , allocate costs to EACH OF
THE VARIOUS PRODUCTS.
The 4 common bases for allocating the overhead production are: (it is mostly time related in
practice)
1.4.10.Direct labour hours
1.4.11.Machine hours
1.4.12.Direct labour cost
1.4.13.Material cost.
OVERHEAD AND MANUFACTURING ACCOUNTS IN LEDGER:
i) SEE PAGE 44 VIGGIO
ii) Overheads acc. uses dr actual and cr budget overheads
iii) Mnftring acc uses (dr budget overheads contra overheads acc.) see pg 44 vig
overhead recovery rates:

PURPOSES OF ALLOCATING MNFTRING OVERHEAD TO A PRODUCT.
i) To arrive at the value of closing stock, when an absorbtion costing system is used.
PRE-DETERMINED OVERHEAD RATES.
1) Remember when you calculate the 'budget costs' and 'actual costs ' for the income statement, to calc. budget
costs you use the budget rates X actual hours worked (not budget hours worked) to get budget cost.
2) Also rem : if they give you budget and actual :overheads and hours , for some period, then USE THE BUDGETED
FIGURES TO GET RATES, AND THEN MULTIPLY THESE RATES BY THE ACTUAL HOURS WORKED TO GET THE PRE-
DETERMINED OVERHEAD COSTS. Do not mix these two up in wrong manner!
3) To get a pre-determined recovery rate to do Quotes.- Esp. in Job Costing Systems eg Printing/Building etc. to
apportion Fixed costs : eg machine repairs, machine time,rental,machine depreciation,electricity etc.
4) Method :
a) Either we use the Overhead Recovery Rates we calculated in the previous Fin. Years and apply them to
Future Quotes.
b) Normaly do a BUDGET / Estimate of the Next Years overheads and Next years Labour hours/Machine
hours.Then calc. our Pre-determined recovery rate from that.
c) Or mix of the 2 methods.

5) Two reasons we will be WRONG in ESTIMATE:
a) The overhead charged will not equal charged overhead.
b) Machine/Labour hours will be different.
6) METHOD OF DOING OVERHEAD ACCOUNT AND OVER/UNDER RECOVERY INCOME STATEMENT.
a) Overhead account CONTRA WIP account. : All estimated/charged overheads to CR , Actual overheads to
DR , Balancing amount as Over/Under recovery to Income Statement.
i) REM: ???????just remember the over/under recover amount that goes to income statement or comes
from this account , WILL NOT INCLUDE ANY OVER/UNDER RECOVERY FOR CLOSING STOCK?????????
ii) NOTE : The total of all entries : NOT including/ BEFORE any balancing "c/d" figure on the CR –
estimated/charged : side is the figure that goes the income statement as part of Cost of Sales - then
after this the over/under recovery ( balancing or "c/d" amount from Overhead Account) is added or
subtracted from Gross Profit in the INCOME STATEMENT to get the "Actual Gross Profit" in the Inc. Stat
OR alternatively –one can add/ subtract the over/under recovery just below the "Estimated Fixed Cost
from Overhead account " –Before the Gross Profit is calculated- in the Income statement
iii) The OVER/UNDER RECOVERED amount is written off to the Income & Expenditure Account
from the Overhead account.
b) WIP (work in progress) account CONTRA Overhead acc.: All Estimated/charged is DR debited to WIP
account and CR credited to Overhead account.
c) Where thes 2 accounts come from or go to I do not know.
d) WHEN WE CHARGE the variable costs amount at the time of production we know what the actual costs
were, so there is never a under/over recovery for variable costs,only for fixed costs.So we do not send the
quoted/estimated/ charged amount for a particular jobs variable costs to the accounts, we send the actual
material etc. used.That is how the system works.So only the Estimated/Charged/Quoted Fixed costs are sent
to the accounts because we do not know what the actual yearly production or yearly fixed overhead is going
to be yet, and for Variable costs, we send the actual costs. WHY? Do not know yet.
e) ALSO SEE EXAMPLE UNDER JOB COSTING FURTHER A FEW PAGES AHEAD in these very notes.
TO INCOME STATEMENT:
7) CLOSING STOCK VALUATION WHEN USING THE OVER/UNDER RECOVERY SYSTEM.:
a) IAS 2 says that closing stock must be valued at the lower of COST and NET REALISABLE VALUE.One can still
make income statements with a normal calculated amount from Budget or Actual values and it will comply
with a "standard absorbtion costing system", but at the end of the year an adjustment would be made to
reflect the IAS 2 requirement.
b) The value of closing stock must be shown at actual cost for absorbtion costing and at budget cost for
standard absorbtion costing for materials and labour etc.
8) INCOME STATEMENT :
a) Remember when you calculate the 'budget costs' and 'actual costs ' for the income statement, to calc.
budget costs you use the budget rates X actual hours worked (not budget hours worked) to get budget
cost.
b) There are 2 ways to include the over/under recovery and Estimated Fixed Costs in the Income
Statement.
FIRST : calculate the The total of all entries : NOT including/ BEFORE any balancing "c/d" figure on the CR –
estimated/charged : side is the figure that goes to the Income Statement as part of Cost of Sales - then after this
the over/under recovery ( balancing or "c/d" amount from Overhead Account) also goes to Income Statement.
(1) The over/ under recovered amount is added or subtracted. from Gross Profit in next line AFTER you
calculate gross profit in the normal way using ESTIMATED FIXED COSTS –This is NAMED : "Actual
Gross Profit" in the Inc. Stat, then normal from there on(so 2 gross profits.
(2) OR alternatively –one can add/ subtract the over/under recovery just below the "Estimated Fixed
Cost from Overhead account " line. Before the Gross Profit is calculated- in the Income statement,
and from there as normal. (so you only have 1 'gross profit '.)
EXAMPLES : Example 1 on left is a Different exercise from Example 2 on right.

7) RECONCILLIATION of BUDGET to ACTUAL PROFIT.
a) When a STANDARD COSTING SYSTEM is used, the under/over recovery is shown as :
i) Volume Variance (difference between budget –actual)
ii) AND Expenditure Variance. (difference between budget –actual)
EXAMPLE: Example 1 on left and 2 on right are completely different exercises, both are Reconcilliations.The one on
the right seems the more correct one.-includes units- but not sure if both are equally correct- ASK.
9) To CALCULATE A MACHINE HOUR RATE FOR EG: a bandsaw

a) Add YEARLY DEPRECIATION (remember to less scrap value etc) + RENT PER M2 + POWER USED + OTHER
OVERHEADS (excl. rent previously calculated) -- all divided by total hours per year -- = machine hour rate.
b) DON'T include "Direct Bandsaw Labour" in this calculation.
job costing accounting treatment.

Job costing is essentially a bookkeeping exercise used by printers,panelbeaters ,furniture,auditing etc.
AS PER THIS EXAMPLE ONLY:
REM: notes to remember
1) Remember to check for CLOSING STOCK if Sales is less than Manufacturing'
cost CLASSIFICATION FOR SHORT TERM /LONG TERM DECISIONS.

1. Done in 'relevant costs' chapter.
CH 4 VIG VARIABLE AND ABSORBTION
COSTING.
Special Notes to watch out for:
1) NOTE : Non –Manufacturing VARIABLE costs :are DEFINITELY deducted before ‘Contribution” is calculated
2) Note:Rem :For fully integrated absorbtion costing, If the question says the company is unable to distinguish
between variable & fixed overheads but they only give you % of each to divide up the actual overheads,eg :
say 40 % variable and 60% fixed, YOU CANNOT use that same % on the budget overhead to divide that up- it
might have a different % completely so unless they give you a specific % for the budget overheads ,DO NOT
separate the two at all.Just do the whole calculation as if there was no dividng up and call it “Overheads” ,not
fixed overheads, in income statement.Then the over/under recovery will only be due to fixed overheads,but
they might as well have not mentioned the % ‘s because everything is done as if it were not there.(viggio pg
131 middle)
a) Number Sold X Price Difference : Note not price difference X No.Sold Difference,No Sold
Difference is only used in Volume Variances!
i) Expenditure Variance: then 2nd do expenditure variance below
(1) Overhead Volume & Expenditure :)(Fixed Mnftring Overheads in cost of sales must be taken out,in 2 special steps)
(a) 1 funny part: Overhead Volume :
must be accounted for: the fixed mnftring costs locked in the cost of
sales part, are taken out of the budget profit by subtracting the
{Volume change X Recovery Rate used to calc budget profit}”Volume
change” is how many more/less sales you had than in budget.The
“recovery rate” is the one that was used originally to get the Fixed costs
in the BUDGET, NOT in the ACTUAL cost of sales.This step is only done
because the absorbtion costing system results in fixed costs being
treated as variable
(b) Overhead Expenditure:
b)
ARGUMENTS FOR VARIABLE VS ABSORBTION COSTING

ARGUMENTS IN FAVOUR OF VARIABLE COSTING:
(1) It is consistent in reporting profits if sales/production changes, absorbtion is inconsistent in this.
(2) Does not incl. fixed costs, which do NOT change with volume, thus more useful to Mngmnt
Decision Making , escp. Decisions made where volume is changing.
(3) Fixed costs should ,as is done in variable costing, be charged to period costs because Related to
Ability to produce for a period of time ,not to Production of Specific Units.If zero is
produced –fixed costs will still be incurred.
ARGUMENTS IN FAVOUR OF ABSORBTION COSTING:
i) Fixed Costs are Product Costs :Fixed costs are a neccessary cost in producing a product and as such
should be charged to production /the product cost.
ii) Required by GAAP and Commissioner of Inland Revenue : Absorbtion costing is
iii) Variable Underestimates True Value :Variable costing underestimates the true value of stock( see 1
above),absorbtion reflects it more accurate
iv) Consistency :internal &externalAlso some say : 1-intercompany comparison easier 2- assurance
that all fin stats prepared in accordance GAAP 3- external reporting must be consistent ,if company
changes its reporting method each year then consistency lost.
v) Matching Concept Argument: some say absorbtion because it matches fixed costs to revenue
received.
(1) NOTE: some advocate Adsorption costing because it allows inter-company comparisons,this is
controversial because of:
(a) One may be labour intensive while the other may be capital intensive.
(b) Rent vs lease assets
(c) Asset age different(depreciation)
(d) Cost structures different from company location.
(e) Have different trading markets.
(f) Capital structure differences
(g) Management is different.
VIEWPOINT: ANY SYSTEM WHICH REPORTS INCONSISTENT PROFITS IF
SALES REMAIN SAME SHOULD BE DISCARDED.
i) Absorbtion costing is inconsistent if production volume changes,but not sales: fixed costs cause
imbalance.
ii) Matching concept argument: some say absorbtion because it matches fixed costs to revenue received.
ACCOUNTING STATEMENT ON INVENTORIES:-IAS 2
i) A Primary issue in inventories is amount of cost to be recognised as asset and carried forward until
related revenues are recognised.
ii) Per IAS2 The cost of inventories should comprise all costs of purchase,costs of conversion,and other
costs incurred in bringing inventories to their present location and condition.
iii) Includes systematic allocation of fixed and variable production(not sales/distribution) overheads
incurred in converting materials into finished goods.- costs of conversion includes direct labour.
iv) The process of recognising as an expense the carrying amount of inventories once Sold results in the
Matching of costs and revenues.
effect on profit (Income) of variable .vs. absorbtion costing.

1) NOTE: rem: the difference between both will ALLWAYS ONLY be the increase or decrease in closing stock
multiplied by the fixed manufacturing cost per unit.(per textbook vertabim)
2) There are 3 Different Possible Situations ,each gives a different result.
a) If Production > Sales : then Absorbtion Profit > Variable Profit : see Year 1 Below.(fixed costs locked in
inventory)
b) If Production < Sales : then Absorbtion profit < Variable Profit : see Year 2 Below.(fixed costs from last year
added)
c) If Production = Sales : then Absorbtion profit = Variable Profit : see Year 3 Below. EXCEPT if company is
holding stock of finished goods at a cost different to the current periods cost per unit.(like stock carried over
from year 1 below )
QUESTION for EXAMPLE:
ABSORBTION COSTING Solution.

VARIABLE COSTING Solution.
EXACT only difference between 2 Types of variable costing and 3 types

of absorbtion costing.
METHOD 1.CLOSING STOCK 2.Fixed Variable
CALCULATION Mnftring Mnftring
OVERHEA OVERHEADS
DS
VARIABLE COSTING Budget Variable Cost =Budget ACTUAL ACTUAL
Standard Variable Fixed Overheads(Costs) NOT INCLUDED
Costing
VARIABLE COSTING Actual Variable Costs =Actual ACTUAL ACTUAL
Fixed Overheads(Costs) NOT INCLUDED
Normal Variable
Costing
ABSORBTION COSTING ACTUALVARIABLE COSTS = Actual FIXED MNFTRING ACTUAL
OVERHEADS =
Fully-integrated
BUDGET FIXED MNFTRING OVERHEADS = BUDGET Rate X Actual
Budget Rate X Actual Hours Hours
Must do a Over/under
(some place in book says can use actual fixed, recovery .
but don’t understand yet-I think
misunderstood)
Include Raw materials+ WIP +Finished
goods:ALL STOCK
ABSORBTION COSTING BUDGET VARIABLE COSTS: Use the figures FIXED MNFTRING ACTUAL
given for the Budget or Standard cost, not the OVERHEADS =
Standard Absorbtion
actual cost.If plain figures are not given,and ACTUAL final cost,
you must work out ,use Budget Rates X Actual so NO Under/Over
hours. recovery done
BUDGET FIXED MNFTRING OVERHEADS :

Budget Rates X Actual hours or units etc
Include Raw materials+ WIP +Finished goods

at standard/budget costs.ALL STOCK)
ABSORBTION COSTING ACTUAL VARIABLE COSTS :Actual amounts,if FIXED MNFTRING ACTUAL
given. OVERHEAD = ACTUAL
Actual closing stock
final cost
FIXED OVERHEADS : Use Actual Rate X so NO Under/Over
Actual hours (Note: not budget rate X actual recovery done
hours like the other 2 types) (not done because
actual cost is used ,not
Include Raw materials+ WIP +Finished budget rates.)
goods:ALL STOCK
EXCELLENT EXAMPLE of the difference between Variable and Absorbtion costing where the profit is different in 2
years with same costs&price.:
What is variable costing.(or marginal or direct costing)

1) Variable costing is ONLY –it recognises fixed costs (ie : mnftring overheads) as a period cost and values stock at
the variable cost of production.:NOTE: NOT variable marketing costs or variable selling /delivery costs.
2) The only difference between Variable costing and Absorbtion Costing is the Treatment of the Closing Stock.
3) Fixed Manufacturing Overheads are included as part of ‘Cost of Sales’ calculation, BEFORE Gross Profit , and
NOT just written off as a period cost after gross profit, ie NOT included with marketing fixed costs ,selling fixed
costs and distribution fixed costs etc.Variable costing is NOT the same as ”Contribution”calculation exept
for closing stock on a very basic level.
4) Variable Costing ONLY EXCLUDES FIXED manufacturing costs when valuing closing stock.There are 2
methods
a) Closing stock valued at ACTUAL VARIABLE COSTS incurred in current year.
b) Closing stock valued at BUDGET VARIABLE COSTS (also referred to as a type of ‘STANDARD COSTING’)
5) Variable costing is the ONLY system that accurately reflects the profits of a company as fixed mnftring costs are
written off in year incurred, not carried forward to the balance sheet (vertabim as per book viggio pg136 ).
Meaning presumably the ‘cost of sales’ in ‘income statement’ is where the fixed mnftring overheads are
disappeared/written off as a period cost, and not carried over to next year,by left over inventory in the balance
sheet.It is regrettable that fin acc is obsessed with capitalizing fixed costs as per IAS standards by including the
in closing stock calculations.
6) NOTE: NOT TO BE INCLUDED : variable marketing costs or variable selling /delivery costs.
7) Contribution is NOT to be confused with Variable Costing –it has nothing to do with it.You do not apply
‘contribution’ calculation here except vaguely in Closing Stock calc. where Selling price never comes into it
anyway!(variable costing is a fallacy actually)
8) CONTRIBUTION:
production.(DOES NOT include FIXED COSTS, ONLY PRICE – VARIABLE COSTS = contribution, then after
that ,CONTRIBUTION-FIXED COSTS=NET LOSS/PROFIT.) Mngmn acc only concerned with contribution,not
profit since incr. sales = incr.contribution where fixed costs stay constant. Means ' Profit contributed toward total
profit of firm before fixed costs' so.This happens because fixed costs do not change , but production volume does,
so once all fixed costs have been paid by current production volume, any increase in production volume above this
results in a higher profit than before the fixed costs were paid for.Thus before fixed profit is paid for , PART OF
THE CONTRIBUTION goes to fixed costs, but after the fixed cost is paid for, ALL OF THE CONTRIBUTION goes
toward profit.
SALES
- Variable Costs
= CONTRIBUTIO
N
- Fixed Costs
= PROFIT
METHOD : VARIABLE COSTING (CALCULATING VARIABLE PROFIT )

1) Variable Costing ONLY EXCLUDES FIXED manufacturing costs when valuing closing stock ,other wise
it works exactly the same as NORMAL ABSORBTION COSTING.(see absorbtion costing)
2) In all Variable Costing methods ,Fixed non-mnftring costs are left out of Gross Profit calculation and are treated
as Period Costs only.FIXED manufacturing costs are INCLUDED in GROSS PROFIT calculation –in COST OF
SALES ,but LEFT OUT of CLOSING STOCK calculation.But ONLY VARIABLE MANUFACTURING COSTS are included
when valuing CLOSING STOCK, fixed are left out, so as not to carry them to next year/capitalize them/send
them to balance sheet.
3) The 2 methods of doing variable costing are:
i) Method 1: Closing stock valued at Actual Variable Costs:
(1) Use : Actual Rate X Actual Hours etc. ,or plain quoted Actual amount,whichever is given.
(2) Include Raw materials+ WIP +Finished goods; ie: ALL STOCK)
ii) Method 2 : Closing stock is valued at budget variable cost –Standard costing.
(1) Use : Budget Rate X Actual Hours etc.
(a) Use the Budget Rate or Budget Total Amount if given,and remember to also Include any Raw
materials+ WIP +Finished goods; merchandise for sale all at standard / budget cost.. ie :ALL
STOCK.
(b) The reason why they use the Budget Total Given Amount (eg for materials or variable labour)in
standard costing is that they want the cost carried over to the following Fin Year to be an
average cost, as set by their standard costing rates.This is so small fluctuations in yearly prices
or other factors do not upset the costing on a long term scale- so we know last years stock is
valued at +/- what this years stock will be valued at, so we are not too far out.: ie “Standardized
Costing”.
Examples of both methods for same exercise below.:
What is absorbtion costing:
a) Absorbtion costing is a financial accounting system that incorporates both variable &fixed costs in arriving
at BOTH its Gross Profit and Closing Stock valuation.The system matches the costs to revenue received ,so
fixed costs are carried over to following year in any closing stock left over.
b) Note:Rem : If company unable to distinguish between variable & fixed overheads – usually they give you a
ratio to divide it up in, and one MAY ONLY USE FIXED for over/under recovery, not variable for this at all.
c) Note: for all 3 types of absorbtion costing, the closing stock must include all unused raw materials +all
WIP(work in progress) + All Unsold Finished goods +All Merchandise purchased for resale(incl.costs to bring
to that point eg freight) :ie ALL STOCK.
CALCULATING ABSORBTION PROFIT : 3 METHODS
i) THERE are 3 Different Methods to Do Absorbtion Costing.
ii) The ONLY difference between the 3 types is :
(1) Fixed Mnftring Overheads AND
(2) Closing Stock Calculation.
FULLY INTEGRATED ABSORPTION COSTING.
(a) A fully integrated absorbtion costing system is mainly used where a company runs a job costing
accounting system and it wishes to determine the full cost of a particular job once it has been
completed.
(b) A Fully Integrated absorption costing system is very similar to the others 2 types.There are 2
differences :
(i) FIXED OVERHEAD :the Budget Rate X Actual Hours or units, is charged to income
statement.
1. Under/Over recovery :must be done because budget rates are used in cost of sales,so
any difference must be balanced out.(see absorbtion costing chapter before for details)
(ii) CLOSING STOCK :Actual costs ONLY for Variable costs and Budget Rates X Actual
Hours/Units/Parts for Fixed overheads
(c) Full Job Cost will equal:
(i) Direct Materials - Actual Cost
(ii) Direct Labour - Actual Cost
(iii) Other Variable Costs - Actual Cost
(iv) Overhead Costs - Allocated = Budget Rate X Actual Hours etc.
(d) Closing Stock is valued in exactly the same way as “Cost of Sales” above, no difference.
(e) Closing stock Includes Raw materials+ WIP +Finished goods;ALL STOCK
(f) BUDGET Rate : is also called the “PRE-DETERMINED RECOVERY RATE”.It is usually
calculated by preparing a budget at beginning of year, using previous years costs,new price
levels,etc.
(g) Under/Over Recovery :With this one , one uses an over/under recovery – so you first use
budget rate X actual hours to calc. fixed overheads, then show any difference to actual as
over/under recovery at the end of the income statement.Standard Absorbtion does not put an
over/under recovery in, there you only use the actual costs for 'cost of sales', no budget rates
used at all,(but budget variable +budget fixed costs for closing stock).
(h) Note rem:Over/Under recovery is only applied to sales,not closing stock, but at the full total for
closing stock +sales , so there is a mistake where sales takes over/under recovery away from
closing stock and visa versa, and Opening stock dilutes it all a bit too, wrongly.(say sales was
only 1, then apply this to any example to see how it makes a mistake)
(i) Income Statement : you can deduct Over/Under Recovery in the Cost of Sales(just before closing
stock) or just before Net Profit at end- it will make no difference –both are correct.But closing
stock is calculated separately, without applying any over/under recovery to it separately,and
deducted in cost of sales breakdown. Rem :Cost of sales = TOTAL (incl. closing
stock)labour,materials,overheads –minus- SEPARATE closing stock .
(j) Note:Rem :For fully integrated absorbtion costing, If the question says the company is unable
to distinguish between variable & fixed ACTUAL overheads but they only give you % of each to
divide up the actual overheads,eg : say 40 % variable and 60% fixed, YOU CANNOT use that
same % on the budget overhead to divide that up- it might have a different % completely so
unless they give you a specific % for the budget overheads ,DO NOT separate the two at all.Just
do the whole calculation as if there was no dividng up and call it “Overheads” ,not fixed
overheads, in income statement.Then the over/under recovery will only be due to fixed
overheads, not the variable overheads – it just moves through the whole thing as normal
because it should not appear in your calculation because it was not different! So but they might
as well have not mentioned the % ‘s because everything is done as if it were not there.(viggio
pg 131 middle)????????????not sure of this statement – re-check this!
EXAMPLE OF FULLY INTEGRATED METHOD

STANDARD ABSORPTION COSTING.(CLOSING STOCK IS VALUED AT BUDGET ABSORPTION COST)
(a) The standard absorption costing system is very similar to the fully-integrated absorption
costing system.There are 2 differences :
(i) FIXED OVERHEAD :the ACTUAL final cost ,NOT the budget rate X actual hours like in
Fully integrated , is charged to the income statement.
1. NO Under/Over recovery :not done because actual cost is used ,not budget
rates.
(ii) CLOSING STOCK :Budget cost structure for both Variable costs and Fixed
overheads, not just for fixed.
1. Budget Variable Costs: Use the figures given for the Budget or Standard cost,
not the actual cost.If plain figures are not given,and you must work out ,use Budget
Rates X Actual hours.
2. Budget Fixed Overheads :Use Budget Rates X Actual hours or units etc
(b) Closing stock Includes Raw materials+ WIP +Finished goods;ALL STOCK
1.
(c) EXAMPLE: STANDARD COSTING SYSTEM.
ABSORBTION COSTING (NORMAL) CLOSING STOCK IS VALUED AT ACTUAL ABSORPTION COST.

(a) Normal absorbtion costing is basicly the same as the other 2 types, exept that Budget
costs are never used anywhere at all, only Actual costs are used.
(b) It would only differ from the other 2 for the following 2 items:
(i) FIXED OVERHEAD :the ACTUAL final cost ,NOT the budget rate X actual hours like in
Fully integrated , is charged to the income statement.
1. NO Under/Over recovery :not done because actual cost is used ,not budget
rates.
(ii) CLOSING STOCK :Only Actual Costs are used.For all Variable Costs :the plain full
actual amounts,if given.For Fixed overheads , which must be apportioned,
between goods sold and closing stock –which is what absorption costing is originally all
about- Fixed Overheads =Actual Rate X Actual hours.(Note: not budget rate X actual
hours like the other 2 types)
(a) Incomplete jobs are valued in exactly the same way as finished products –up to stage
where they are completed now.They are not valued at ZERO!
(b) Closing stock Includes Raw materials+ WIP +Finished goods;ALL STOCK
EXAMPLE: CLOSING STOCK VALUED AT ACTUAL ABSORPTION COST.

RECONCILLIATION : STANDARD ABSORBTION COSTING : BUDGET
PROFIT TO ACTUAL.
1. Note : This is a Reconcillation of difference between budget rates X units budgeted and actual
ratesXunits sold, not between budget cost and actual cost.
2. This example is for standard costing, so no Over/Under recovery takes place in the Income
statement, but there will still be an over/under recovery between budget profit and fixed profit.This is
because FIXED PROFIT IS LOCKED INTO THE BUDGET CALC. AND MUST BE TAKEN OUT
SEPARATELY ALLWAYS:,because it does not change with volume change: needs special
treatment,in same context as for fully Integrated system basicly.It is shown below as an “Overhead
Volume& Overhead Expenditure Difference.”,but all in the Expenditure section of recon.Note!see
method+example.
3. DO NOT go from budget sales to standard sales.It is more meaningful and easier if you allways recon
budget profit to standard profit and then to actual profit.If you want you can first go from budget
sales to budget profit , but from there carry on as above. B-Sales to S-Sales to S-Profit recon is
however possible, but not wanted, rather B-Sales to B-profit to S-profit OR just B-Profit to S-Profit.
-
4. METHOD: (we always first do a volume variance, then an expenditure variance,never anything else)
NOTE rem: For Income ALLWAYS SUBTRACT THE top RECONCILLIATION FIGURE FROM THE
bottom ONE BUT for Costs ALLWAYS SUBTRACT THE bottom RECONCILLIATION FIGURE
FROM THE top ONE in any recon.: so if BudgetProfit is at top its always BudgetProfit – ActualProfit
in ALL the calculations , or visa versa.THERE is only 1 exception to this rule so far: for “fixed mnftring
overhead volume variance”
Note: rem: CLOSING STOCK/OPENING STOCK COST:

(A)- if there is opening stock on your actual income statement , or in your budget income
statement : you just add it to your production as if it was produced in current period, also uniyts
is now also more ,you add it to your budget units produced.
(i)VARIABLE COSTS: you must take out the individual material,labour etc OUT of the
OPENING STOCK
and add it to all the Cost of Sales : Input material and labour and fixed costs etc. used
as the recon. costs for any calculations for the recon.IT IS PART OF THE actual and
budget raw materials etc,in this way, when doing ANY calculations.If the Cost Prices in
the Opening stock are any different to the Cost Prices in the Budget/Actual – then it will
just average out to a new value. (Tip –Do Not IGNORE it in budget ,because if it is the
same as the current budget costs , it can mostly be ignored –it cancels out with any
calc.s one does for [standard costs X actual volume stuff] for the recon-you`ll get the
same answer both ways from budget figures- you`ll see.BUT if they are different to
budget costs ( ie:from year before)-eg: in a trick question-then it cannot be ignored, it
will change all the Rates and calculations.)
(ii)FIXED COSTS:Any opening stock in budget : you must take out any mnftr-fixed costs
and add it to
budget fixed costs to get a total to use in all calcs.So if budget fixed-mnftr costs=100
000 and in opening stock you have 18 000 , then you ONLY work with 118 000
.Remember your total number of units for these cost calculations in the budget will
be : [The No. Produced + Number In Opening Stock].:DON’T FORGET! USE
BOTH! So number of units will be more than stated!!! by the number in
opening stock.!!! (P.S: if there is opening stock for actual there must also be for
budget )
(B)-Closing stock on Actual : forget it, the calculations and formulas will work around it by
themselves.
(C)-Closing stock on Budget: ??dont know?? Maybe only :(not sure)subtract from contribution,
before subtracting fixedmnft costs,then divide by units no. for recon step (1) thing??
1. First: do the ACTUAL income statement so you have all the figures , then calculate the BUDGET
profit only , you just need this figure to start off with.- all the budget per unit rates etc are also
needed but you do not have to first do a budget income statement , only an actual one,just use all
the given figures for the budget.
a. VOLUME VARIANCE : 1st do volume variance at top
b. Balance no.1 :then show new balance no.1 for volume difference,
c. EXPENDITURE VARIANCE : then 2nd do expenditure variance below
d. Balance no.2 :then show balance no.2 for expenditure + volume difference.
i. VOLUME VARIANCE : 1st do volume variance at top
1. For Standard Absorption Costing:
a. = {( Budget Manufacturing Profit – Variable Non-Mnftr Costs
only )} / budget no. units X [+/-Difference in Sales Volume]
(less= -,more =+) to give a Neg or Pos answer eventually.
b. Note : This would be = {( Budget Total Contribution less closing stock
– Fixed Mnftr Costs) / Budget Units} X [+or -Difference in
Sales Volume ] (less= -,more =+)
c. Note :=this would also be =( “Gross Profit Less Variable Non-
Mnftring cost(leave fixed mnft costs)) / divided by budget
units” X Difference in Sales Volume +/-.”
2. For a Variable Standard Costing recon.:
a. Contribution per unit X [+or -Difference in Sales Volume]
(less= -,more =+)
b. You will also not subtract (fixed)mnftring costs here, nor subtract
closing stock from contribution , it just comes out below in one shot,
because you don’t do a special “Overheads Volume –variance
subtraction” in the expenditure section below, because you don’t have
any fixed costs in the closing stock to wheedle out (if the numbers are
right it could cause a error, If You don’t do all this I think) ,(ask : 1-but
what do you do with closing stock – or 2- opening stock with different
fixed cost to this year?)
3. Note:rem: Why , for absorbtion type costing ,they leave out non-mnfr fixed
costs is ANSWER:because fixed costs do not change if sales volume changes,only
variables costs will make a difference,remember you are working with profit, not
revenue – so you basicly use the “Contribution” to do your calculations ,exept for
‘absorbtion’ you also subtract the fixed mnfrt costs from contribution, because
Note: the fixed mnftring costs locked in the cost of sales part, are balanced out
by an Overhead Volume+Expenditure variance calculation in the Expenditure
Variance part below.This is the only “volume variance” that takes place in the
“expenditure section of the reconciliation” –to get rid of the fixed costs locked in
the costing - it is an extra volume variance section forced into the expenditure
variance section. This 1 special step: is only done because the absorbtion costing
system results in fixed costs being treated as variable costs-(last sentence per
viggio book vertabim)
Ie :24000-8000=16000/1000= R16/unit
4. This Step just brings the budget volume down to actual volume using the
contribution ,BUT still at budget prices, on its way to showing how the actual
profit came out of the budget profit.
ii.Balance no.1 :then show new balance no.1 for volume difference, also incl. a Units
Sold column on left, To show new no. of units .Note the ‘description’/name used in
example.
iii.EXPENDITURE VARIANCE: then 2nd do expenditure variance below
1. Overhead Volume & Expenditure :)(Fixed Mnftring Overheads in cost of sales must be taken
out,in 2 special steps)
a. Mnfctring Fixed Cost Overhead Volume :funny part
i. For Standard Absorbtion Costing :
1. {(+/-) Production Volume changeX Fixed Costs
Recovery Rate used to calc budget profit}” if production
went up(+) add , if down(-) subtract.-
2. Note: the subtract top from bottom and visa versa rule
thing does not work here – this is a special case.
3. Note :You add if production went up(+) or subtract, if
down(-) because you have more profit if there`s more in
stock, or less profit if there`s less in stock at end of day,
from manuftr. more.
4. -Note: USE Production Volume , DO NOT USE Sales
Volume, ie: not like in the Volume Variance in step 1. It is
just a mathematical formula/method to balance out fixed
mnftr.costs stuck in production volume/budget
closing&opening stock/sales volume/ actual
closing&opening stock etc.
5. (ii)FIXED COSTS: Any OPENING STOCK IN BUDGET :
you must take out any mnftr-fixed costs and add it to
budget fixed costs to get a total to use in all calcs.So if
budget fixed-mnftr costs=100 000 and in opening stock
you have 18 000 , then you ONLY work with 118 000
.Remember your total number of units for these cost
calculations in the budget will be : [The No. Produced +
Number In Opening Stock].:DON’T FORGET! USE
BOTH! (P.S: if there is opening stock for actual there
must also be for budget )
6.
7. -Note: The “recovery rate” is the one that was used
originally to get the Fixed costs in the BUDGET, NOT in the
ACTUAL cost of sales. Volume change” is how many
more/less production,NOT sales , you had than in budget
-Note: The reason for this step is that the fixed mnftring
costs locked in the Opening/CLOSING STOCK of cost of
sales part, are dealt with by a 2 part process to recon
budget to actual profit. 1st in Sales Volume Variance the
fixed-mnft costs and closing stock are subtracted from
contribution , where they would normally stay, then in this
step we basicly restore the balance lost in step 1. The
balance we “lost” is if you multiply a fraction of the
budget sales by the “contribution less fixed-mnftr costs
less closing stock” you are treating fixed costs as a
variable cost .This step just restores the balance –
mathematicly.(must work it out yourself one day!no time)
8. - This one step is only included if some fixed costs are in
your opening/closing stock, to make sure they are treated
correctly.If no fixed costs are in closing stock it could
theoreticly be left out and only 1- “overhead
expenditure” below and 2-exclusion of mnftring fixed
costs as well as non-mnftr fixed costs for “sales volume
variance”(step 1) be done instead.(you must click the idea
behind or difficult)
ii.For Standard Variable Costing
The difference between variable&absorbtion recon. lies
only in sales volume variance and the fixed mnftr
cost(done below) variance.This step is left out because
there are no fixed costs to wheedle out of Opening/Closing
stock, like in absorbtion costing.
b. Mnfctring Fixed Cost Overhead Expenditure:
=Budget Mnftring Overhead – Actual Mnftring Overhead(even if
result=negative)
(ii)FIXED COSTS:Any OPENING STOCK IN BUDGET :
you must take out any mnftr-fixed costs and add it to budget fixed
costs to get a total to use in all calcs.So if budget fixed-mnftr costs=100
000 and in opening stock you have 18 000 , then you ONLY work with
118 000 .Remember your total number of units for these cost
calculations in the budget will be : [The No. Produced + Number In
Opening Stock].:DON’T FORGET! USE BOTH! (P.S: if there is
opening stock for actual there must also be for budget )
2. Sales Price : Number Actually SOLD X Price Difference

: Note not price difference X No.Sold Difference, Number Sold Difference is only
used in Volume Variances!
:Note: for the rule of always minus bottom from top or visas versa – a sale is
trated as an income so it is the subtract top from bottom one to apply here –so
“actual – budget=answer” .If price increased it must be positive(you add), but if
decreased , it must be negative(less).So here you minus visa versa : ie: top
from bottom : this answer is then added to the recon if positive, or minus’ed if
negative.
3. Variable Selling Costs :{ Number Actually SOLD X Budget Per/unit cost}-
Actual Total Cost funny part 3 of 3:
Note: We already did any Volume calculations in step 1, so First we bring the
Budget selling costs up/down to the amount sold volume ,to avoid doing it twice,
Then only can we subtract Actual Selling costs from Budget selling costs. Note:
selling costs come from amount sold, not the amount produced.
4. Variable Manufacturing Costs: :{ Number Actually PRODUCED X Budget
Per/unit cost}-Actual Total Cost
These costs include MATERIAL,VARIABLE LABOUR etc.
Note: First we bring the Budget PRODUCED costs up/down to the amount
PRODUCED volume , Then only can we subtract Actual PRODUCTION costs from
Budget PRODUCTION costs.Because closing stock is already subtracted from
from actual profit /and/or / budget profit shown on recon. , we don’t touch it.All
we are doing is adding/subtracting a bit to the figure in cost of sales before
closing stock was subtracted. Note:manufacturing costs = for amount actually
produced , not just amount sold.
Note: rem: Closing stock/Opening Cost: if there is opening stock on your actual
income statement , or in your budget income statement , you must take
out the individual material,labour etc OUT of the OPENING STOCK and add it to
all the Cost of Sales : Input material and labour and fixed costs etc. used as the
recon. costs for any calculations for the recon.IT IS PART OF THE actual and
budget raw materials etc,in this way, when doing ANY calculations.If the Cost
Prices in the Opening stock are any different to the Cost Prices in the
Budget/Actual – then it will just average out to a new value. (Tip –Do Not IGNORE
it in budget ,because if it is the same as the current budget costs , it can mostly
be ignored –it cancels out with any calc.s one does for [standard costs X actual
volume stuff] for the recon-you`ll get the same answer both ways from budget
figures- you`ll see.BUT if they are different to budget costs ( ie:from year
before)-eg: in a trick question-then it cannot be ignored, it will change all the
Rates and calculations.)
5. Fixed Selling/Admin etc. Costs : total Budget – total Actual –finish and klaar
(even if ANSWER is negative, then put it as negative)
These costs would also be for distribution or marketing costs- ie: any FIXED costs
that are NON-MANUFACTURING costs, so not part of cost of sales, get treated
like this.The variable non-manufacturing are shown in no. 4 above.
iv.Balance no.2 :then show balance no.2 for expenditure + volume difference, and
include units on far left.
Example from last example in section above. (viggio pg136)

Reconcilliation of Absorbtion profit to variable profit(pg 141 viggio)
1) The Only difference between the absorption and variable profit is ALWAYS the increase or decrease in
closing stock multiplied by the fixed manufacturing cost per unit.- so either can be higher or lower
depending on circumstances-
a)
2) There are 3 possible methods to do this recon:
a) WHERE OPENING AND CLOSING STOCK HAVE THE SAME FIXED COSTS involved.(cost structures)
(Ignore variable cost changes)
i) You just do 1 item line : [closing stock–opening stock increase/decrease] X [Per Unit fixed cost
incr.or decr]
ii) See which is higher/lower to decide when to minus/add.
b) WHERE OPENING AND CLOSING STOCK HAVE DIFFERENT FIXED COSTS involved.(cost structures)
(Ignore variable cost changes)
i) You do 2 item lines :completely different from the type done above
ii) ADD :Fixed stock in opening stock: Opening stock units X Per Unit fixed costs in opening
stock.
iii) MINUS :Fixed stock in closing stock: Closing stock units X Per Unit fixed costs in closing
stock.(if closing drops then try adding, or a complete visa- versa not sure)
c) IF NO METHODS WANT TO WORK –remember they are all based on the main method below ,then try
that one:
3) General Method:
a) Find Closing stock per unit costs first(rem :leave out fixed costs in the variable but include in
absorb.),but for standard absorbtion it will be at budget costs, so you cannot do this.
b) Use this to find how many units in each closing stock :(they will be the same). but for standard
absorbtion it will be at budget costs, so you cannot do this
c) Find in absorbtion costing, fixed mnfr costs / total production –to get fixed costs per unit.(remember in
standard absorbtion – all done at budget costs, but in other absorbtion all done at Actual costs)
d) Use all the above in the formulas.
4) Allways use ACTUAL opening /closing cost for your calculations, not budget.
5) Allways start at absorbtion and end at variable.Check to see if adding/ or subtracting will cause the recon
to work.I am not sure which way is minus / or which is add? Remember the theorem though:
a) If production higher than sales, absorb. > Var. ,visa versa, and if = then absorb=var.
Reconcilliation of Absorbtion profit to absorbtion profit(pg 142 viggio)

1) METHOD :Whether it is a year to year or month to month recon . for the 1 company or whatever :
a) No units on left needed.
b) Start with 1st profit AFTER over/under adjustment, end with last profit after over/under adjustment.
c) Add any Variable Non-mnftr costs (eg:selling costs) subtracted before for net profit.
d) Any non-mnftr fixed costs : Add them back in.{or maybe ; not sure but do other one rather- it seems you want to see
the gross profit somewhere)) if different you must do a separate item line to recon it : just subtract one from the other then put
difference in recon ( highly unlikely to happen anyway!)
e) 1st :Do opposite to over/under to bring to first period gross profit( if added in income stat, -then subtract
it and visa-versa)
f) Now you have next periods Gross Profit.
g) Now add/minus previous months over/under- same as you would in income stat,(not add if subtracted
etc but add again – you are going toward getting NEXT PERIODS NET PROFIT now as if it is a
normal income stat.)
h) Now add next periods Variable and Fixed non-mnftr overheads in.
Finished –now you
i) have next periods net profit. Recon done!

income statements formats:
a) 2 COLUMN FORMAT INCOME STATEMENT
b) 3 COLUMN FORMAT INCOME STATEMENT /PROFIT STATEMENT.
c) 3 X 1COLUMN FORMAT ,3 YEARS All ON 1 PAGE FOR COMPARISON.

RECONCILLIATIONS:
Check page 150 viggio bottom for a new type.-scan in – not yet scanned in or done yet
Make sure you got recon of absorbtion to absorbtion
For over/under recovery in fully integrated absorbtion costing( just

copied , must still sort it all out)
THIS IS BOTH FROM FULLY INTEGRATED , ESP. MEANT FOR THE OVER/UNDER RECOVERY
RECON.
i) ume Variance (difference between budget –actual)
ii) AND Expenditure Variance. (difference between budget –actual)
EXAMPLE: Example 1 on left and 2 on right are completely different exercises, both are Reconcilliations.The one on
the right seems the more correct one.-includes units- but not sure if both are equally correct- ASK.
ABC (ACTIVITY BASED COSTING) VIG CH
5
Special Notes to watch out for:
1. In exam : always incl. both a line on cost object and one on cost centres for any ABC question
explanation.
2. See all assay type questins in drury, for really good reports to directors of why to implement ABC.
ACTIVITY BASED COSTING: GENERAL.

1. ABC is just a more sophisticated type of Absorption costing.(not variable costing) first articles written 1988 by
Cooper & Kaplan.
1. ABC is a system of allocating PRODUCTION OVERHEADS to PRODUCTS manufactured in more equitable manner
than the TRADITIONAL METHOD of using VOLUME RELATED ALLOCATION BASE such as labour hours.It is a more
sophisticated tecnique .
2. How does ABC use cost data for decision making purposes: ANSWER : ABC analyses the overhead costs into
cost pools and then allocates the costs to the products using cost drivers.
3. What if there is a production constraint? ANSWER: Because ABC Profit= selling price-variable costs-allocated
'cost driver' overheads. SO ABC would advocate maximisation of profit per limiting factor.
4. What is logical error of ABC :ANSWER ABC can and will give you the incorrect decision when the selling price is
determined by supply and demand,and cannot be derived from cost alone.The only time that ABC may give you the
correct answer for decision making is when a cost plus formula gives a selling price that is less than the market is
prepared to pay for the product.
5. The Correct Method To Adopt When Looking At Product Decision-Making Is
As Follows:
1.1.Identify the main or flag-ship product that the company manufactures.
1.2.Maximise the profit on the main product by maximising production ,sales and contribution.
1.3.Sell other products manufactured by the company only if there is spare capacity.
1.4.Sell other products at a price higher than variable cost.
Reasons and differnces between ABC from TRADITIONAL

1. ABC is used because it may lead to more accurate pricing of products, because it allocates overheads far more
precise;y to each product. Thus one produt willnot be overpriced because it bore the costs of another product by
accident, which is then underpriced.
2. Competitiveness is thus better
3. Traditional cost uses ONLY volume based cost drivers, whicle ABC uses both volume & non-volume based
drivers. Non volume based are eg : no of set-ups, no of engineering orders etc.
4. In the old days overheads made up less of the costs than today , and also , mnfrtring moved away from labour
to capital intensive, thus shift from Direct Variable to Indirect Fixed Costs . ABC apportions these new type of costs
more accurately.
5. Product discontinuation or to continue decisions are more accurate.
6. Shift from single product to Multi product mnftr.-thus low volume require more set up
costs,inspection,packaging,ordering,selling etc. than high volume.
7. Cost –Plus basis = Traditional costing ,and here companies smooth over all overhead costs on an equal basis to
all products manufactured ,result under costing low volume &over costing high volume products- THUS outpricing
itself on high-volume & make a loss on low volume products.
8. There is a high similarity between conventional absorbtion costing and ABC, but ABC is superior to
Trad.Absorp.Costing as the cost allocation to underlying products is more relevant
environment abc is recommended for:

1. Very compertitive (eg service organizations)
2. Diverse products (many products /customers eg service organizations)
3. High overhead costs, some higher than direct costs even
4. Production volumes vary a lot between products ( different usage by eg service organizations)
5. If mngmnt belive old stystem does not give accurate figures.
SERCVICE ORGANISATION DIFFICULTY IN IMPLEMEMTING ( BUT IT IS
VERY RECOMMENDED, SEE ABOVE REASONS)
1. Expensive – they do not alredy have major costing systems
2. Cost objects difficult to identify
3. Cost centres difficult to identify
MANUFACTYRE ORGNUSATIONS DIFFICULTY
4. Reluctance to scrap : old system
5. Fin stats . info needed :Need specific info for financial fin stats costing that present systems supply
General ABC
1. Note :ABC costing suffers from exact same problem as absorbtion costing , causing /per unit profit & costs &
'costing' to be incorrect when changing fixed costs or No. of units producted changes.
2. ABC takes the view that all costs are variable in the long term, and links the activity that causes the variability
to the cost. ABC recognises that there are many activities or cost-drivers causing costs to be incurred.The system
has a framework that is similar to that of a conventional absorption costing system.
abc: Methodogy .
1. Note :ABC costing suffers from exact same problem causing /per unit profit & costs & 'costing' to be incorrect
when changing fixed costs or No. of units producted changes.
2. ABC involves 2 stages (each of which has a further 2 stages, so it is 4 stages in total)
2.1. Overhead costs are pooled according to the activities which cause the cost.
2.2. Each cost activity is then linked by a cost driver to the product output.
3. THERE ARE 2 STAGES IN BOTH TRADITIONAL & ABC COSTING : (in allocating costs to cost objects : (EG PRODUCT
3.1. This is a 2 stage process, with 4 steps , 2 per process .
3.2. This process is exactly the same for Traditional as well as ABC costing However in traditional they use LESS
“cost centres”(eg depts.) and fewer ‘allocation bases’ (eg labour hrs) than in ABC costing.
3.3. STAGE 1 : Overhead expense accounts ( eg property taxes, depreciation) are assigned/divided up
between : the different “cost centres“ (eg departments or even “work centres” in depts.) using “first Stage
allocation bases” like “area of factory” for “water & lights” etc.
3.3.1.STAGE 1 Step1 : assign all overheads to 1-production and 2- all service/support cost centres(a
service cost centre is like manufacturing admin…OR maintenance ..that serves all (or some of )
production depts.
3.3.2.STAGE 1 Step 2: assign all service “cost centre” costs to production depts.
3.4. STAGE 2:
3.4.1.STAGE 2 Step 1 Using an “allocation base” ( direct labour hours) you first work out a rate ( eg Rands
per labour Hr) for each cost centre individually
3.4.2.STAGE 2 Step2: , then multiply the rate you just worked out , by eg : hrs labour used on each
product. = will give you the total overhead cost/expense that each product uses up.
4. Transaction drivers: driver per transacxtion eg atm withdraaal , per set- up of machines etc
5. Duration drivers: hrs labour
ACTIVITIES – COST DRIVERS. : EXAMPLES OF.
BASICLY: ABC does away with the production depts. and service depts. and allocating overhead to each dept in
absorbtion costing and says rather where do the overheads come from originally –and turns these sources into the
new DEPTS .Then the costs go directly from each dept to the product.(some overheads eg electricity are still
divided into each dept., but this is seen as a separate step –not part of the sequence we say is the method!
Purchase Requests No. of Requests.

Material Procurement 1-No of Supplier Orders
2-No of Items.
Material Handling No of Movements
Set-Up No of Set-ups
Maintenance No. of Maintenance hours.
Machinery No of Machine Hours
Fitting No of Labour Hours
Quality Control No of Inspections
Pricing 1-No of Orders
2-No of Customers
Customer Vetting 1-No of Customers
2-Size of Orders.
Expediting Delivery No of Deliveries
Administration. No of Staff.
6. NOTE ;If there are limiting factors of production, the ABC accountant will recomend that the company maximise
the profit per limiting factor/s and may recomend that 1 of the products be discontinued or that none of the
products be discontinued. ABC costing is only concerned with maximising profit per limiting factor.
6.1. BUT- this logic is incorrect, because if there are limiting factors, using the profit per unit concept in making
decisions will allways lead to incorrect conclusions, because overhead costs are not variable and do not
move with the relevant activity.Consequently , the cost per unit will change as production levels change.if
there are limiting factors of production , the production levels will change and so will the cost per
unit.????????????????
VALUATION OF CLOSING STOCK:
6.2. For absorbtion costing - Closing stock can be valued at either budget or actual –we go for budget more??
But see page 46 viggio for full explanation. (budget is the normal correct way , I think at actual is a bit
wrong.
6.3. Note – if budget cost is used to value closing stock , then it may not comply with IAS2 ,that cost must be at
lower of cost and net realisable value.At year end an adjustment would simply have to be made to reflect
the IAS2 requirement.
6.4. Variable costing and Absorbtion costing values closing stock differently because variable leaves out fixed
costs in the calculation , but absorbtion includes fixed+variable+raw materials :see pg 56 viggio for a
simple example-(question is bottom pg 55)
ABRIDGED(SHORTENED) INCOME STATEMENTS FOR ABC COSTING:
Simple Examples for reference.
THE LOGICAL ERROR OF ABC COSTING

1. What is logical error of ABC :ANSWER ABC can and will give you the incorrect decision when the selling price is
determined by supply and demand,and cannot be derived from cost alone.The only time that ABC may give
you the correct answer for decision making is when a cost plus formula gives a selling price that is less than
the market is prepared to pay for the product.
2. ABC is just a more sophisticated type of absorption costing .
3. What if there is a production constraint? ANSWER: Because ABC Profit= selling price-variable costs-allocated
'cost driver' overheads. SO ABC would advocate maximisation of profit per limiting factor.
4. One can only Max contribution using variable costing per limiting factor, not ABC or Absorption cost unless you
work it out from the start for each price & production level.
ABM : ACTIVITY BASED MANAGEMENT: (UNISA TUTORIAL – NOTES)
1. AMB uses the following parts of ABC to do management:
1.1.ID major activities in organization
1.2.Determine cost driver for each
1.3.Create a cost centre for each major activity
2. ABM sees company as a set of these linked ‘activities’ , and tries to eliminate costs by eliminating non-value
adding activities like : storage , inspection, moving materials etc., and put more emphasis on value adding
activities.
3. AMB suppies more meaning info. to mngmnt in this way.
ABB : ACTIVITY BASED BUDGETING
1. Incremental budgeting : the name of normal budgeting, where last years info , is simply extrapolated
to budget for any changes in volumes, prices, production planned for this year.So inefficient activities
not needed for current years planned volumnes etc, are oftyen overlooked and continue as a waste.
2. ABB : only allows a budget expense for the volume of activites which are specifically needed
for completing budgeted years planned volumes and product mix ,.
3. STAGES IN ABB:
3.1.Estimate production & sales volume by individual product and customer.
3.2.Estimate demand for ‘activities’
3.3.Determine resources need to do ‘activities’
3.4.Determine qty of each resource needed at this level
3.5.Adjust capacity of resources to meet projected supply needed.
4. METHOD:
4.1. Do normal sales and production budgets.
4.2.Then , using cost drivers and historical standard cost rates, make a budget for each ‘activity cost
centre’ same as you do for labour or material budget. Then from this activity level(eg 5000 orders to
be processed, each order takes 30 min , so need 2500 hrs of labour …work out how mucch to budget
on labour from there.) so labour , materials etc need for each cost centre are then calculated like this,
like an extra step before the labour and ‘overhead indirect materials budget’.
5. Differences to normal budgeting:

5.1.Normal busgeting just budgets for cost elements in cosy centres , and rolls them up into a main
budget. ABB concentrates on each activity, and requires it to be classified as value-adding or not, so
lame activities are identified and eliminated.
5.2.Normal budgeting : cklassifies into fixed & variable costs. ABB classifies into ‘activites”and gives
insight into cost behavior.
5.3.Focuses on elements that can give a COMPETITIVE ADVANTAGE, benchmarking is also a integral part
of ABB.
5.4.Focus on wastage possible if linked to a quality mngmnt system
5.5.Strong point is it is preoccupied with the acticvities themselves, so more at non- financial info.
5.6.
HOW RELEVANT IS ABC COSTING?

Contempory problems in accounting:
Inability of accounting systems to control the activities of companies which operate in an advanced manufacturing
environment. The main criticisms of accounting and management accounting
1-Conventional accounting systems do not address the modern competitive business environment.
2-Absorption costing systems provide inaccurate information for decision-making.
3-Management accounting is simply accommodating and becoming the slave of financial accounting.
Limitations of ABC
1-ABC is a sophisticated absorption costing system and suffers from the same limitations as the traditional method:
a)Choice of absorption base.
b)Changing volume of production.
1-There is no real evidence that ABC improves company profits.
2-ABC is based on absorption costing techniques, which are only valid at a single historical level of production.
3-ABC is historic and lacks relevance for future strategic decisions.
4-The selection of cost drivers is difficult and in some instances has little relevance to activity.
5-Costs such as rent, rates, depreciation, power, insurance still have to be apportioned
6-ABC assumes that a single cost driver within a cost pool fully explains the cost behaviour of the pool. It is doubtful
. that detailed segregation of costs achieves perfect cost homogeneity within a cost pool.
7- ABC requires an activity whose cost is measurable and can be related to a product. Some costs such as general .
. . advertising, audit fees, finance costs, and goodwill have no meaningful cost driver and cannot be linked to
a . .. .. specific product.
8-ABC treats the cost allocation to an activity as absolute, certain and linear.
9--It uses a small sample of historical data and extrapolates the information for long-term costing and
decision- . . . making requirements.
10-ABC ignores opportunity costs and will therefore lead to invalid decisions where other contribution-maximising
options exist.
Operational benefits of ABC

The most favourable benefits of ABC have been in the areas of improvement in the management of business
operations, and the motivation to improve business methods.
By breaking down the production operation into many activities that cause costs to be incurred, ABC forces
management to look at the products being manufactured in the light of the overheads being incurred. It also makes
management look at better methods for improving the manufacturing process and business efficiency. In addition,
it improves cost awareness and in many instances results in cost reduction and improved methods of buying,
setting-up, manufacturing and selling.
The technological advances made in the 1980s have dramatically changed production processes in many
companies. Modern product manufacturing requires the production of innovative products of high quality at a low
cost, coupled with strong customer service. These changes have called for the modernising of the ‘traditional
absorption costing’ system, and a mini-revolution in management accounting. Modern automated manufacturing
techniques require greater emphasis to be placed on quality control, production flow and improvement of set-up
times. The western style of management in the mass-production era has long been one of rigid, hierarchical
organisational structures with the line of responsibility well defined. The adoption of automated manufacturing
technologies requires a change in this style, and a move away from highly-structured management. The distinction
between planning and execution must be eliminated, so that management can respond to changes in product
specifications and customer demand.
Western management styles have traditionally concentrated on the costs of individual responsibility centres, rather
than on the costs of the company’s strategic activities, which requires the co-ordination of the activities of many
departments. These requirements are seldom found in the traditional accounting set-up, which does not focus on
determining the costs of providing product characteristics and, in the end, value to the customer.ABC is one system
that can help focus on prominent issues and developed in this time for this reason.
Eastern + Western Business strategy:

Product Strategies :Japanese Businessmen start a costing strategy exercise by determining the selling price that
the market accepts : to ensure a desired size of market share , taking into consideration the changing marketing
environment for that product , according to demand and supply, first.
Future market share is planned for and strong customer service is established.
From the selling price they work backwards , to determine max allowed costs that will determine ...according to a
calculus determined primarily by the potential customers utility for the product, the desired marketing positioning,
and internal resource inputs to manufacture product.
Co-ordinated efforts of accountants , designers,and engineers to achieve the desired cost.
Companies establish a strong cost reduction policy that ensures long term survival.
They then go to their books and determine the costs from that starting point – on the basis of cost reduction.
Any decision made on a cost plus basis will invariably give a wrong signal – ie not to actively keep costs in the right
category but to charge the customer for your first choice in production setup.
CVP ANALYSIS
special things to remember:
1. NOTE : Non –Manufacturing VARIABLE costs :are DEFINITELY deducted before ‘Contribution” is calculated
2. Per unisa: always round UP fpr a B/E analysis, if rounfd down it will casue a small loss.
3. Net Profit use MUST always be before tax, so if After-tax profit is given , and tax is given, first minus the tax
out of it .
4. Know graphs, cvp assumptions,
5. NOTE: It is incorrect to unitize fixed costs since if fixed costs are 10000 for a period and 5000 in the next
period then unit profit will therefore not be constant over varying output levels due to absorbtion
costing/variable costing effect..
SP :Sales
les VC :(Variable costs)
s
CM :Contribution Margin
=
Les FC :(Fixed Cost)
s
OP :Operation Profit
=
Les Tax :(Taxation)
s
NP :Net Profit
=
6. Definitions:
6.2. Direct (avoidable) fixed costs : applies only to single 1 of many products.
6.3. Sales mix: the ratio to each other of the different products which are made eg 1: 5: 8
ECONOMIST VS ACCOUNTANTS VIEW

1) The economists view is different from the accountants view for following reasons:
a) Economists view whole range of activity zero - end Accountants view only relevant range + short run
period where costs behave in a linear relationship.
b) Economists assume info.on price, cost, volume is available all levels activity , Accountants assume
limited availability of this info , and linearity over relevant range.
c) Economists view is EXPOSITIONAL , Accountants view is PRACTICAL.
d) Economist adds chnges such as decreasing production as limit of capital equipment bottlenecks, and labour
that gets less effective as too many people become employed to increase production- so revenue starts to
fall at a certain level
2) Mathematical difference :
a) For economist there are 2 break-even points, for accountant there is 1 .
justification for accountants view over econ0mists:

1) Justification for accountants viewpoint as opposed to economists (exam question) = The accountants view is
only in the relevant range over a short-run period of time(<1year) .Thats why all graph lines are linear and
not curved.
2) Accountant assumes non-price competition.
Economists VS Accountants COST-VOLUME-PROFIT graph :

ECONOMISTS GRAPH:
a) TOTAL REVENUE LINE IS CURVILINEAR : Firm cannot increase sales by holding selling price constant- thus
total revenue will be max where slope is zero(starts to fall as sales volume increase) or marginal revenue
from n'th sale = zero.
b) INCREASING AND DECREASING RETURNS TO SCALE :Costs at start (A-B) increase direct linear (normal
increase) then (B-C) as bulk buy discounts & division of labour, kicks in , costs level out (decrease ) then
(C- end) costs increase sharply again due to bottlenecks & production beyond normal capacity& production
beyond normal capacity & overly complex production schedules.
c) Note : there are 2 break –even points for econ. View. ,profit max where distance between cost/revenue
lines is greatest.
ACCOUNTANTS GRAPH.
i) CONSTANT FIXED COST LINE :Assumption that costs are constant in relevant range only
ii) CONSTANT VARIABLE COST & SELLING PRICE /UNIT: these 2 are also constant in relevant range –
because range is small.(sales increase from promotion etc)
iii) This is representative of a VARIABLE COSTING SYSTEM method.
C.V.P. ANALYSIS. (COST-VOLUME-PROFIT.)
uses of cvp analysis:

1. Powerful Tool used to provide answers on consequences of particular courses of action eg: ? many units to be
sold to break-even , effect on profit from reducing selling price and selling more units, ? should we pay
salespeople on commission or salary basis or both etc.
2. It is a systematic method of examining relationship between output(sales) and changes in sales
revenue/expenses/net profit.
assumptions of cvp analysis:

1) CVP is a MODEL which simulates real world activity. Like most models it is subject to certain underlying
assumptions & limitations.
(1) All other variables remain constant (when you calc. change from another variable)
(2) A single product or constant sales mix exists. (each product has a different contribution! If mix
changes , then the total contribution AND total var. costs also changes)
(3) Total costs and and total revenue are linear functions of output.(relevant range –var. +fixed costs)
(4) Profits are calc. on the variable (direct) costing basis. ( absorbtion costing can only be used if
production=sales for the period otherwise the fixed costs will get included in closing inventory and
not get charged as a period cost/ expense , so they become incl. in profit as well)
(5) Assumes a short term (normally 1 year) planning period –( ie inflation/ market changes fixed costs
eg : /salary changes/tax/prices do not change)
(6) Analysis applies to relevant range only :(as in step-fixed costs will change outside relevant range)
(7) Costs can be accurately divided between their fixed and variable elements.(this can be extremely
difficult in practice)
Standard Formula for CVP (write down once in exam- makes things
easy)
SR :Sales Revenue ( or use SP=selling price for

per unit calc. )
l VC :(Variable costs)
ess
CM :Contribution Margin
=
L FC :(Fixed Cost)
ess
OP :Operation Profit
=
L Tax :(Taxation)
ess
NP :Net Profit
=
Fixed costs:
1. NOTE: It is incorrect to unitize fixed costs since if fixed costs are 10000 for a period and 5000 in the next
period then unit profit will therefore not be constant over varying output levels.
2. Accountant assumes Step-Fixed costs with CVP analysis - per relevant range - which would be 1 step at a time.
RELEVANT RANGE
1. The CVP model only applies to the “relevant range” ( short run period where costs behave in a linear
relationship.)that is being studied. Anything over or under that would be incorrect because of :
1.1. Restricted to period where output is restricted to that available from current operating capacity.- ie to time
where plant facilities cannot be expanded, or reduced.(both take a long time to effect.)
1.2. Outside This Range the unit selling cost as well as the variable cost are no longer deemed constant per
unit.
Break-even analysis:
1. Calculation of break even :
1.1. Method 1 : Contribution margin approach :The number of units that must be sold to break even = Fixed
Costs / Contribution.
1.2. Method 2 : The break-even point is where ( [Selling price * Units Sold]- Net Profit) = (Fixed Costs)
+ (Unit Variable Cost * Units Sold)
1.3. Method 3 : where units sold not given : = [Fixed costs / P-V-Ratio] (PV Ratio = contribution/sales)
1.3.1.PV ratio is how much % contribution you get for every rand of sales
2. Per unisa: always round UP fpr a B/E analysis, if round down it will cause a small loss.
3. Why is break-even important :

3.1. Starting business it is important to know
3.2. More important to know when costs are covered than to make a profit
3.3. In long term focus on profit , short term on B/E.
target profit:
1. If a company requires a certain profit during a period- we must determine whether it is fixed or varies with
each unit sold. If profit required is fixed we treat it in same way as fixed cost – if variable we treat it in same
way as a variable cost. So you just add it to those costs and work out the ‘break-even’ point in units sold (or
in sales price if given a specific number of units to be sold) from there. ie Set : required variable as answer you
are looking for to = all other variables in the CVP formula below.
2. You can just use the Standard Formula(in heading above) for CVP and substitute in there to calc. it.
Contribution :
OR Total Sales revenue
less Variable Costs
= CONTRIBUTION
less Fixed Costs
= PROFIT
1. NOTE : Non –Manufacturing VARIABLE costs :are DEFINITELY deducted to calculate ‘Contribution”, in
Variable Costing ,and CVP , BUT are NOT to be included as part of closing inventory, nor included in the COST
OF SALES blocked off part. They go below this , but before contribution line item of course.
2. CONTRIBUTION is the SELLING PRICE of a product LESS all VARIABLE COSTS. The term used by Management
accountants to describe the incremental profit that a company will make as the company sells one more unit
of production.(DOES NOT include FIXED COSTS, ONLY PRICE -less– VARIABLE COSTS =
CONTRIBUTION, then after that ,CONTRIBUTION-FIXED COSTS=NET LOSS/PROFIT.) Mngmn acc only
concerned with contribution,not profit since incr. sales = incr.contribution where fixed costs stay constant.
Means ' contribution contributed toward total profit of firm before fixed costs subtracted .This happens
because fixed costs do not change , but production volume does, so once all fixed costs have been paid by
current production volume, any increase in production volume above this results in a higher profit than before
the fixed costs were paid for. Thus before fixed profit is paid for , ALL OF THE CONTRIBUTION goes to fixed
costs, but after the fixed cost is paid for, ALL OF THE REST OF CONTRIBUTION goes toward profit.
Semi – variable costs :

1. Note these are not proper variable costs , they have a fixed cost component which must first be removed
using the high-low method., before you use them to calc. contribution.
Change in Variable Costs

(NOT change in UNITS)
Divided by Change in SALES VOLUME
= CONTRIBUTION per unit
margin of safety:
a) Indicates by how much sales may decrease before a loss occurs.
b) Difference between : (Budgeted Sales Volume MINUS Break-Even Sales Volume)
c) Sometimes Expressed as % of Budgeted Volume or Budgeted Revenue.
d) Standard Formula : (Expected Sales – Break-Even Sales) / Expected Sales * x 100/1 = % answer
CHARTS/graphs
BREAK-EVEN CHART USED AS A “CVP” ANALYSIS:
1. You must know how to construct these charts. Watch out for the units on side.(work it out before)
2. Notice: Rands on Y axis, Sales units on the x axis. ( this is the same in ALL graphs types done here)
COST –VOLUME –PROFIT CHART/DIAGRAM SHOWN IN A DIFFERENT
WAY(VIGGARIO).
1) Simply draw a diagram as shown below detailing all totals shown with arrows/labels /units /zero/x&y axis etc
all marked.The prices/units are a bit difficult to get precise on graph-think carefully. (not sure this graph is
correct –contributin should have a separate line to profit , and they both need only 2 points – Y intercept( at 0
units) and B/E point, to draw them both.
|____________|
Margin Of Safety.
LABELS:
i) "Margin of safety" (break-even point to selling price- write below the x-axis)
ii) "Variable costs" : arrow from fixed costs line up to var.costs line –labeled.
iii) "Fixed costs" : arrow from fixed costs line down to x –axis-labelled.
iv) "Revenue/sales"
v) "Total costs( fixed + variable costs)"
vi) "Break-even point"
vii) "Increase in profit /contribution"-arrow showing along Profit&Contribution Line +++ from break-even
point.
viii)"DECREASE in profit /contribution"-arrow showing back Profit&Contribution Line ---- from break-even
point.
ix) Loss area
x) Profit area
ALTERNATIVE PRESENTATION : CONTRIBUTION GRAPH USED AS A CVP

CHART
1. TYhis is exactly the same as the above graph , exept here a variable cost line is added below the total cost
line.This MANAGES TO SHOW THE CONTRIBUTION AS THE DIFFERENCE BETWEEN THE vc LINE AND THE sr
LINE .( between variable cost line and Sales Revenue line) The fixed cost line can or cannot be left out- as one
would wish. Difference between variable cost line and total cost line = fixed cost.
ALTERNATIVE PRESENTATION : PROFIT –VOLUME GRAPH USED AS A
CVP CHART
1. Notice that “rands” on the left is not “sales” like the other 2 graphs but “profits” !
2. Only 2 points are required to plot the profit line.
3. When units sold = 0 a loss equal to the fixed costs is incurred.
4. The break-even point is on the X axis- ie where profit is equal to zero (remember that it is profits & costs on
the left, not rands)
MULTI-PRODUCT cvp ANALYSIS

1. To apply the normal CVP analysis to many products at the same time.
2. Where there are many products each product has its own fixed costs called direct fixed costs (disappears if
product is dropped) and then all products together also have a single communal fixed cost called indirect or
common fixed costs , which cannot be avoided by just dropping 1 or 2 products-it must be paid.( eg rent)
3. There are a number of different methods , each for a different multi-product problem : the methods are the
following
3.1. Another method if below one does not work (numbers can get too big to handle in below one) : you can
also calc. the avg. contribution to at the required sales mix , and divide fixed costs by this number.
NOTE ; you will get the total numer of the ‘ sales mixes ‘ needed . So this number must be DIVIDED up in
the ratio of the sales mix to get the smaller amount of each product in the sales mix that is needed.!
3.2. Calc. Break- even point for multiple products: First calc. the product ‘sales mix’, this is the normal ratio in
which products are sold- eg 1 pen : 5 pencils. Then calc the total contribution for that sales mix : (add
1*pens contribution + 5* pencils contribution). Then calc [total fixed costs / total sales mix contribution] =
Break–Even units. Note: total fixed costs here means all direct fixed+ indirect fixed costs. Then don’t
forget to convert your answer to how many of each must be made ie:Ans. X 1= xxx pens and Ans. X
5=xxxx pencils.
3.3. Use the average contribution per unit : if they ONLY give you the sales mix ratio & contribution to sales
percentage.; or some other tricky kind of question where you have to use the average contribution or
something.
3.4. Calc. break-even when unit costs are not given. : use : Fixed costs / PV Ratio = Break-Even Sales
Value ( PV ratio = total contribution / total sales )
4. Note: increase in proportion of sales of higher contribution margin product will decrease the break-even point &
visa-versa.
5.
CVP method of Manipulating Multi-Product Analysis
Pens Pencils
Sales Volume (units) 1200 600
Unit Selling Price 300 200
Unit Variable Cost 150 110
Unit Contribution 150 90
Total Sales Revenues 360000 120000 480000
LESS: total Variable costs 180000 66000 246000
Contribution (to 180000 54000 234000
Indirect+Direct costs)
LESS :direct (avoidable) fixed 90000 27000 117000
costs
= contribution to indirect 90000 27000 117000
fixed costs.
LESS: indirect(common) fixed 39000
costs.
=Operating profit 78000
The use of computer applications

1. The output is as good as the input. There are applications developed which managers can use without waiting
for reports from man.acc.
2. Sensitivity Analysis: this is a technique where the result is calc. for how the scenario will change if the original
estimates change. Eg: if sales mix changes, fixed costs up by 10% & VARIABLE COSTS down by 5%.
semi-variable costs : separation of fixed –variable

1. Use the high-low method or statistical methods to do this.
2. Eg: maintenance is an example of a semi-variable cost: it has 2 components :planned maintenance = fixed
cost + activity level dependant variable element.
key ratios for cvp

(PV RATIO) PROFIT VOLUME RATIO: ( OR ALSO CALLED ‘CONTRIBUTION
MARGIN %’ )
= Contribution / Sales. =0.abxy or ( * 100/1= ab.xy %) TO 4 decimal places OR to 2 decimal places for
%
PROFIT RATIO
=Profit / Sales =0.abcd or ( * 100/1= ab.cd %) TO 4 decimal places OR to 2 decimal places for %
(B/E SALES) BREAK-EVEN SALES REVENUE:( NOT A RATIO)
=Fixed Expenses / PV Ratio = Rands ,2 decimal cents.
REM: FIXED expenses is NEVER just the totals that do not change –it could also be in the
totals that do change -you must FIRST CHECK EVERY TOTAL eg: labour-MATERIALS-
OVERHEADS ETC FOR THE FIXED PART AND VAR. PART BEFORE you calc. the total fixed costs.
(ie watch out for semi-variable costs mixed up as fixed costs)
BREAK-EVEN SALES VOLUME:( NOT A RATIO)

=Fixed Expenses / Contribution per unit. = units (round- off unwards only –ie: per unit)
MARGIN OF SAFETY RATIO

Sales - (B\E Sales revenue) / Sales = =0.abcd or ( * 100/1= ab.cd %) TO 4 decimal places OR to 2
decimal places for % {sales means budget sales revenue. –but could also be actual... depends on needs)
OTHER TYPES:
1.1. contribution ratio or contribution margin % or ratio = marginal contribution/marginal sales (seems the
same as PV ratio !)
1.2. variable cost ratio = marginal variable costs / marginal sales
abbreviations for ratio’s etc:

(1) FC -fixed costs
(2) VC -variable costs
(3) SP -selling price
(4) OP - operating profit = net profit before tax
(5) UCM -unit contribution margin IE: contribution per unit
(6) UVC -unit variable costs :the variable costs per unit.
(7) CM or ContM. – contribution margin
(8) USP -unit selling price : the selling price per unit
analysis of cost structure USING CVP PRINCIPLES : (of a company)
1. If sales ‘NUMBER OF UNITS’ not given –do the same ‘analysis spreadsheet’ but calculate ratios TO FIND
ANSWERS instead of using the per unit cost to calculate them:
1.1. ie: contribution ratio = marginal contribution/marginal sales
1.2. variable cost ratio = marginal variable costs / marginal sales
1.3. Use the var cost ratio to find fixed & var. costs from sales – then you can firn break-even sales volume etc
etc from here.
1.4. Use the contribution & var. cost ratios to also find increase in sales effect on contribution etc etc. IF NO
UNITS OF PRODUCTION ARE GIVEN
i) REM: if selling price goes up by 10% -you cannot just * profit by 10% to get new answer- because fixed
cost : var. cost ratio will stuff it up.You must first * ‘contribution’ by 10% then subtrACT fixed costs to
get new profit (esp if . it was a loss at first)
METHOD: FORMAT OF SPREADSHEET FOR: FULL YEAR FINAL

ANALYSIS VIGGARIO PAGE 247
i. Simply divide costs up into a spreadsheet of 4 columns with totals at bottom(see where to
write names):
a. Names/itemised
b. all Variable costs PER UNIT/ea – Not Totals
c. All Fixed costs PER TOTALS – Not per Unit/ea.
d. Total column Per Item (multiply Variable cost column * Number sold
Then add Fixed Costs)
Name Variable per Unit Variable Cost Fixed Total Initial (TO ILLUSTRATE
Totals (R) figures from ONLY)
budget.
Units 100000 (TO ILLUSTRATE
units ONLY
(Put R here to split lines) Note format!!!R Format!R R R Note (TO ILLUSTRATE
FORMAT: ONLY
Sales 58(see calc.below) 5800000 5800000 (to illustrate) (TO ILLUSTRATE
ONLY
Mnftr Costs: (to illustrate) (TO ILLUSTRATE
ONLY
Direct materials (20) 2000000 2000000 2000000 Only var
Labour Costs (8) 800000 200000 1000000 1000000 80% variable
Overhead Costs (2) 200000 300000 500000 500000 40% variable
Non-Mnft Costs
Rent 400000 400000 400000 fixed
Accounting 200000 200000 200000 Fixed
Marketing (1.2) 120000 180000 300000 300000 40% var
Salaries 500000 500000 500000 Fixed
Other Costs (0.2) 20000 80000 100000 100000 40% var.with
prod.units.
(to illustrate)
For MULTI –PRODUCT : if there are more than 1 product, rem : you
do from here on the following lines instead :
1-separate mnfr.Costs like above for each product, above here
2-AND then under that ‘CONTRIBUTION to common + fixed costs
3-then first each products direct fixed costs ,
4-then another line “CONTRIBUTION to common fixed costs”
5- then below “common fixed costs”
6- , then below THAT comes Profit.
CONTRIBUTION 26.6(=sales-all var 2660000 (to illustrate) (TO ILLUSTRATE
costs) ONLY
FIXED COSTS NOTE ABOVE 1860000 (to illustrate) (TO ILLUSTRATE
ONLY
PROFIT 800000 (to illustrate) (TO ILLUSTRATE
ONLY
Income statement (or budget) showing contribution separately.

INCOME STATEMENT OF XYZ FOR PERIOD 123 R
Sales(Revenue) 58000000
Variable Costs: Total Var.
Cost of Sales : Xxx
Direct materials
Direct Labour costs etc. Xxx
Variable Overhead costs : mnftr only Xxx
Add: Opening Inventory Xxx
Less : Closing Inventory (Xxx)
Gross Profit: Xxx
Less :Non-Mnftr Var.costs : (not to be part of closing Xxx
inventory)
eg :Marketing –variable costs Xxx
Contribution: (or Total Mnftr. Costs)= (sales – variable costs) 2660000
Fixed Costs: Total Fixed

Marketing- non-variable costs Xxx
Other costs – non-variable costs Xxx
Rent : non-variable costs Xxx
Accounting :non-variable costs Xxx
Etc : non-variable costs Xxx
Profit/Loss =(contribution – fixed 800000
costs)
Add: opening Inventory Xxx
Less : Closing Inventory (Xxx)
NOTE : Non –Manufacturing VARIABLE costs :are DEFINITELY deducted before ‘Contribution” is calculated in
Variable Costing ,and CVP , BUT are NOT to be included as part of closing inventory, nor included in the COST OF
SALES blocked off part. They go below this , but before contribution line item of course.
CHAPTER :BUDGETS
Still add a raw materials needed per product budget- check all last years budgets for an example of this-magato-
Principles of Budgeting:
DEFINITIONS:
1) Definition: Budgeting :are accounting plans that normally serve the purpose of quantifying the objectives
of the firm and provide a basis for control and performance evaluation. It is long & short term goals that are
quantified Financially OR Physically. Important is Comparison between goals & results.
2) The 3 motives for holding cash, as described by Keynes ;
a) Transactional
b) Speculative
c) Precautionary
3) Definition Management by exception: mngmnt focusses their attention on significant variances from
expected results
4)
TYPES OF BUDGETING:
1. Continuous or rolling budgeting : 5 quarters ahead ,mnthly for next quarter & quartery for rest. Reset
next 3 mnths & 5th mnth again every quarter .
2. Incremental budgeting : old budget is used to prepare next one.
3 CATEGORIES OF BUDGETS:
1) Operating Plans:
a) Operating plans are directed at the Production and Investment objectives of the firm.
2) Administrative Plans
a) These form the objectives of the development and maintenance of the Companies structure.
3) Strategic Plans
a) Long term company objectives in relation to Competitors , Company growth, and Philosophy.
REASONS FOR BUDGETING:
1) Periodic Planning : budgeting process’ creates a formal planning framework that provides specific deadlines for each phase of the
planning process:
2) Co-ordination of company activities and quantification of objectives. : exchange ideas between various
company segments +quantify costs of available alternatives + compare cost/revenue of each product&dept.
3) Performance evaluation : compare actual to original or flexed budget.
4) Control : manage all inputs & outputs : budget vs actual
5) Cost Awareness : promote cost awareness in managers who are normally concerned with other things eg production or marketing
strategy.
6) Goal Orientation. : makes depts. achieve company goals, not their own goal. Often highlighted in the the transfer and use of
products intercompany- looks like nothing but it could be too much.
FINANCIAL & MANAGEMENT BUDGETING:

1) Define the objectives of the budgeting system to prevent: a battle of wills to by dept managers to get the Max.
expenditure and the Min. results.(to just keep fin. Managers happy)
2) Companies must realize there are 2 separate budgetry functions in the corporate objectives
a) Financial control: ie the Master Budget incorporating all the financial budgets.
b) Management Control : Line & production managers : system should allow greater freedom of action by line
managers varying from specific details to more general target specifications thereby improving attitude of
workers etc.
LONG TERM PLANNING:
1) Concerned with defining company objectives eg:
a) Profit maximization
b) Or Increase market share
c) Or Improve company image
d) Or Increase shareholder wealth
e) Or non-financial issues
i) Eg :environmental issues /
ii) Employee job satisfaction
iii) Improve company image ( where do we want to be in 10 years)
iv) Environmental issues.
v) Staff training
2) Strategic Planning :
a) Requires :(it is a whole process to be read up about)
i) SWOT ananlysis : Strengths & Weaknesses + Opportunities & Threats evaluation.
ii) Establish Data Banks to provide past & current information for planning.
iii) Establish Preliminary Long Term Forecasts.
iv) Review Expectations of internal + external company participants.
b) The 3 Generic Strategies that a company can aim for:(porter,1985) : view is that in seeking a
sustainable competitive market , you must select appropriate generic strategy instead of becoming all
things to all people.
i) Cost Leadership
ii) Differentiation
iii) Focus: eg aimed at particular buyer group /smaller geographical area /segment of (possible)product line
only. Esp : Small companies focus on niche market , very small segment so that they can become
competitive there.
(1) After determining which one: , you determine direction you wish to take in doing it : choose 1 or
more of the following:
(a) Do nothing
(b) Withdraw from some markets
(c) Market penetration :Sell existing products more effectively in existing markets
(d) Market development : existing products in new markets
(e) Product development: develop new products for existing markets
(f) Diversification :new products for new markets
3) 5-10 years management to look at where it wants to be : as per asset base + labour force + market share. +
non-financial issue (as mentioned above)
4) See where resources are to be directed.
5) Most common Problems with Strategic Planning:
i) To make managers do Long term goals because they are vague and do not allways cause short term
profit (no-bonuses) etc.
ii) The assumption that historical data can be extrapolated to the future because unknown economic &
political changes make future strategies void within a short time.
POSITIVE FACTORS OF BUDGETING
BUDGETING & THE HUMAN FACTOR

1) Meeting goals means employees must 1- understand them and 2-act in certain manner to meet them
2) Coersion is often used eg : bonus or take action if budgets not met.
3) Lack of consultation as to employees reaction can lead to industrial disputes.
4) Dangers of Strict Performance Evaluation :Line managers could make sure budget is not bettered as future
budgets will be even more stringent.- ie deviousness. Also manipulate data and dysfunctional behavior to get
around tight budgets.
5) Defined, quantitative targets are more likely to motivate management to perform well, even if they are difficult,
as long as they are accepted by management.
6) Budgets will motivate workers if they represent a set of definite, quantitative goals, together with regular
feedback on the attainment of the standards. It is therefore essential that management is involved in setting
standards and budgets.
7) Companies should strive for a budgetary system that will achieve complete goal-congruence between the
workers and the company.
8) Positive aspects of budgeting
9) If the budgeting system creates a negative reaction in workers, who may see the system as unfair and
inequitable, you will create a subversive spirit leading to dysfunctional behaviour in conflict with corporate
goals.
The budgeting process should, where possible, be structured in such a

• El sets appropriate standards of performance:
• El defines good performance and provides a means of measuring such pertormance, anc
• U stipulates how rewards are to be linked to results.
• El Communication of corporate objectives and budgetary guidelines to all people responsible for budget
preparation.
• El Determination of the success factors of the company.
• El Full participation by all line management, with a commitment to meet corporate goals.
• II Preparation of the sales budget.
• El Preparation of budgets for all major operating activities.
• U Negotiation of budgets and standards.
• Co-ordination and review of budgets.
• El Acceptance and communication of all budgets by managers who will bear responsibility.
• El Frequent feedback of actual performance against budget targets.
• El Flexible budgeting capabilities.
• El Monetary and non-monetary incentives.
TIMING OF BUDGETS
1. Irrspective of whether budgets are prepared on a continuaous or yearly basis, it is imperitive that monthly
or 4 weekly budgets be used for control purposes.
2. 2 METHODS;
a. YEARLY BUDGETING
b. CONTINUOUS or ROLLING BUDGETING.
i. THE budget is broken down by mnths for the 1st 3 mnths, then by quarters for the remaining
3 quarters.
ii.Then when quarter 1 is finished, the next quarter is done by mnth again.
iii.A 5th quarter is also added every time a quarter finishes. This means there are ALLWAYS 4
quarters in the process .
iv.BENEFITS: managers encouraged to look ahead and review plans , constant review and
updating – means nothing lags behind for a whole year , actual compared to budget for more
realistic target each time ( was only detailed 3 mnths ago , not 1 yr)
v.DISADVANTAGES: can create uncertainty for managers because the budget is constantly
being updated.
STAGES IN BUDGETING:
Method for Budgets:
MASTER BUDGET:
1) The master budget is the total budget package for a company; It is the end product of the budget preparation
process. The master budget consists of all the individual budgets for each part of the company aggregated into
one overall budget for the entire company. The development of the master budget is a sequential process, in
which information from one budget is carried forward to another budget. Some elements, such as the capital
expenditure budget, are independent.
2) Components of the master budget

• Operating budget
• Sales budget
• Budget of ending inventories
• Production budget:
— Materials budget
— Direct labour budget
— Manufacturing overhead budget.
• Budgeted cost of goods sold
• Administrative expense budget
• Marketing expense budget
• Budgeted net income from operations
• Budgeted non-operating items
• Budgeted net income
FINANCIAL BUDGET
Consists of the following parts:
• Capital expenditure budget
• Budgeted statement of financial position (balance sheet)
• Budgeted statement of changes in financial position
OPERATING BUDGET
• The operating budget is composed of the income statement elements. A manufacturing business budgets
for both manufacturing and non-manufacturing activities. We will discuss the various elements of the
operating budget of a manufacturing firm shortly.
CASH BUDGET: (OR CASH FLOW STATEMENT)

• Cash Budget is one of the most important budgets because it shows how liquid a company is.
• Normally prepared Weekly or Monthly as they are required for management (liquidity) information.
KEY PREPARATION OF CASH BUDGET PRINCIPLES STEPS

Notes :
1.Rem: wessels calls Gross Profit of 45% to meanit is gross profit on “sales” x 45% = profit so sales x
55%= cost of sales/inventory/purchases. Other lecturers seem to call the same thing as to mean it is
on “cost of sales” X 45 % = profit so always ask the lecturer what they means by “gross profit of
45%
2.Remember if they say bad debts = 5% of all credit sales, and they give you a figure for credit+cash sales
combined, and say credit=40% and cash = 60% ,you cannot say total X (40%-5%=35%) = credit sales after
bad debts , it will give you a wrong figure. You must say: first get credit sales ie 40% X total, then after that
deduct bad debts.
3.If they say ‘company contributions;:
3.1. are payable on 7th of following month, it means they ONLY pay then , not before ever.
3.2. Company contributions are not deducted from salary, it is paid by company separately.(uk system)
3.3. Secondary tax on companies on DIVIDENDS is not ever deducted from the dividends declared. What is
declared is what will be paid, and any tax is worked out before this. So if they say dividends of 10000 and
secondary tax = 10% of dividend declared it does NOT mean deduct 10% from 10000, it means 10000
for dividends and 1000 for STC(secondary tax) =11000.
4.Rem: depreciation and other non-cash expenses always DO NOT appear, are removed from, the cash budget.
KEY CASH BUDGET STEPS:

1. First you prepare the Debtors Collection Schedule, then the Creditors Payment Schedule, and then you can
go and prepare the final Cash Budget (or also called the Cash Flow ). Also , it is one of the last budgets one
prepares, because you must do all the sales,production, purchases etc budgets first to get all the figures
you need.
2. The cash budget is one of the most important budgets as it shows how liquid the company is at any point in
time. Cash budgets are normally prepared weekly or monthly, as they are required for management
information.
3. Key factors in preparing a cash budget are
a. Establish opening cash balance
b. Estimate cash from operations, ie net income after adjusting for non-cash items such as depreciation
c. Estimate timing of debtor cash receipts taking into account customer payment behaviour
d. Include all non-operating cash items such as capital purchases, repayment or advances on loans, etc
e. Estimate the amount and timing of credit payments, salaries and wages
The difference between the net income figure and net cash flow is explained to a large extent by the
changes in working capital.
Note: The cash budget is normally the more complex budget to complete, because non-cash items appearing in
different budgets must be adjusted for (removed). Receipts &payments also usually lag behind periods incurred in
Note: Esp. in exam, it is recommended to first draw up a diagram to determine where cash flows take place.
STEP 1 DEBTORS
COLLECTION
SCHEDULE:
Cash Flow at Top
MONTH TOTAL JAN FEB MAR
December - 10000 (if8000
credit(cash in from it
previous credit sales) is
calculable
)
January-Cash 20000 20000
January-Credit 80000 16000 40000 20000
Feb-Cash 24000 24000
Feb-Credit 96000 19200 48000
Mar-Cash 32000 32000
Mar-Credit 128000 25500
Workings for Debtors Schedule: (rather
Capital expenditur? 1000 500 500
write jan/feb with/ instead of %) : see all
Loan repayments? 5000 1000 2000 2000
the calculations on the left of this debtors
Etc. 10000 5000 5000 0
schedule for how to do the calculations.
TOTALS This total will 52500 98250 127500
include
april,may,etc
,so leave
out.
This is the
January-Cash 100% AS
PER
exercise
January-Credit(cash in 20% 50% 25%
from previous credit
sales)
Feb-Cash 100%
Feb-Credit 20 50%
Mar-Cash 100%
Mar-Credit 20%
STEP 2: CREDITORS PAYMENTS SCHEDULE
• You can do the same type of creditors payment schedule as above
• or.
• Rem: wessels calls Gross Profit of 45% to meanit is gross profit on “sales” x
45% = profit so sales x 55%= cost of sales/inventory/purchases. Other
lecturers seem to call the same thing as to mean it is on “cost of sales” X 45 %
= profit so always ask the lecturer what they means by “gross profit of 45%
MONTH TOTAL JAN FEB MAR

January-Cash 20000 20000
January-Credit(cash 80000 16000 40000
out from previous credit
sales)
Feb-Cash 24000 24000
Feb-Credit 96000 19200 xxxxxx
iTOTALS xxxx xxxx xxxx xxxxx
• Another type of payments/purchases budget.
Creditors’ payments schedule/Purchases

March April May
Sales 100 000 105 000 117 000
Cost of sales 66 667* 70 000* 78 000*
Opening Stock (15 625)* (60 000) (60 000)
100
Closing Stock (90 000 x /150) 60 000* 60 000* 60 000*
Increase Stock 44 375* - _ - _
Purchases 111 042 70 000 78 000
Discount @ 4% (4 442)* (2 800)* (3 120)*
106 600 67 200 74 880
Solution: CASH BUDGET or CASH FLOW

STATEMENT
Jan Feb Mar Apr Total
Open Bank (10000)(eg: from (142000) (from
Balance material being paid 1 below left)
Qtr in advance)
Sales 0(there were sales 60000(cash
but no receipts of received for previous
cash yet) sales etc.)
OR :
Debtors Collection xxx Etc Etc Etc Etc
CreditorsCollection xxx Etc Etc Etc Etc
Total (10000) Etc Etc Etc Etc
Less:materials (80000) Etc Etc Etc Etc
Less:labour (10000) Etc etc Etc Etc
Less:other (20000) Etc Etc Etc Etc
Less:etc (22000) Etc Etc etc Etc
Capital expendit. Etc Etc Etc Etc Etc
Etc etc.
Closing Bank (142000) Etc Etc etc Etc
Balance
SALES BUDGET:
1) The sales budget is the first budget to be prepared, and it is usually considered the most important budget
because so many other budgets are directly related to sales and are therefore largely derived from the sales
budget.
2) Factors that are taken into account include
(a) Decisions taken by competitors
What the competitors are doing is important, as we need to consider whether we are likely to gain or lose
market share. Perhaps we should even consider diversifying.
(b) State of local and world economy
We need to consider our current markets as well as the potential for export. Local and world trends are
important, especially as the two begin to merge as lechnological advances improve. We need to consider
inflation rates, exchange rates and cost of debt.
(c) International markets
These must be considered from both the exporting side and the effect that imported goods will have on our
projected sales.
(d) Effectiveness of advertising and promotion policies
The effect that advertising will have on our product needs to be considered. Where necessary, surveys
should be carried out to ascertain consumer tastes. Demand elasticity should also be ascertained in setting
a pricing strategy.
(e) Effects of seasonal fluctuations
We need to ascertain if there are any seasonal or cyclical trends that should be considered in creating our
objective or subjective forecasts.
(I) Stability of supplies
Consideration of supply lines is important, as disruption will cause production bottlenecks that will affect
sales.
(g) Historical data
In preparing forecasts, it is always important to analyse historical data to ascertain trends and determine
whether future expectations are likely to mirror historical trends.
Key General Budgeting Factors
1) The key to budgeting lies in the recognition of the sales market as well as the production limitations.: These
are:
a) Expected Sales levels of products
b) Production capacity dictated by space, machine output, availability of labour and material.
c) Financial Resources, both short and long term
Sales Budget (EXAMPLE per

viggio)
JUNE Total JUL Total AUG Total

Value Value Value
Products Price Units Total Units Total Units Total
Value Value Value
June
Mondi 120 1000 120,000 Etc etc etc Etc
Hilton 150 2000 300,000 Etc etc etc Etc
420,000 Etc etc etc Etc
OR ALTERNATIVELY YOU CAN USE THIS LAYOUT, IF THERE are workings to be shown in the columns,
and not enough space etc.
Products Price Units Total Value

June
Mondi 120 1000 120,000
Hilton 150 2000 300,000
420,000
July
Mondi Etc etc
Hilton etc
etc
July
Mondi …total total …total
Hilton …total Etc …total
total
etc
Another Example Of Sales Budget “Workings”(vigio)

May June July Aug
Sales –Units 800 1000 1000 1200
Sales –Value 96000 120000 120000 144000
More “Sales” workings: (Vig) (for getting the % in weird questions with multiple % discounts etc to work out
first, before you do the answer)
May 45% 30% 15%
Jun 45% 30% 15%
Jul ` 45% 30%
Aug 45%
PURCHASES BUDGET : FOR RAW MATERIALS / OR RETAIL STOCK /OR

ANY
1) Purchases layout is similar to the production budget layout – both use ALLWAYS START WITH :
Opening balance
Production Units to be used/needed
REQUIRED Closing balance NB: needed that for month-could mean extra must be bought / produced
=TOTAL NEEDED FOR THAT MONTH.
2) One can do a purchases budget for Raw materials or Stock for a retail shop or anything else. One can do a
separate purchases budget for each of these things , then combine them in a master purchases budget, or just
add the figures from each to get the total purchases for the Budget Income Statement (SCI) or Cash
Budget(cash flow budget)
3) Before you do the purchases budget you must do the Sales Budget then the Production Budget then the Raw
Materials Opening Stock Budget etc. to get all the figures needed to do this budget. So it is one of the last
budgets you do.
PURCHASES BUDGET for: Raw Materials (MANUFACTURING)

(EXAMPLE per viggio)
1st half 2nd half Total
Material A
Required closing 13500kg Etc Etc
Stock
LESS:Opening 12500kg Etc Etc
stock
1000kg Etc Etc
ADD: materials 1250x20 Etc Etc
needed for ea=25000kg
current
production
Budget 26000 Etc Etc
Purchases
Material B.
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc
Another type of payments/purchases budget:
PURCHASES BUDGET for RETAIL SHOP STOCK.

March April May
Sales ( cosmetic ie: X 70% = cost) 100 000 105 000 117 000
Cost of sales 70 000* 78 000* 66 667*
Opening Stock (60 000) (60 000) (15 625)*
Closing Stock (eg 105 000 x 100/150) 60 000* 60 000* 60 000*
Increase Stock Could be used for pure info. purposes.
Purchases 111 042 70 000 78 000
Discount @ 4% (2 800)* (3 120)* (4 442)*
106 600 67 200 74 880
OPENING STOCK (FINISHED GOODS OR RAW MATERIALS ETC) BUDGET:

1) This is a very specialized budget , actually just a calculation to work out the opening stock. The budget of this
type which would be more of a ‘budget’ is a ‘Stock’ or “stock-holding” budget –There can be many different
“stock ‘ budgets, eg 1-raw materials 2-finished goods etc.
2) A Raw Materials budget can be done in EXACTLY the same format and way- just different names&numbers.
3) This budget could be prepared in a format where the periods are in columns and materials on the left if it is
more convenient. Ie column 1=Material 2-Cost each 3- July: no.Units & Total Cost 4-Aug no.Units&Total
Cost 5-Sept. No.Units & Total Cost etc. etc. etc.
Given a policy to keep sufficient stock on hand to meet 50% of sales in following year:
1-First work out the cost of each finished goods.
Finished Goods Budget (EXAMPLE per viggio)
Products Units Cost Total Value
Opening stock Begin Year
Mondi 50%x1000=500 80 40,000
Hilton 50%x2000=1000 100 100,000
140,000
Stock Begin Second Half
Mondi Etc Etc
Hilton Etc
Year End Stock

Mondi Etc total …total …total
Hilton Etc total …total …total
PRODUCTION BUDGET:
• The production budget is dependent on the expected sales, together with required inventory levels of finished
goods. The production plan must take the opening stock levels into account, and specify the timing of
production.
• Remember: if the question says the policy of company is to keep 50% of the ‘estimated’ sales of finished goods
in stock then even if they DID NOT SAY there is any opening stock in the first year, THERE PROBABLY IS so
you must work it out as the OPENING STOCK for the first year of production ( this is a hidden figure- not given
or logical & plain)
• Production budget works on Units, not normally on Rands Value.
Given a policy to keep sufficient stock on hand to meet 50% of sales in following year:
1-First work out the cost of each finished goods.
Production Budget (EXAMPLE per viggio)
Mondi
Required closing 750 600 600
Stock
LESS:Opening 500 750 500
stock
250 (150) 100
ADD: Expected 1000 1500 2500
Sales
Budget 1250 1350 2600
Production:
Hilton
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc Etc
Etc Etc Etc
OPENING STOCK -RAW / DIRECT MATERIALS- BUDGET:

Direct materials budget
• Purchases will be determined by opening stock levels, desired closing stock levels, and production
requirements. We need to consider:
○ Quantity discounts
○ Storage capacity
○ Stock and re-order levels
○ Delivery times from suppliers
○ Liquidity constraints
• So you first have to do the production budget in order to get the figures to be able to do this raw materials
budget next.
• This budget could be prepared in a format where the periods are in columns and materials on the left if it is
more convenient. Ie column 1=Material 2-Cost each 3- July: no.Units & Total Cost 4-Aug no.Units&Total
Cost 5-Sept. No.Units & Total Cost etc. etc. etc.
Given a policy to keep sufficient stock on hand to meet 50% of PRODUCTION(not sales) in next 6mnth period:
For unit calculation is was here: 50% x 1250(from previous budget) x20kg per unit= total material A needed
Raw Materials Stock Budget (EXAMPLE per viggio)

Materials Units Cost Total Value
Opening stock Begin Year
Material A 50%x1250x20=12500 2 25000
Material B 50%x1600x10=8000 5 40000
65000
Stock Begin Second Half
Material A 50%x1350x20=13500 Etc
Material B Etc
Year End Stock

Material A Etc total …total …total
Material B Etc total …total …total
LABOUR BUDGET:
1) The direct labour budget is useful for production planning as well as for personnel management. Consideration
must be given to any changes in the type of labour talent needed as a result of changes in the mix of products
manufactured and sold. Significant swings in production during the year cause much greater problems in
planning for labour than for materials and manufacturing overheads.
2) Factors requiring consideration
(a) Establish general requirements for skilled and unskilled labour
(b) Training needs
(c) Staff turnover
(d) Wage negotiating policies.
3) It is Taken from other budgets prepared for eg :Production Budget etc. above then carried on from there, so:
LABOUR Budget (EXAMPLE per viggio)

Mondi type product.
Budget 1250 Etc Etc
Production
Direct Labour x4 Etc Etc
Hour
Total hours =5000 hrs Etc Etc
Hourly rate x10 Etc Etc
Direct Labour =R50000 Etc Etc
Cost
Hilton type product.
Budget Etc Etc Etc
Production
Direct Labour Etc Etc Etc
Hour
Total hours Etc Etc Etc
Hourly rate Etc Etc Etc
Direct Labour Etc Etc Etc
Cost
Total hours =50000 hrs Etc Etc
Hourly rate x10 Etc Etc
Direct Labour =R50000 Etc Etc
Cost
OVERHEADS BUDGET:
Eg :
1. You could have a factory overheads budget, direct & indirect overheads budget, Selling Expenses &
Administration Overheads Budget etc.
2. They are all basicly like this ,
3. Stationary
4. Salaries
5. Indirect materials
6. Depreciation
7. Power
8. Maintenance
9. xxxxxxxxxxxxx
DEPARTAMENTAL BUDGET:
1. FOR EACH DEPT, YOU COULD HAVE 1 BUDGET JUST TOTALLING ALL THEIR EXPENSES OR SALES OR
WHATEVER.Like a master budget but just for each dept – depending on what they require.
BUDGET INCOME STATEMENT/ STATEMENT OF INC&EXPENDITURE:

Taken from budgets above then carried on from there, so:
Sales 140000
Opening Stock: Finished product 65000
Opening stock: Materials 138250
Purchases: Materials 130000
LESS :Labour costs: (130 000)
473250
LESS Closing stock: Finished product (120000)
LESS Closing stock: Materials (73000)
COST of SALES: 280000 (280000)

Profit for the Year/half year/etc. 140000
Q1 Q2 Q3 Q4 Total
Sales (15000)(eg: even if (142000)
not paid for yet)
Costs
Less:materials (10000) Etc Etc etc etc
Less:labour (80000) Etc Etc etc etc
Less:other (10000) Etc Etc etc etc
Less:etc (20000) Etc Etc etc etc
Planning etc (22000) Etc Etc etc etc
Total costs ******** Etc Etc etc etc
Profit/loss (51)
NOT FINISHED YET : STILL TO DO: no

time
The following set of scans is what you could not finish due to no time:
still to study very well.as budgets are very common & important.
h
FLEXIBLE BUDGETING
1. Flexible budgeting is just taking the actual sales and making a new budget from the old one based on the
actual sales but using the old budgets costs and other figures. Then we can compare the flexible budget with
the actual budget and see all the variances that happened with costs etc. (see variable and absorbtion costing
and
2. A good example of a change in the actual sales compared to budget is the Cost-Volume-Profit (CVP) graph. The
CVP graph shows the cost structure for the company within the relevant range and the expected increase or
decrease in profits if the actual sales are different to budget. If we wish to cornpare the actual performance to
budgeted performance, we would construct a flexible budget in accorr dance with the company cost structure
and compare it to the actual results.
3. Note: The CVP chart and performance analysis are variable costing concepts and cannot be done on an
absorption costing basis. I-lowevcr, if we wish to analyse the actual results on an absorption costing basis we
can do so, hut the results will not he consistent with CVP assumptions and will not reflect a correct analysis of
performance.
4. lfwe compare the flexible budget to the actual results when analysing performance, does that mean that the
original budget is irrelewint? The original budget is very important, as it is based on the expected sales and if
the actual sales are different to the expected sales we would want to know why. A correct analysis of
performance must start with the original budget, reconcile to the flexible or standard budget followed by
analysis of variances to arrive at actual profit.
ZERO BASED BUDGETING

1. Also known as priority-based budgeting.
2. Basicly you start at zero for each budget, not using last years reworked figures. Then it forces you to rethink
each process /activity (ABC based) and eliminate non value adding activities or parts of activities and
concentrate on customer driven needs for putting the money into those areas .It eliminates useless spending.
3. All activities are JUSTIFIED and then PRIORITIZED before decisions are taken as to budgets.
4. This is an extension of ABC (activity based costing budgeting) and one must first understand ABC budgeting to
be able to do this ( see ABC budgeting heading further below)
5. Decision Packages: are identified for each decision unit , each decision unit represent an operation or group of
activities that an organization undertakes. For example, managers might be asked to specify the base package
in terms of level of service that can be provided at 70% of the current cost level and incremental packages
identify higher actrivity or cost levels.
ABC BUDGETING (ACTIVTY BASED COSTING) OR INCREMENTAL BUDGETING.
These are the only 2 pages out of the drury book on ABC budgeting.
COMPUTERISED BUDGETING
1. This new method of budgeting has reducted the workload of accountants a lot, allowing then to focus on the
important parts of the process instead of the figures . it allows easy and automatic comparison to actual and
flexible budgets and original budget.
2. It is easy for mngmnt to evaluate different possibilies eg 10% higher cost etc and do extensive what- is
analysis. So eg if credit terms are decreased to 30 days, or unit costs increase by 5% , can all be shown in
terms of a master budget instead of having to re-do all the product cost budgets or sales receipts budgets etc-
the computer does it all automaticly.
3. Control reports and revised budgets are easy in the middle of the year.
Web- based budgeting:

1. This is an offshoot of computer budgeting allowing cost centres all over the world to update and access their
budgets and fill in all the needed info, instead of the accountant having to do costant input of info and recons.
2. Eg Clarus corporation’s Web deployed enterprise version of its budgeting tool – used by Toronto-Dominion
bank.
LINE ITEM BUDGETING

1. This is the original format of budgets esp. for non-profit organizations. Each type of expenditure has the figure
for last year,AS WELL AS this years budget, and revised budget and next years budget all in one line to
be able to compare them effectively.
2. These budgets fail to take ABC and cost centres/ wise usage of resources into consideration. See PPBS
(Planning ,Programming Budgeting Systems ) for a method suited to overcoming this (esp for non-profits eg
municipality.
RELEVANT COSTS
AA
1. A
SPECIAL NOTES FROM UNISA

Please note the following:
1. Costs and benefits that are independent of a decision are not relevant and need not be considered when
making the decision. Only differential or incremental cash flows should be taken into account. Cash
flows that will be the same for all alternatives are irrelevant. Cash flows that have already been
incurred are sunk costs and irrelevant for decision-making.
2. The total relevant cost of production :is usually the variable cost per unit multiplied by the additional
units produced plus (or minus) any change in the total expenditure on fixed costs.
3. Committed costs : cannot be relevant to a decision that a manager is making now to improve ormaximise
profits.
4. Fixed Costs : are irrelevant costs (Except for such costs as incremental and divisible fixed costs)
5. Total Variable Costs: Variable costs are often considered as relevant costs. Committed variablecosts are
nevertheless irrelevant to decision making.
6. SOME GUIDELINES FOR DETERMINING MATERIAL AND LABOUR RELEVANCY
7. Material
a. Purchased in the past = • Sunk cost
a. Ordered or received, not yet paid = • Sunk cost (already committed to pay), unless able to return
the goods to the supplier
a. No other use at present = • No value (0)
b. Could be sold directly = • Net realisable value
c. May be used on another job = • Lost contribution (opportunity cost)
d. Frequently used = • Replacement cost
e. Used as a substitute = • Cost saved by not having to purchase other material
f. Must otherwise be disposed of = • Opportunity saving
1. Labour
a. Salaried labourers: Already working at business = No cost
b. Work overtime = Overtime cost
c. Additional labourers / wage workers:
d. Employ additional labourers = Basic pay
e. New labourers work overtime = Basic pay plus overtime
f. Specialised labour (scarce) = Opportunity cost of projects sacrificed
SPECIAL NOTES:
1) GENERAL NOTES:
1. Question: explain the misconceptions relating to relevant costs&revenues = 1-var.costs are not always
relevant,they can be irrelevant if they are the same for both choices,2-fixed costs are not always irrelevant,
they can be relevant if they are different for both choices.
1) DETERMINING THE RELEVANT COSTS OF DIRECT MATERIALS
1. Where materials are taken from stock the original purchase price of the materials is a sunk cost , and only the
replacement cost of the materials should be taken into consideration when making decisions.
2. BUT if the materials have no value – useless exept for that 1 activity- then their relevant cost will be zero.
2) DETERMINING THE RELEVANT COSTS OF DIRECT LABOUR
1. Direct labour can be a relvant or irrelevant cost – casual = relevant , full time cannot fire = irrelevant over
short term, but relevant over the long term. If there is other work to be done = contribution opportunity cost +
hourly labour rate etc etc, each case is different,on its own basis.
3) DO NOT COMPARE UNIT COSTS, THERE IS THE DANGER THAT FIXED
COSTS WILL BE UNITIZED AND TREATED AS VARIABLE COSTS. IN MOST
CASES ONE SHOULD COMPARE TOTAL AMOUNTS OF REVENUE & COSTS
RATHER THAN UNIT COSTS.(PER TEXTBOOK VERTABIM)
1. Students have a problem with presenting info. clearly. DO put same cost down for each alternative next to
each other in columns. Common fixed costs should never be allocated to the alternatives( the exam marker
will have different figures there –leave it out)
CONTEXT OF RELEVANT COSTS:

1) Management accounting is primarily concerned with producing budgets, setting performance standards, and
evaluating performance.
2) Relevant costs Requires an understanding of:
1) Special Orders: A special order is one that will not affect a companies current sales to its regular
customers (often as an export). It is usually sold at below full cost – by using contribution to work out an
extra low price, because overheads are covered by sales to normal customers. { {Note : Be careful : even
doing this for export can cause the goods to re-appear on the local market at lower price than you usually
even sell at.}
a) 2 Alternative Decisions: is about comparing a capital–intensive business to a labour intensive-business.
b) Limiting Factors: always look out for when assessing any exam question: eg: production bottlenecks/raw
material supply problems ie. : quotas.
terms:.
1) Relevant Cost:
i) a future cash flow arising as a direct consequence of the decision under review.-ONLY RELEVANT COSTS
should be considered in decision making , because it is assumed that in the long run future profits would
be maximized if the ‘cash profits’ of the company, ie: the cash earned from sales minus the cash
expenditures incurred to sell the goods, are also maximized.
ii) COSTS WHICH ARE NOT RELEVANT INCLUDE:
(1) Past sunk costs, or money already spent.
(2) Future spending already committed by separate decisions.
(3) Costs which are not of a cash nature eg: depreciation
(4) Absorbed overheads (only cash overheads incurred are relevant to a decision)
iii) The relevant cost of a unit of production is usually the variable cost of that unit plus (or minus) any
change in the total expenditure of fixed costs.
2) Differential cost /cash flow
a) A differential cost is the difference in cost of alternative choices. If Option A costs an extra R300 Option B
costs an extra R360, the cost differential is R60, with Option B being more expensive. A differential cost is
the difference between the relevant costs of each option.
3) Incremental cost / cash flow
a) The differential cost of an extra unit of production is the extra cost required to make that unit, ie it is the
difference in cost between making the unit and not making it. This type of cost is also called incremental
cost. Incremental costs are relevant costs.(can also be used as another way of saying differential
costs in some books- not marginal per unit - so it could mean plain differential costs in some questions,
you cannot be sure)
4) Opportunity cost
a) An opportunity cost is the benefit foregone by selecting one alternative in preference to the most
profitable alternative. If, for example, a company is currently making a cash-flow of R100 000 from the
use of a machine and it now has an opportunity of investing in a new machine, the choices are:
i) Continue with the existing machine
ii) Replace with the new machine
iii) Sell existing machine (opportunity cost)
5) Sunk costs
a) A sunk cost in decision-making terms is a past expenditure incurred as a result of past decisions, which
the Present Decision about a specific problem will not change , nothing can be done about it -it is gone and
past:
i) It could have been charged as a cost of sale in a previous accounting period, OR Will be charged in a
future accounting period, although the expenditure has already been incurred (or the expenditure
decision irrevocably taken). An example of this type of cost is depreciation. if the fixed asset has been
purchased, depreciation may be charged for several years but the cost is a sunk cost about which
nothing can now be done. Or Eg: if you want to decide between travelling by train or car, say you
decide to keep the car no matter what your decision, then the car of car licence and insurance is
irrelevant , only petrol and train ticket is relevant , the licence&insurance is a sunk cost.
6) Special Studies : decisions that are not routinely made at frequent intervals.
7) Decision making problem - either adding a new product or make or buy decision or special orders etc each
one is a problem for making a financial decision
8) Decision relevant approach : used to describe the specific costs and benefits that should be reported for
special studies ie what is relevant and what is not
9) Qualitative factors : those factors which cannot be expressed in monetary terms are classified as qualitative
factors- eg if you close a division down then the employee moral that you might loose is a qualitative factor. It
does count a lot, and must still be taken into Account, but cannot be measured accurately.( eg *customer
satisfaction* from better quality control OR more on time deliveries from new production process causes better
*customer satisfaction*)
10)Production Point Of Indifference: ie where the total cost of a capital-intensive company = the total cost of
a labour-intensive company
11)Optimized production technology: new method of reducing bottlenecks & increase production- see notes
12)Theory of constraints :new method of reducing bottlenecks & increase production- see notes
13)Throughput accounting: new method of reducing bottlenecks & increase production- see notes
14)
METHOD OF RELEVANT COST DECISIONS:

1. The relevant costing decisions could be over any time-horizon the decision maker wants, but generally we
concentrate less on short term and because the objective is generally to increase long–term net cash inflows.
2. The following types of Special Studies involving relevant costs are dealt with in this chapter as an introduction
to relevant costing:
2.1. Adding a new product
2.2. Decisions on replacement of equipment
2.3. Discontinuation decisions (dropping a product or division)
2.4. Outsourcing (make or buy)decisions
2.5. Special selling price decisions (SPECIAL ORDERS)
2.6. Product –mix decisions when capacity constraints exist
1) adding a new product

Following factors are to be considered: 1- working capital :cash to be invested in stock and debtors , as well as 2-
incremental admin.costs, 3-advertising ,4-incremental marketing costs, etc.
2)Decisions on Replacement of old equipment- the irrelevance of past

costs
1. To make this decision you might have to take into account : depreciation on both machines , new cost (an
expense), old selling value(an income),higher variable costs on old etc etc. See scanned example below for
setout method for a solution.
What on earth is the “lump sum depreciation write-off” in column 2? How can you write off deprec. if you sell it? It
is mos just a ‘loss’ of 90-40= 50000 depr. write – off? Not 90000. And where is the deprec. for the new machine
then, it also gets 70000 over 3 years!
3) Discontinuation decisions : (Dropping a product or division)

1) Following factors are to be considered:
i) Production capacity taken up by product :
(1) Under-utilisation condition of capacity : if it at least contributes to fixed costs it should not be
dropped.
(2) Operating At Full Capacity: strong consideration should be given to an alternative product if it has a
higher ‘Contribution’ .
ii) Long term prospects for recovery of demand
iii) Market competition
iv) The cash break-even point /CHART
(1) The cash break-even point is only a short term solution where the long term prospects for recovery
are good.
(2) Where the CVP chart shows the profit break even point below which a company is said to be making
a loss,
(3) the CASH BREAK-EVEN CHART is an analysis based on the receivable cash from sales minus the
outflow of all cash payable.It ignores all NON-CASH OUTLAYS and takes account of time lags in
accounts receivable and payable. Eg depreciation could make a difference between the 2 chart
types. So if cash outflows are low the company could SAFELY continue to operate at a financial
actual loss without big risk of INSOLVENCY.
v) NOTE :
(1) “Cause and Effect Allocation” : means the thing it is apportioned to causes its cost, if that thing is
discontinued the cost is GONE-taken away-less. It is a RELEVANT cost.
(2) “Arbitrary Apportionments” : this is not a relevant cost, it means it is the departments share of the
‘fixed costs’ basicly.- it will have to be paid anyway. (eg rent) arbitrary seems to mean ‘sundries’
4) Outsourcing (Make or buy decision)
1) Includes outsourcing a service (eg: IT Dept functions. )
2) Method: ALLWAYS work out the COST of each alternative separately in 1 column. So ‘extra income’ (would
REDUCE costs(brackets) and costs would be the positive(no brackets) + figures. Then compare the total of
each column to see which is LOWEST costs!
3) IQualitative as well as Quantitative aspects must be considered:
a) QUALITATIVE ASPECTS:
i) Consideration of competitiors economies of scale
ii) Consideration of inhibited future expansion due to the tying up of available capacity.
iii) Reduction in dependence on outside supplier
iv) Internal quality control, rather than relying on outside companies quality control dept.
v) Risk of destroying long term relationships with suppliers which may prove to be harmful and disruptive.
vi) Technology change often makes internal production more costly than purchasing from outside.
b) QUANTITATIVE ASPECTS :
i) This means the Actual numbers involved : see example below.
c) Note: in example below in Section B there are 3 choices, not just 1.

5) Special selling price decisions (special orders)
1) In This case, a product is sold at less than its cost price (or far less than normal price) as a special once off
order- the logic behind it is the fixed overheads portion of its cost price will remain the same to company
whether it is made or not, so it is an irrelevant cost and can be left out. So the order is only evaluated on
whether the variable costs – ie: the relevant costs- will be covered and still make a profit.
2) A special order is one that will not affect a companies current sales to its regular customers (often as an
export). It is usually sold at below full cost – by using contribution to work out an extra low price, because
overheads are covered by sales to normal customers. {Note : Be careful : even doing this for export can cause
the goods to re-appear on the local market at lower price than you usually even sell at.}
3) The following aspects must be considered for special orders:
a) The effect of selling at lower prices to use excess capacity: the buyer might undersell you to your normal
customers.
b) One might have to use normal customers capacity to fulfill a large order and loose normal sales.
c) Also be careful if you do too many of theses orders because then costs which were fixed in the short
term(for 1 special order) will suddenly start going up from all the extras that go into doing a special
order( eg set up time/complication break downs etc etc)
d) Competitors may engage in similar practices which may then start the market price falling which would lead
to a price war.
e) The special order may be packaged in a different brand so as not to compete with the normal sales, or sold
on a foreign market.
f) Price must cover variable costs, special shipping& production costs and some contribution.
g) For a short term order , direct labour&fixed costs are likely to be irrelevant costs –they wont change
quickly- but over a long term they are likely to be relevant. So in the long compared to the short term you
will probably have to deduct rent saved, labour saved, overheads saved, as well etc etc. Remember , if
there will be additional income from NOT doing the special order eg: from renting out part of the factory to
others, then this goes separate at the bottom , below all costs , and you add it separately. (when you
arrange everything in columns)
h) Opportunity cost of tying up the plant must be considered.
i) mEffect on commissions paid to company staff.
j) Accommodation of sales to existing customers
k) Future long term contracts from company requesting a special order price.
l) Market factors: how will the special order affect our competitiors attitude to pricing.
4) To present the difference between the profit if you take the job and the profit if you don’t take the job you can
do it in 3 ways:
a) In 2 columns only show the Relevant costs &income for if you leave it in 1 column and if you take it in the
other
b) Or in 2 columns show relevant&irrelevant costs & income for both options in each column
c) Or in 1 column only show the differential costs & income(difference between taking & leaving the job)
5) Example:
6) Product MIX decisions where capacity constraints exist.(IMPortant :

using the relevant costing decision model as an aid in choosing amoung
competing alternatives.)
1) Remember when you work out a no. of products,round off DOWN. Ie: as 3.7 of product A : you bring this
down to 3 : because you normally cannot produce the extra o.3 with limited resources, you must usually bring
it down to the number below, not above.
2) Type 1 :Contribution per Limiting factors: with these, profit is maximized where the greatest contribution
to profit is achieved per limiting factor
a) The ”Contribution” per limiting factor could be measured by limiting factor eg: machine hours / material
available /labour hours etc.
3) Type 2 :DIFFERENTIAL Contribution PER LIMITING FACTOR: When there is a comparison between 2
contributions eg: for importing or producing localy, which to produce more of &which a bit less AS WELL as a
limiting factor like only a certain amount of raw materials available–so here First minus contribution no.1 from
no.2 , then with this new ‘differential contribution’ , if there is still a problem left with raw material usage, you
go and work out the ‘differential contribution’ per limiting factor ie per kg raw material used for each
‘differential contribution’– then you find the greatest differential contributing factor per limiting factor, and
choose that one.
4) LABOUR VS CAPITAL INTENSIVE EVALUATION: To Evaluate by Normal Method:
a) first calc. the fixed costs, then evaluate how long it will take to break even.
b) Next calc. indifference point: fixed+variable x X = fixed + variable x X.
c) Draw a graph to see which is more profitable ABOVE the indifference point.
d) To evaluate a decision with limiting factors, choose the one which maximizes profit on the basis of
contribution per limiting factor.
5) LIMITING FACTORS EVALUATION: How To Evaluate Management Accounting Information For All
Questions And In Particular Where There Is A Limiting Factor
a) Step1-5 Simplified: 1-sort variable/fixed costs+ work out totals.2-do contribution VS limiting
factors(bottlenecks).
Step 1
Sort out the information given by evaluating fixed costs and variable costs, both budget and actual. Virtually all
questions require an analysis of the cost structure. Have headings, eg fixed costs, variable costs, high / low,
absorption costing, variable costing. You will invariably be given information on a variable costing or absorption
costing basis that requires you to sift through the information and show the costs as variable costs or fixed
costs.
Step 2
Identify maximum production capacity for machinery or labour and show whether there is a limiting factor.
Headings should read “Potential limiting factor — machine hours”, (or labour hours or material, etc). You must
also conclude whether there is a limiting factor for each cost analysed.
Step 3
When there is a limiting factor, you must determine the contribution per unit, followed by the cost per limiting
factor.
Step 4
Do the budget.
Step 5
Evaluate possible alternative information that may change the contribution per unit determined in Step 3
above.
NOTE :EXAMPLE OF CONTRIBUTION PER LIMITING FACTOR WHERE BUYING IN IS A PROBLEM.

This is often a problem for students . Where there is an option to buy in , the correct method is to calc. the
contribution per limiting factor.Method is shown here:
6) 2 Alternative Decisions: is about comparing a capital–intensive business to a labour intensive-business.

7) When evaluating a business decision or when answering an examination question that requires an opinion on
how a business should be structured you should consider the following:
a) BUSINESS COST STRUCTURE
Business is about maximising contribution and minimising ‘overheads’.The goal should be lower fixed costs to
be able to generate a positive contribution or profit faster.When starting a company it is therefore better to
start small and not ‘too flashy’ in order to minimise the fixed costs. If the business does not work, your losses
will be restricted to the fixed costs. Low fixed costs, however, tend to go hand in hand with high variable
costs. The contribution per unit for new companies will normally tend to be relatively low.
b) FIRST MILESTONE
The first objective of a business should be to break even. If a company cannot break even in the short to
medium-term, it is probably a bad investment. You should therefore always determine the break even point
and the margin of safety. Companies with a low fixed cost structure or low overheads be less risky than
companies with high fixed costs. In an examination question asking for advice how a company is performing,
focus your answer on an analysis of the companies cost structure, ie its fixed costs and contribution per unit.
c) MEDIUM /LONG TERM OBJECTIVE:
Once a company has established itself and has passed the break-even point, the company will look to changing
its cost structure so that the contribution per unit increases. Invariably, this means moving from a ‘low fixed
cost, high variable cost’ cost structure to a ‘high fixed cost, low variable cost’ cost structure. It therefore
becomes important at this point to determine the Production Point Of Indifference, ie where the total cost
of a capital-intensive company = the total cost of a labour-intensive company
d) LONG-TERM OBJECTIVE
The long-term objective should be to maximise return on investment. Companies should therefore aim at
increasing sales and reducing variable costs. In the long-term, a company will aim at minimising the variable
costs of production, and therefore maximise contribution. Targeting fixed costs is counter-productive. Fixed
costs are the engine-room of the company and represent the manufacturing assets that generate sales profit. If
the overheads are too high, it is because the sales are too low. Target sales, and the costs will look after
themselves. Most companies, when faced with difficult times, tend to target fixed costs such as salaries and
the infrastructure of the company, which often leads to a slow death. It is better to target variable costs which
will increase contribution and sales rather than a cost reduction. Always focus on sales.
THE THEORY OF CONSTRAINTS AND THROUGHPUT ACCOUNTING (TOC)
1. THROUGHPUT ACCOUNTING: Theonly thing you have to know about throughput accounting is the formula.
Then the product with the HIGHEST T/A or Throughput Accounting ratio , wins, and second is next one etc.:
1.1. JUST LEARN THIS FORMULA :(incl. in formulas)
1.2. T/A ratio= Return per factory hour / Cost per factory hour where:
1.2.1.Return /P/F/A = SALES PRICE –only MATERIAL COST(no other costs eg labour etc, only direct materials)
1.2.2.Cost /P/F/A = TOTAL FACTORY COST / TOTAL TIME AVAILABLE ON KEY RESOURCE.(bottleneck)
2. 1980’s Goldratt & Cox started “optimized production technology.(OPT)” The theory behind this new approach
was called “The theory of constraints and throughput technology (TOC) “ this approach identifies bottlenecks
and fixes them or makes sure they are fully utilized at all times.Also non-bottleneck stations should only
produce what the bottleneck can handle so as not to increase inventory too much.
3. The difference to normal relevant costing(contribution type) is that throughput accounting is more short term
orientated abd assumes that direct labour and var. overheads cannot be avoided within the short term. (it
tries to jack up production instead of the usual Man. Acc. method of cutting costs and bringing down production
volume somehow in the process)
4. The process involves 5 steps:
4.1. Identify the systems bottlenecks
4.2. Describe how to exploit the bottlenecks
4.3. Subordinate everything else to the decision in step 2
4.4. Elevate the systems bottlenecks (means elevate it to Non-bottleneck status by eg :buy a new machine so
botttleneck goes away,and so another station becomes the new bottleneck)
4.5. If in the previous step a bottleneck has been broken go back to step 1
5. three key measures are used here:
5.1. Throughput contribution :rate at which the system generates profits through sales-defined as sales less
direct materials
5.2. Investments(inventory) :inventories+R&D costs +costs of buildings and equipment
5.3. Other operational expenses : all operating costs incurred to earn ‘throughput contribution’ except direct
materials.
6. The priority orientation is :
6.1. Throughput is given first priority (increase, not reduce)
6.2. Inventories second (reduce , not increase)
6.3. Operational expenses last (decrease)
7. It adopts a short-term time horizon & regards all operating expenses as fixed, exept direct materials.This
implies that variable costing be used for all calcs.
8. Basically you just use the method of ‘maximizing contribution per limiting factor’ as far as bottlenecks go.
9. Galloway&Waldron (1988) devised ‘Throughput Accounting”: to apply the TOC effectively : they developed the
TARatio.it is just a restatement of contribution per limiting factor. The product with the highest TA Ratio wins.
10. TA Ratio = Return per factory output/cost per factory hr.
10.1.Where “return per factory hr”= (Sales Price-Material Cost )/ Cost per factory hr
10.2.And “ Cost per factory hr” = total factory cost/total time available on key resource
10.3.NOTE : sales less direct material = “throughput contribution” from above
10.3.1.AND return per factory hour is same as contribution per most limiting factor
10.3.2.AND total factory cost= “other operational expenses” above
a) EXAMPLE: NOTE: the examples below are very simple, to get the idea of all the angles, incl.
multiple limiting factors at the same time where you must use ‘linear programming’ to solve it,
you must go through examples in the book.
The example below evaluates two production options, high fixed costs, low variable costs vs. the option of low
fixed costs and high variable costs. In examinations, you must focus on the overall discussion.
1- Effects of different cost structure

2 -Break-even point
3 -Point of indifference
4 -Long-term cost structure
EXAMPLE B: A BIT MORE DIFFICULT: CHOOSE BETWEEN 1-IMPORTING & 2-LIMITING FACTOR.
STANDARD COSTING
EXAM TIPS :
1. If the question does not tell you specifically what type of accounting system is being used, take a look at
the cost per unit for the product (standard cost card) that the company produces. If it includes fixed
production overheads, an absorption costing system is in place.
2.
3.
BASICS:
DEFINITION
1) STANDARD PROFIT STATEMENT: This is like an income statement but sometimes for just a single
product, using pre-determined standard cost rates , showing what profit we can expect from a given sales
volume.The volume is estimated from known sales and production capacity.Could also mean the flexed budget
when using standard costing.
2) STATIC BUDGET:The plain original realistic budget for the year drawn up at beginning of year.
3) FLEXED BUDGET:/Standard Budget : The budget the is drawn up using the ACTUAL sales VOLUME, but
with the original costs from the Original Budget, not the Actual Costs. This can then be compared to the actual
Income statement to see what the difference in each cost was once converted to the actual sales level.
4) STANDARD PROFIT: same as a flexed budget basicly , it is like an income statement using standard
costs at actual sales level, not budget sales level.It does not need to be for the whole company, it could also be
for just 1 product .Formula = [actual units sold X standard sales price] – [actual units sold X standard costs].
5) BILL OF MATERIALS: A list of all the actual materials needed to manufacture a specific product.Does
not include labour/overheads etc. like the ‘standard cost card.’
6) STANDARD COST CARD: card with the costs of all the Inputs used to make 1 output product , also a
card is kept for each process for same reason.(That should (actual) be used to produce a product.)1 card is kept
for each different product made and for each process.
7) STOCK ACCOUNTS: raw materials, work in progress, finished goods and the like.
8) A “RUN DOWN OF STOCK” : is the transfer of raw materials from inventory to WIP.
9) STANDARD COST CENTRES : each cost centre gets a ‘standard cost’ to use it , eg per hour, so if there
are 5 std. cost centres in the factory, then for each product that uses any 1 or more of these cost centres , you
just add those std. costs to get the products total std. Cost. So at yr end Manger of each cots centre is
answerable for diffference between actual and std costs for that cost centre.Easy.Then if the difference is found
to be permanent, the std. costs. ‘budgeted’ for the cost centre are just changed permanently.
PURPOSE OF STANDARD COSTING

1. Provide prediction of future costs, to use for decision purposes. (so you don’t try recover
inefficiencies in the bid price –you will start loosing customers.
2. Provide challenging target
3. Assist in setting budgets
4. Control device – alert managers to situations that need correction.
5. Evaluate Managerial Performance : To evaluate managerial performance device
6. Profit Measurement & inventory valuation : simplifies this task.
BASICS
1. Generally applied to mnftring activities, and NON-MNFTRING activities in the same firm are not
incorporated.
2. STANDARD COSTING IS BEST SUITED TO : companies where:
a. Input can be specified
b. Output can be measured
c. Company consists of a Series of repetitive or common operations
3. EG : manufacturing : factories for , or even some service organizations eg :banks , where input can be
measured in terms of no. of loan applications or cheques etc.
4. Standard costs are the same as budget costs that have been unitized, ie per unit. They are ‘target’ costs
that should be incurred under ‘normal’ operating conditions.
5. STANDARD COST CENTRES : each cost centre gets a ‘standard cost’ to use it , eg per hour, so if there
are 5 std. cost centres in the factory, then for each product that uses any 1 or more of these cost centres ,
you just add those std. costs to get the products total std. Cost. So at yr end Manger of each cots centre is
answerable for diffference between actual and std costs for that cost centre.Easy.Then if the difference is
found to be permanent, the std. costs. ‘budgeted’ for the cost centre are just changed permanently.
6. VALUATION OF INVENTORY: in most countries law allows inventory valuation at std. Cost levels.(then
why in tut1 in the absorbtion/marginal example, do they re-price inventory to actual levels???)
7. TYPES OF COST STANDARDS ( there are 3 types):
i. BASIC COST STANDARDS:
Not used much : A value which does not change over long periods of time.-Developed from years of
experience. Used more as a basis to develop current standards from and to compare actual results with.But
not used much for standard costing, as they are too easy to attain, not a very high goal to set, most efficient
way is not necessarily found/studied.
ii.CURRENT ATTAINABLE / STANDARDS:
Most frequently used : based on current operating conditions,they make a study to take account of machine
breakdowns, substitute materials, etc.= a fair base from which to evaluate employee performance.In the short
term.
Basicly- higher than basic but still attainable.
iii.IDEAL STANDARDS:
Seldom used: Reflect the minimum operating costs under ideal conditions. Seldom used as they are usually
seen by workers as being impossible.
ESTABLISHING COST STANDARDS

1) METHODS OF SETTING STANDARD COSTS :
a) HISTORICAL: from historical cost –most widely used method, just the avg of past costs , perhaps leave out
outliers, but does not set a very high goal or find most efficient way of production.
b) ENGINEERING STUDIES: do studies to find most efficient way of production ,yet still attainable: 1-
Materials: purchasing dept makes a study ;2-Labour :time &motion study incl.machine breakdowns etc 3-
Overhead –any method 4-“Standard Hours Produced” – is the time it takes to produce one product ,used as
a common denominator to divide up costs into different products.
2) STANDARD COST CARD: card with the costs of all the Inputs used to make 1 output product , also a card is
kept for each process for same reason.(That should (actual) be used to produce a product.)1 card is kept for
each different product made and for each process.
3) DIRECT MATERIAL STANDARDS
a) Bill of MATERIALS :this is where the std. material costs are written down for each product, incl. normal
wastage etc , at best price & quality per purchasing dept.
4) DIRECT LABOUR STANDARDS : “Time and Motion” study done , it should eliminate any unneccessary
elements and determine most efficient production method. Unavoidable delays eg breakdowns & maintenance
incl. in estimate. Then wages divided by time calculated is used as the std. cost per hr.
5) OVERHEAD STANDARDS : main difference to std VS normal costing , is in normal actual costs are used, here
std costs are used.
a) Fixed: separate rate to ‘variable overheads’ is calculated. This rate is not used much for ‘control & making
more efficiant’ purposes , since fixed costs don’t change much. But it is used fin.reporting purposes to calc.
inventory etc.
b) Variable : a rate is calc. to be able to assign costs to products.
6) STANDARD HOURS PRODUCED.
a) This is just : for all the products you make, the units producted X std time per unit = Std Hrs Produced(per
product) then if you add these up you get the total std hrs produced. So in flex.budget std hrs produced is
quoted first , then variance, so a lazy manager does not get extra hrs budgeted for being inefficient.
METHOD:
1) Note: actual costs are compared to std costs , at the cost centre level, so that actual costs are not assigned to
individual products.
2) YOU CAN DO ALL VARIANCES BY COMMITING A TABLE OF FORMULAS TO MEMORY, BUT IT IS EASIER TO
UNDERSTAND IT THAN MEMORISE IT.
VARIANCE ANALYSIS:
1) Note : in the picture below, if you were using absorbtion costing, for the [Var. & Fixed Overheads]
below it would be replaced by :
a) TOTAL fixed overhead variance
i) Expenditure Variance
ii) Volume Variance
(1) Capacity Variance
(2) Efficiency Variance
2)
All INCOME/REVENUE is ACTUAL minus BUDGET and all

EXPENSES/COSTS is BUDGET minus ACTUAL EXCEPT “FIXED
COSTS VOLUME VARIANCE”.
MATERIAL & LABOUR &VARIABLE

OVERHEADS All INCOME/REVENUE is ACTUAL minus BUDGET
and all EXPENSES/COSTS is BUDGET minus ACTUAL EXCEPT “fIXED
COSTS vOLUME VARIANCE”.
These 3 all use exactly the same formulas for the 2 sub-variances:
(1) a PRICE VARIANCE = (SP-AP) X AQ
(material price, wage rate, overheads expenditure)
(2) a QUANTITY VARIANCE = (SQ-AQ) X SP
(material usage, labour & overheads efficiency)
MATERIAL
Material Price Var. SP : standard price - AP : actual price X QP : quantity purchased
Material Usage Var. SQ : standard quantity (at - AQ : actual quantity X SP: standard price
Actual level produced, not (used in total anyway)
budgeted level)
Total Material Variance SC : standard cost - AC : actual cost ----------------
LABOUR
Wage Rate Var. SR :standard wage rate - AR : actual rate X AH : actual hours
Labour Efficiency Var. SH : standard hrs - AH : actual hrs X SR : standard rate
Total Labour Var. SC : standard cost - AC : actual cost ----------------
VARIABLE
OVERHEAD
Variable Overhead.Exp. Var. BFVO: (SR X AH)budgeted - AVO :(actual figure) This is the only one that is
flexed variable overheads actual variable overheads different- to get AP X AQ
you just take amount
Variable Overhead Efficiency Var. SH : Standard Hours - AH : Actual hours x SR :Standard rate
Total Variable Overhead Var. SC : Standard cost - AC : Actual cost -------------------
FIXED OVERHEADS All INCOME/REVENUE is ACTUAL minus

BUDGET and all EXPENSES/COSTS is BUDGET minus ACTUAL EXCEPT
“fIXED COSTS vOLUME VARIANCE”.
Fixed Overhead Expenditure BFO : Budgeted Fixed - AFO : Actual Fixed

Variance:
Overheads Overheads
SALES VARIANCES THIS WHOLE SECTION IS

NEVER REAL – IT IS ALL AT- MAKE BELIEVE – STD
COSTS SO YOU CAN SEE THE VARIANCES CLEARLY
EXCEPT FOR ABSORBTION COSTING IS CORRECT
ABSORBTION COSTING: All of these are done with “profit” instead of “contribution” , that’s all
VARIABLE COSTING : DONE WITH “CONTRIBUTION”, NOT PROFIT.
Total Sales Margin AC : Actual contribution(at - BC : budget contribution
Variance STD cost of sales. (at std cost of sales)
Sales Margin Price AM : actual contribution – SM : standard X AV : actual volume.
Variance per unit contribution per unit
Sales Margin Volume AV : actual volume - BV : budget volume SM : std contribution per
Var. unit
All INCOME/REVENUE is
ABSORBTION COSTING SALES & FIXED COSTS ACTUAL minus BUDGET and all
EXPENSES/COSTS is BUDGET
CHANGE minus ACTUAL EXCEPT “fIXED
COSTS vOLUME VARIANCE”.
FIXED COSTS:
FIXED EXPENDITURE BFO : Budgeted Fixed - AFO : Actual Fixed
Overheads Overheads
FIXED VOLUME: AP : ACTUAL PRODUCTION – BP: BUDGET PRODUCTION X SR : std rate.
TOTALVOLUME VARIANCE
VOLUME EFFICIENCY VARIANCE SH : STD HRS X AUNITS. - AH : actual hrs X SR : std rate
VOLUME CAPACITY VARIANCE AH : ACTUAL HRS TOTAL - BH : std hrs total X SR : std rate
DIRECT MATERIAL :
MIX AND YIELD VARAINCES
MIX VARIANCE: (Actual Qty in Std Mix Proportions Less Actual Qty Used) X Std Price of each
material bought.
YIELD VARIANCE: (actual yield – std yield supposed to get from actual input of material) X Std cost per
unit of finished product
SALES MIX AND QUANTITY

VARIANCES :
QUANTITY / YIELD VARIANCE
SALES
SALES MIX VARIANCE
Direct material + Labour + Variable Overheads. All INCOME/REVENUE is ACTUAL minus BUDGET
and all EXPENSES/COSTS is BUDGET minus ACTUAL EXCEPT “fIXED COSTS vOLUME VARIANCE”.
1. These 3 are similar in that they have 2 parts :

a. (1) a QUANTITY VARIANCE = (SQ-AQ) X SP (material usage, labour & overheads efficiency)
b. (2) a PRICE VARIANCE = (SP-AP) X AQ (material price, wage rate, overheads expenditure)
1. MATERIAL VARIANCES:
a. MATERIAL PRICE VARIANCES: SP-AP X QPurchased

i. QPurchased : is not amount of material actually used for production, it is all material actually
bought that period, whether used or not.
ii.If the reason for the excess usage of materials by any production dept. is due to inferior quality
materials bought by purchasing dept, then the variance should be charged to the purchasing
dept, not the production dept. – in the final analysis.
iii.Period used : if 10000 tons are purchased in period 1 at eg: R1 over standard, but it is only used
over the next 5 periods. You can either :
1. Charge full price variance to Current Period :recommended method:so you can see.
2. Charge price variance per unit used in each period : not recommended-can’t see.
b. MATERIAL USAGE VARIANCE: SQ( at actual production levels) –AQ X StdPrice
i. Normally controlled by production cost centre mngr, due to eg pilferage, wastage, low qlty.
ii.NOTE : You do NOT GET or ever use std qty budgeted!!! You only get std. price , like a rate
you work out beforehand, std costing never involves itself with what the budgeted level of
production is meant to be, only the costs/rates , ie: std “costs”! for this calc. : since you use
actual qty for both sides, it will give you a different answer than if you use “budgeted” qty you
thought you would use. .(ie at the FLEXED budgeted quantity)
c. TOTAL MATERIAL VARIANCE : SC –AC (ie:SC X AQ – Acost X AQ)
i. This is the total variance before it is analysed into Price and Usage variances.
ii.The cost means : the std cost X Actual Qty and the Actual Cost X Actual qty.
iii.NOTE : You do NOT GET or ever use std qty budgeted!!! You only get std. price , like a rate
you work out beforehand, std costing never involves itself with what the budgeted level of
production is meant to be, only the costs/rates , ie: std “costs”! for this calc. : since you use
actual qty for both sides, it will give you a different answer than if you use “budgeted” qty you
thought you would use. .(ie at the FLEXED budgeted quantity)
2. LABOUR VARIANCES:
a. WAGE RATE VARIANCE SR-ARate X AHours

i. This is just the difference between what the hours actually worked would have been at the
standard rate , as compared to at the actual wage rate paid.Since the wages could have gone up
from a wage dispute etc.
ii.The no. hrs BUDGETED does NOT come into the calc. at all – it has NOTHING to do with
std.costing variances. Here you only work with standard “COSTS” , ie rate per hour, not ever
budgeted hours presumed. - (the only place “budgeted no. of hours to be worked ” is used in std
costing is when the ‘std. rate’ eg. R5 per hr, is worked out at beginning of year)
b. WAGE EFFICIENCY VARIANCE : SH – AH X SRate
i. this is just the actual number of things produced, times what the std. hours should have been for
so many things produced, MINUS what the actual hrs were for so many things produced.
MULTIPLY this by the standard rate applied that year gives you how much your estimate was over
or under the actual number of hours (efficiency) – but all at the standard rate.
ii.This variance has nothing to do with the actual wage rate- you are just doing an efficiency
comparison, using the std. wage rate worked out at beginning of year as a “common
denominator” – the actual wages paid rate is done in the ‘wage rate variance’. So then Both
Labour variances added together should give you the total wage variance.
iii.Can be due to machines in bad condition, or foreman was lazy with controlling, or bad planning
in planning dept etc.
c. TOTAL LABOUR VARIANCE: SC –AC
i. Again, same as for total material variance, this is just the total cost st standard rate less tot.cost
at actual rate. It should be the same as adding the 2 wage variances together – the rate &
efficiency variances.
ii.Note : this is all done at the ACTUAL hrs worked , “budgeted hrs” does not come near anything
at all. .(ie at the FLEXED budgeted hrs)
3. VARIABLE OVERHEAD VARIANCES: ( Calc. in same way as labour & material variances.)
Try to re-understand why the 2 sub-variances here make up the total var. below
a. VARIABLE OVERHEAD EXPNDITURE VARIANCE : BFVO(SR X AH) – AOV (actual figure)
i. This Is budgeted flexed variable overhead MINUS actual variable overhead
ii.You only get this if overheads are apportioned according to labour hrs or machine hrs etc.
iii.this is not the same thing as the “total variable overheads” just put in a other way, because this
is Hrs x Std rate for BFVO, you leave out the fraction which come from ActualMoney/AH. – this
part shows in the efficiency variance below!!!!
iv.This comes from using more electricity than what you should have and other similar etc.
v.This is not very informative, it should be broken down into its parts, eg electicity, water etc. so
you can see what happened.
b. VARIABLE OVERHEAD EFFICIENCY VARIANCE : :(SH – AH) x SR
i. this means that more/less labour hrs were required to produce each product than was expected
by the std rate. – so its efficiency measure in money terms.
c. TOTAL VARIABLE OVERHEAD VARIANCE: SC- AC
i. Difference between std var.overheads charged to production and actual var.overheads incurred.
ii.The 2 sub-variances above added together should give you this answer as well.
iii.Note: all done at ACTUAL no. of machine hrs or labour hrs.(ie at the FLEXED budgeted hrs)
used to charge std. overhead rates to manufacturing account – never at budgeted hrs/etc.
iv.Note: here you use ACTUAL UNITS PRODUCED x RATE PER UNIT from the budget- ie Std
rates per hr per unit X hrs per unit = a per unit rate. In the above 2 sub-variances they
never use a “per unit rate” they only work with : part of that rate ie either the std hrs or
the std rate per hr, never the answer per unit ie never the std rate per unit, only the std hr or std
rate per hr.
FIXED OVERHEAD VARIANCE S : BFO –AFO All INCOME/REVENUE is ACTUAL minus BUDGET and
all EXPENSES/COSTS is BUDGET minus ACTUAL EXCEPT “fIXED COSTS vOLUME VARIANCE”.
d. This is just the simple figure – budgeted less actual.

e. It is unlikely to be very informative unless split into component parts later. Not controllable in short
term.
SALES VARIANCES : All INCOME/REVENUE is ACTUAL minus BUDGET and all EXPENSES/COSTS is BUDGET minus ACTUAL
EXCEPT “fIXED COSTS vOLUME VARIANCE”.
a. This is the only one of 2 – FIXED COSTS and SALES - that is different for ABSORBTION and
VARIABLE costing systems. In absorbtion this one must be done on PROFIT basis whereas
for the variable system it is done on a CONTRIBUTION basis. The profit basis one is not
very useful to compare differences in volume and price change though – but it will give
you an accurate overall figure.
b. TOTAL SALES MARGIN VARIANCE: Variable system : AContribution –BC (BudgetContribution)
c. Absorbtion system : Aprofit -BProfit
i. For Absorbtion system anything here is Profit MARGIN instead of contribution margin, thats all.
ii.AC = Actual sales REVENUE – [Std Variable Costs X actual sales number of units sold] =
contibution
iii.BC = Budgeted sales REVENUE – [Std Variable costs X budget sales no. of units sold] = contrib.
iv. The sales margin variance is calc. specially and only to measure the sales dept performance. So
these variances forget/exclude ACTUAL COSTS and only use STD COSTS to deduct from. So both
of these AC and BC as well as the answer are all not very real or accurate, they only work with
“std. cost of sales per unit” and never actual cost of sales per unit-
v.The 2 sub-variances below add up to give this variance. BUT these variances are all wrong- I
don’t think they are used in the books – just used for info sakes. They will however work for the
Budget to Actual Profit recon. because they somehow cancel out budget errors (not sure how
though)
a. SALES MARGIN PRICE VARIANCE: (AM-SM) X Actual Units

i. For Absorbtion system anything here is Profit MARGIN instead of contribution margin, thats
all.
ii. Both AM (actual contribution margin) and SM (budget price (meaning Std. price) contribution
margin) are worked out at Std.Costs rate GOT from beginning of year – the actual costs NEVER
comes into this calc. It only shows the difference in SALES PRICE CHARGED at the std cost
rate.- THAT IS ALL it is interested in- sales price change, not “costs changes”.
iii. This is similar to “ TSMV total sales margin variance” in that it works with contributon : but
here it is contribution per unit. And Here it is Actual Cont.(or margin) per unit (AM) MINUS BM
times ACTUAL UNITS. [budgeted units does not come into it anywhere like in TSMV in the BC
part ie: total budgeted units X budget price per unit less std costs.]
a. SALES MARGIN VOLUME VARIANCE: (AV-BV) X Std. Contribution only.

a. For Absorbtion system anything here is Profit MARGIN instead of contribution margin, thats
all.
b. The reason the std. contribution (budget price – std costs) is used is because it is just like a
common sort of denominator – so we can see the “variance in volume” without any changes
in “costs” or “sales price” coming into it AT ALL.
ABSORBTION COSTING All INCOME/REVENUE is ACTUAL minus BUDGET and all EXPENSES/COSTS is BUDGET minus
ACTUAl EXCEPT “fIXED COSTS vOLUME VARIANCE”.
a. Note: every formula in this fixed costs is multiplied X SR or std. rate.- every one!
b. For this system, all fixed overheads are divided by budgeted activity to give you a rate per unit produced.
Where many products are made this rate should be converted to standard hours rate. So :
a. FOR SINGLE PRODUCT : budget overheads / budget units = eg R12 per unit produced.
b. FOR MULTI PRODUCT : budget overheads / budget hours = eg R10 per hour.(labour or machine
hrs)
i. Budget hrs of input : budget hrs it should take
ii.Budget hrs of output : (or std hrs produced) this is the actual hrs it took
iii.In practice these 2 will be different, so it forms part of the stuff up.
c. Same as in other absorbtion chapter, this stuff will cause : an expenditure & volume variance.
d. TOTAL FIXED OVERHEAD VARIANCE : SC-AC
a. This total is made up of 2 parts :
i. “Expenditure” if the total spent was more/less than the total budgeted it will cause a
expenditure difference. This is the same thing exactly as the ‘fixed costs’ variance in “variable
system” - you just use the same formula and same figures.
ii.“Volume” : if you used less/more std hrs than you thought, so you thought you would use
100 hrs , and fixed costs are 500, so you charged at the std. rate to the WIP accounts R5 per
hr. Now when actual use is 125 hrs, you find you should have charged 500/125= R4 per hr ,
so you OVERCHARGED your WIP accounts (and customer!) by R1 per hr= 100X R1.25
=R125 .So you OVERRECOVERED by this much in the WIP account , now it must be reversed.
This is all as if total fixed costs re,mained the same – it is just a WIP allocation error which does
not happen in a variable costing system of course. This has nothing to do with an incr/less total
fixed costs ! just your WIP estimate entries are wrong.
e. EXPENDITURE VARIANCE : same as fixed expenditure variance in variable costing – ( BFO –AFO)
f. VOLUME VARIANCES : (AProd.-BP) X SR : (this is the only one that breaks the rule on expense= B-A)
a. This is the only one that breaks the rule on expense = B-A , here it is visa - versa due to fixed
expendit. Variance already did B-A , so here it goes opposite to balance you wrong WIP entries.
b. If hrs was less, and UNDERRECOVERY will happen , and if hrs was more, a OVERECOVERY(see
above explanation)
c. The 2 sub- variances below will make up this total above.
i. VOLUME EFFCIENCY VARIANCE: (SHtotal – AH otal) X SR ( this one DOES follow
expense=B-A rule)
1. Indicates failure to use capacity efficiently.
2. Where :
a. SHtotal = (AProductionUnits. X SHper unit)
b. AH otal = (just the actual hrs used)
3. This shows where less/more hrs were used per unit than should have been .
4. From lazy etc.
ii.VOLUME CAPACITY VARIANCE: (AH-BH) X SR
1. Indicates failure to use capacity at all.
2. Full actual hrs less full budget hrs X Std rate per hr.
3. Same as total one- this one also breaks the rule of expense=B-A by saying A – B , not
B-A like for efficiency variance which is the part of this whole thing that does not break
the rule.( SO THERE ARE 2 THAT BREAK THE RULE – BOTH OF THEM FROM VOLUME
VARIANCE)
4. EG: from machine breakdowns, material shortages, labour disputes etc.
DIRECT MATERIALS MIX & YIELD VARIANCES
1. Direct Materials Mix: (Actual Qty in Std Mix Proportions Less Actual Qty Used) X Std Price of each
material bought.
a. This is PRICE OF RAW MATERIALS due to mix change.
b. ONLY Std prices are used to keep out the effects of any PRICE change.- we only want MIX effect
c. Price does not come into any of these mix&yield variances, it is all done at std cost ONLY.
d. Maybe due to cheaper materials/ bad qlty you must use more of one type than another etc.
2. Direct Materials Yield : (actual yield – std yield supposed to get from actual input of material) X Std
cost per unit of finished product)
a. This is COST OF SALES of FINISHED PRODUCT due to mix change.
b. ONLY Std prices are used to keep out the effects of any PRICE change.- we only want MIX effect
c. Eg: use bad qlty. materials or bad production.
3. Materials Usage Variance :( Std. Qty. materials for actual production – Actual Qty. used.) X std price of
materials.
a. This is different to the 2 others, because it has no ‘mix’ ratio difference in it.note: units produced X
total kgs required , divided into std mix and priced at std prices.
b. If you add the 2 others you get this one.
SALES MIX AND QUANTITY VARIANCES

1. Try work this thing out a bit more- these are the basics but had no time with this one for complicated
figuring.
2. The sales VOLUME margin variance can be divided into the SALES QTY / SALES YIELD and SALES MIX
VARIANCE.
3. These can either be measured in marginal contribution or marginal profit. The contribution method is better
because it cancels out the effect of price changes – so you can see the variance. The profit one is not very
accurate.
4. The volume margin variance – (so more is sold revenue–wise ie: more turnover of money is done ) can be
due to more / less qty sold or to a different SALES MIX – ie less of a expensive product sold and more of a
cheaper one etc.So the sales mix, which is treated as a ‘product’ , but is actually many products, is different
to the std sales mix giving a different giving a stuff up for the volume variance calc. earlier, which stuff-up
must now be divided up into its components. – so if you have many products, you use these variances.
5. SALES MARGIN MIX VARIANCE : Actual sales qty LESS actual sales qty. in budgeted proportions
X std profit margin.
a. This formula is done per each product in sales mix – then all the answers are added to give you the
totals. So- one by one in a list sum.
b. This one follows the rule of A-B for Income and B-A for Expense
6. SALES MARGIN QUANTITY / YIELD VARIANCE :(ACTUAL sales qty in budgeted proportions –
budgeted sales qty) X std profit margin.
a. This formula is done per each product in sales mix one by one – then all the answers are added to
give you the totals. So- one by one in a list sum.
b. This one does not break the rule of A-B for Income and B-A for expense much – there is more
budget ie B in the 2nd part than in the first part – look carefully above in formula.
7.
RECONCILING BUDGETET PROFIT TO ACTUAL PROFIT

1) It is just a tool for management to show how the budgeted profit eventually changed into the actual profit.
2) EASY : just start with Budget Profit and add all the variances above – ALL – and then end with Actual Profit (do
it logically :start with sales and work through to overheads one by one)
3) It should all add up nicely to give actual profit!
BUDGET PROFIT 80000

VARIABLE SYSTEM
Sales Variances
Sales Volume Xxx
Sales Price xxx Xxx
ABSORBTION SYSTEM
Sales Variances
Same as above except they will be different because
Profit Margin is used instead of Contribution Margin.
Direct Cost Variances
Material
Material Usage 200
Material Price 300 500 Xxx + 500
Labour
Labour Rate
Labour Efficiency
Manufacturing Overhead
Fixed Overheads :
VARIABLE SYSTEM :
Fixed Expenditure Ovrhd
ABSORBTION SYSTEM:
Fixed Expenditure Ovrhd Xxx
VOLUME total variance
Volume Efficiency xxx
Volume Capacity xxx Xxx XXX
Variable Overheads
Variable Efficiency
Variable Expenditure
ACTUAL PROFIT 40000
WIP ACCOUNTS
1. There is no need to record stocks on a first in first out basis, or weigheted avg. basis, because most
countries laws state that Inventory (raw materials etc) may be kept at std costs, as long as the std costs
are :
a. Current and
b. Attainable
2. Variation exist in accumulation of costs methods eg: labour hrs / units etc , but : “inventory calc. & profit
calc. are the ALLWAYS the same whichever method is adopted.
3. SALES VARIANCES ARE NEVER RECORDED IN THE BOOKS – they are for mngmnt acc. purposes only.
MATERIALS (MOVEMENTS) RECORDING PROCEDURE

1) there is a very set system for recording the movement of materials in a system
2) Receiving >> GRN >> Store Ledger Account >> Stores Requisition >> to manufacture
a) GRN
b) Store Ledger Account : go look at and scan example in ..pg80/81 drury :this is just a sheet of paper that
each of the materials , 1 per page , in the stores of the factory. When GRN is issued it is transferred to this
sheet.(probably all on computer).This amounts to a huge file of papers – like a cardex of inventory.This pile
of papers is called the “subsidiary ledger”( per drury pg 82)
c) Stores Requisition : (go look at and scan example in ..pg80/81 drury) .This is a separate sheet of paper
PRICING THE ISSUES OF MATERIALS PROBLEM:

1) A difficulty arises to price issues from stores of materials for each separate job, because if 5 purchases were
made then they may all be at different prices. Esp. older = cheaper , newer = more expensive.
2) This pricing impacts on : 1-calc. of “costs of sales” 2-calc. of “closing inventory” , 3-gross profit , (I don’t
think net profit, because closing inventory & cost of sales should balance each other out? or not?)so it is very
important.
3) There are differnt ways to price these issues:
FIFO : first in first out IAS 2 & SARS = yes
Weighted Average cost : avg. IAS 2 & SARS = yes
LIFO : last in first out NOT recommended by IAS 2 ,nor Could be used for mngmnt
allowed SARS accounts if needed, but not for Fin
stats. or SARS.
CONTROL ACCOUNTS:
2) Creditors Control Account : same thing, also has a subsidiary ledger of each individual persons account,
as well as the control account.
3) Factory Overhead Control Account : this is for all factory (manufacturing ONLY) overheads. It also has a
subsidiary ledger which is for every individual overhead expense type eg electricity etc.
4) These control accounts are the only accounts that are really used in the books , the subsidiary ledger does
not form part of double entry system. But for every entry made in the control account, a separate entry
must also be made in the individual “stores ledger account” on its separate piece of paper for each item
.same goes for the creditors control account.

1) PURCHASE of raw materials: REM to do 2 entries in the “creditors control Acc.” , one for each of “stores” &
“variance” Accounts in the exam, even though in G. Journal just 1 entry for both is needed, (so lecturer can
see- for extra points)
2) The materials PRICE variance account is debited(expense used more) OR credited(income used less) here with
the difference between what the Std. PRICE is supposed to be for the raw material bought. If the price actually
paid is more or less than the Std. price estimated at begin of year, it must go to the Materials PRICE Variance
Account.
a) If More is paid than Std Price. : Dr the variance account as an EXPENSE to be written off as period cost.
b) If Less is paid than Std Price.:CR variance account like an INCOME to be done as a “period income”???

DR Materials PRICE variance Control Acc. R500 (if less than std qty = CR Income/If more =DR Expense)

CR Materials PRICE variance Control Acc. R500
4) For every entry made in control account, a equal entry must be made in ‘subsidiary ledger’

1) The materials USAGE variance account is debited(used more) OR credited(used less) here with the difference
between what the Std. Qty. is supposed to be for the no. of units of finished products produced by the type of
“Job Process Done” with the materials. If they draw more or less than this from the stores, it must go to the
Materials USAGE Variance Account.
a) If More is issued than Std Qty. : Dr the variance account as an EXPENSE to be written off as period cost.
b) If less is issued than Std Qty :CR variance account like an INCOME to be done as a “period income”???
2) DIRECT MATERIALS : JOB NUMBER is recorded on the ‘stores requisition’ in top corner.
DR WIP Work In Progress Account R5000

DR Materials USAGE variance Acc. R 200 (if less than std qty = CR Income/If more =DR Expense)
3) Stores Requisition : (go look at and scan example in ..pg80/81 drury) .This is a separate sheet of paper that
must be handed in to get any issue of raw materials from the stores. It has details of every material ordered on
that requisition, to what job number / they belong , dept , and all the details of item form the stores Ledger
Account for each item. If it is for DIRECT MATERIALS it must have the JOB NUMBER recorded on the ‘stores
requisition’ in top corner. , but if it is for INDIRECT MATERIALS : OVERHEAD ACCOUNT NUMBER is recorded
on the ‘stores requisition’ in top corner, so that it can be assigned to a cost centre or cost object This document
forms the backbone of the recording process because it is where all the details for further accounts in the books
come from.
4) Scan in pg 453 drury exercise question & answer for accounting entries example , and paste in here to see
what end result looks like. For standard costs, pg 139 own notes chapter.
RECORDING LABOUR COSTS:
1) Accounting for Labour costs can be divided into 2 sections :

a) Payroll accounting
b) Labour cost accounting (to jobs , overhead acc.,capital acc.)
2) PAYROLL ACCOUNTING: (done same as in any other system.)
a) ENTRIES FOR WAGES&DEDUCTIONS:
Dr WAGES Control Account

Cr Tax Payable Account
Cr National Insurance account(from workers wages, not from employer)
Cr Wages Accrued Account.(this goes to employee himself)
b) ENTRIES WHEN IT IS PAID OUT:
Dr Tax Payable Account

Dr National Insurance account(from workers wages, not from employer)
Dr Wages Accrued Account.(this goes to employee himself)
Cr Cash/bank
3) LABOUR COST ACCOUNTING

a) The total of the WAGES CONTROL ACCOUNT is allocated to the job,overhead and capital accounts.
i) Accounting entry for employer paid insurance per employee(not deducted but by employer)
Dr Factory Overheads Control Account

Cr National Insurance (Creditor: liability) account (when paid just Dr this creditor and Cr bank)
Cr Variable Overheads EXPENDITURE VARIANCE ACCOUNT.
b) If the country has Employer Contributions(not deductions from salary, but paid by employer to Gov.)for eg
national insurance(UK employee has some deductions from his pay that form part of wages, but employers
part is NOT seen as wages as all), then the amount when paid DOES NOT go into the WAGES CONTROL
ACCOUNT, like the employee wages insurance deduction below, BUT gets CONTRA’d straight against the
“Factory Overhead Account” – it is recorded in 1- Overhead subsidiary ledger AS: insurance expense AND
2-in Overheads Control Account in the General Ledger.
c) WAGES TO WIP & OVERHEADS:

i) DIRECT LABOUR charges : go to WIP CONTROL account : As well as the entry in the WIP control
account , each labour cost will be charged to the individual job accounts IF THERE ARE ANY,as well, per
drury.(job accounts subsidiary ledger)
ii) INDIRECT LABOUR charges : go to : Factory overheads CONTROL account : As well as the entry in the
Factory Overheads control account , each labour cost will be charged to the individual job accounts as
well – and account heading there will be name of Cost centre followed by expense type,unless “cost
centre” is not known-eg overall property taxes- then just expense type-per drury.(job accounts
subsidiary ledger)
iii) The Wages Control Account DR created by the Payroll accounting entry is cleared as follows:
Step 1:
Dr WIP CONTROL Account (std rate X std. qty hrs for that many units produced.)
Cr Wages CONTROL Account
Step 2:
Wage RATE Variance: R500 (Dr if more=EXPENSE or Cr if less=INCOME)
Wage EFFICIENCY Variance: R300 (Dr if more=EXPENSE or Cr if less=INCOME)
Cr Wages Control Account R800 (difference betwn Std rate charged to WIP account & ACTUAL)
iv) This is clearing the Wages Control Account : so :
(1) first DR (expense) the std wages to WIP account.
(2) Then : DR Dr if more=EXPENSE or Cr if less=INCOME the wage variances: 1-efficiency & 2-rate:
from the wages control account to these two variance accounts. Then wage control account should
be empty.
RECORDING MANUFACTURING OVERHEADS
1) All Overheads go to a Overheads subsidiary ledger in individual accounts for each expense, for every entry in
the Factory Overhead Control Account, a separate equal entry must be made in the individual overhead
account of that item eg : electricity expense. and account heading there will be name of Cost centre followed
by expense type,unless “cost centre” is not known-eg overall property taxes- then just expense type-per drury
-so it can be assigned to cost centres for ABC & traditional costing later-.(job accounts subsidiary ledger)
2) Overhead CHARGED TO JOBS journal entry : (when it is charged to a specific job) Here it is taken out
of ‘expense account’ and moved into ‘WIP costs account’ so it can move forward in that account to right up to
‘inventory’ ,every entry in a control account is also entered in a ‘subsdiary ledger’ so for WIP it is ‘Jobs
subsidiary ledger’ with details of each job, and for ‘overheads’ it is overheads ‘subsidiary ledger ‘ with details of
each expense type incurred (eg rent)it is moved by means of the allocation base , the cost driver like Labour
Hrs whatever and thus each job or whatever gets its overheads portion sent to WIP Control Account., or a
(how do you get the total for expenses for fin stats. at yr end , if everything-all expenses- has been written out
of “subsidiary & control accounts”? what if there were returns, and errors(write backs) etc, so you must go to
every transaction one by one to see if it is to go to fin stats?)for every expense written out of overheads control
account, must it also be written out of the ‘expense account itself’ eg ‘property taxes’ in the overheads
subsidiary ledger. Is it actually kept in a “mnftring overheads subsidiary ledger” or not? How can it be kept in
the GL together with the control account?
3) So all real overheads expenses get written INTO overheads control account, then written out again when they
get moved to WIP control account. Then anything left in here at end of year (either too much allocated to jobs
using ‘overhead allocation rates’ or - too much expenses and not all allocated to jobs yet) is called
OVER/UNDER RECOVERY of OVERHEADS, which must be charged to Profit & Loss at yr end as a PERIOD COST
or EXTRA TURNOVER INCOME – through variance accounts or otherwise..
VARIABLE SYSTEM :
Dr WIP Control Account R140000
Cr Factory overhead Control Account R140000
1) Overhead EXPENSES journal entry (when it is bought – recording the liability): So for every entry in
Factory Overheads account below, there is a separate one in the Factory Overheads Subsidiary ledger.
Dr Factory FIXED Overheads Control Account R50000(& subsidary ledger in each expens accnt)
DR Factory VARIABLE Overheads Control Acc. R21000
Cr Creditors Control Account(for expenses incurred) R41000 (& subsidary ledger)
Cr Depreciation Account R30000
2) VARIANCE ACCOUNTS FOR VARIABLE OVERHEADS: (these will only be for variable overheads, not fixed
overheads for the variable system)
a) This is clearing the factory variable overheads Control Account : so :
i) first DR (expense) the std overheads to WIP account.
ii) Then : DR Dr if more=EXPENSE or Cr if less=INCOME the var.overhead variances: 1-efficiency & 2-
expenditure: from the Var. Overhead Acc. Control account to these two Variance accounts.
Step 1: std costs.
DR WIP Account R500 (Std Hr Rate X std hrs for no. units produced)
CR Factory VARIABLE overhead control acc. R500
Step 2: variances:
These variances could also be the other way around, ie it could be Cr variance and dr control acc instead of
whats shown below, or one could be one way around and the other the other way around! Note!
Dr Variable Overhead EFFICIENCY Variance R500 (this is the variance you work out for efficiency)
CR : Factory Variable Overhead Control Account. R500
Dr Variable Overhead EXPENDITURE Variance R200

CR : Factory Variable Overhead Control Acc. R200
ABSORBTION SYSTEM
1) Same as variable system above, except for fixed overheads, which also gets variance accounts here, whereas
for Variable System fixed overheads does not get variance accounts.
2) VARIANCE ACCOUNTS FOR FIXED OVERHEADS:
a) This is clearing the factory Fixed overheads Control Account : so :
i) first DR (expense) the Std overheads to WIP account.
ii) Then : DR Dr if more=EXPENSE or Cr if less=INCOME the FIXED.overhead variances: 1-volume & 2-
expenditure: from the Fixed. Overhead Acc. Control account to these two Variance accounts.
Step 1: std costs.

DR WIP Account R700 (Std Hr Rate X std hrs for no. units produced)
CR Factory FIXED overhead control acc. R700
Step 2: variances:
These variances could also be the other way around, ie it could be Cr variance and dr control acc instead of
whats shown below, or one could be one way around and the other the other way around! Note!
Dr Fixed Overhead VOLUME Variance R500 (this is the variance you work out for efficiency)
CR : Factory Fixed Overhead Control Account. R500
Dr Fixed Overhead EXPENDITURE Variance R200

CR : Factory Fixed Overhead Control Acc. R200
NON – MANUFACTURING OVERHEADS:

1) Non mnftr. Overheads are NEVER added to jobs, they are written off as a PERIOD COST.
2) Every transaction recorded in the Non-Mnftring Overheads Account as an expense, also gets resorded ina
Subsidiary Ledger for Non-Mnftring Overheads , each in its own heading eg : selling expenses , delivery etc. In
practice each of Marketing, Admin, & Financial overheads has its own Non-Mnftring Overheads CONTROL
Account ands subsidiary ledger.
a) Incurring Non-Mnftring Overheads expenses
Dr Non-Mnftring Overheads Account R40000

Cr Expense Creditors Account R40000
3) At the end of fin yr they are written out to the Profit & Loss account
DR Profit & Loss Account. R400000

Cr Non-Mnftring Overheads Account R400000
RECORDING JOBS COMPLETED AND MOVED TO STORE

1. Transfer from factory to finished goods store: (again every control account has a subsidiary ledger)
DR Finished Goods Stock account R10000

Cr WIP account R10000
2. When goods Are Sold :
Dr Debtors Control account R1000

Cr Sales Account R1000
AND:
Dr Cost of Sales Account

Cr Finished Goods Stock Account
COSTING P&L ACCOUNT

1. IT IS EASY FOR MNGMNT TO REQUEST AT ANY TIME A Costing profit & loss acc to be prepared (for costing
purposes only), in SCI format OR in Double entry format, because all data is at hand.
2. The “cost of sales account” and “variance accounts” are closed by a transfer to the costing P&L
accounts .The balance of the P&L account will be the actual profit for the period.
CALCULATING PROFIT:
1. To get the profit , you subtract the [COST OF SALES plus all the VARIANCES] from SALES.
2. So the cost of sales only contains things from finished goods actually sold (perpetual inventory sys.) , not
from unsold finished goods AT ALL. ( perpertual system costs only transferred to DR“cost of
sales”CR”inventory” when goods are sold.)
SALES
Less: ACTUAL COST OF SALES:
Plus : STANDARD COST OF SALES.
Plus : ADVERSE VARIANCES:eg:
i. Material A price var.
ii.Material B price var.
iii.Material usage var.
iv.Wage rate var.
v.Labour efficiency var.
vi.Fixed overhead Volume var.
vii.Var.overhead Efficiency var.
Less FAVOURABLE VARIANCES: eg:
viii.Var. overhead expenditure var.
ix.Material B usage var.
x.Fixed overhead expenditure var.
=ACTUAL PROFIT:
INVENTORIES
VALUATION OF INVENTORIES
Read: Jackson and Stent: Auditing Notes: p 12/15 – 12/17 and 12/21 – 12/23.
Drury: Pages 148 – 149.
Inventories consist of:
● assets held for sale in the ordinary course of business (finished goods and goods bought for
resale)
● assets held in the process of production (work-in-progress)
● materials or supplies to be consumed in the production process (raw materials)
For both job and processing systems, overhead is allocated on a pre-determined basis. For
manufactured goods, the allocation of overheads to the cost of manufactured inventory must
● include only fixed and variable production overheads
● be based on normal capacity and must
● be allocated on a systematic basis which is reasonable
Wastage should be excluded. Goods for resale and/or goods imported have specific issues that
should be considered. Where standard costs are used, the standard cost can be used for valuation if
it approximates actual costs. This implies that variances, their materiality and causes should be
considered during the valuation process.
Finally, inventory is valued at the lower of cost and net realisable value. NRV is the estimated selling
price in the ordinary course of business less the estimated costs of completion and the estimated
costs necessary to make the sale.
INVESTIGATION OF VARIANCES
1. You only investi=gate variances that will bring a benefit to profit/cost , else one wastes money investigating
for nothing.
2. Std costs change : eg learning curve , changing technology, changing prices.
3. Only 1 measure eg hrs is used for a process with many measures actually, and if any one of these other
changes,it changes the std cost and then it is a uncontrollable /random factor
4. A perforst investigation model only investigates no 3rd one below, of the 3 reasons for variances:
a. Random uncontrollable factors
b. Assignable variances but with costs of investigation exceeding benefits
c. Assignable variances with benefits exceeding investigation costs.
5. The 2 methods used to choose when to investigate variances:
a. Simple rule of thumb: take say any variance over 10% of std – must be investigated , or diff.% for
diff. variances.
b. Statistical methods: statistical theory says if distribution approximates normal then: 68%
obserbvations fall in 1 StDev. , and 95 % in 2 std dev. So 32 % > high probability and 5 % > fair
probability of an controllable investigatable problem.
ROLE OF ABC COSTING
1. ABC costing can also use Std costing variances etc.
2. Only Unit level “ABC activities” can be used ie things which are directly affected by changes in no of units
produced, where eg 10 % incr. imn units will = 10% incr. in costs. These are: ONLY Dir. Labour,Materieals
& Overheads consumed in proportion to hrs eg machine hrs or labour hrs.
3. It is only really advisable per Mak & Roush 1994 that ABC activities where the cost drivers capture the hrs
that separate variances can be made for each activity.- other measures tend to be too erratic for formulas
to work.
TRANSFER PRICING IN DIVISIONALISED
COMPANIES:
INTRODUCTION
1. Transfer prices refer to the prices set on goods or services transferred between two departments or
subsidiaries of a company. A transfer price is therefore the price which a receiving division will pay for the
internal transfer of inventory or products by a supplying division.
2. Note: it is an income to transferring division, and a cost to buying division, so it affects both of their profits
+ also the final cost of the goods, so what customers must pay = supply & demand.
3. This chapter concentrates on Division to Division, but it could also be between cost centres, or cost centre
to division, where the only difference will be no need to incl. a profit for supplying division- ie opportunity
cost of selling to market instead kind of.
4.
GOALS & PURPOSE OF TRANSFER

Goals of transfer pricing include:
• To Provide info. to make good economic decisions : motivate the divisional managers , to the advantage
of the company or group as a whole (goal congruence).
If you add too much profit to a transfer, you might price yourself out of the market in a divisionalised structure,
whereas in a centralized structure you would not have done this. So it must just be done properly.
• To Measure correctly divisional & management performance :To ensure equity the internal transfer price
should ensure that each division’s performance is reasonable, measurable and comparable.so if you add too much
profit, it may affect both divisions profit performance and be unfair to one and too fair to the other.So to “make
good economic decisions” must sometimes be weighed against “ fair performance/profit measurement”
and this means
• The managers / divisions should still have autonomy : the ability to make autonomous decisions and enter
into negotiations with each other.
• Simple :The system should be simple to operate and administer.
• If possible, healthy competition : between divisions should be encouraged by the transfer pricing system.
• To intentionally move profits : between divisions or locations.
SETTING A TRANSFER PRICE

Different companies will use different methods for determining internal transfer prices. Such policies
may include basing the internal transfer price on
• The variable cost of the product
• The full cost of the product
• The market price of the product.
The company has to decide which method will best achieve its objectives and the general goals of
transfer pricing.
THE FOLLOWING ‘RULES OF THUMB’ MAY BE APPLIED WHEN A QUESTION ASKS

YOU TO SUGGEST AN APPROPRIATE TRANSFER PRICE:
Should a question be given in the exam where a specific method is prescribed for setting transfer
prices, you merely have to calculate the required price using the prescribed method. However, transfer
pricing questions are more likely to ask you to SUGGEST an appropriate transfer price, in which case
you should follow the rules set out below.
The following ‘rules of thumb’ may be applied when a question asks for the calculation of a transfer
price that will lead to goal congruence within the company:
• Minimum transfer price (that the supplying division will accept)
Incremental cost (usually variable cost plus any increase in fixed costs) plus opportunity cost
→ Opportunity cost exists only if there are sacrificed external sales due to the internal transfer of
goods (and is the contribution thus lost).
• Maximum transfer price (that the receiving division would pay)
If there is an external market to buy from:
→ Market price less savings on selling and transport expenses
If no external market exists:
→ Variable cost plus a negotiated profit
• The maximum negotiated profit is the incremental profit that would be made by the receiving
division on the ultimate sale of the goods.
The final transfer price is normally obtained through negotiation. It should lie between the
minimum and maximum prices calculated.
METHODS:
1. Intermediate products : these are the ones trnasferrd between divisions, then when sold to customer it is
called ‘final products’
2. Note also that rebvenue from receiving division will cancel out payment by paying division eventually in the
cons. Fin. stats.
3. These 2 are the conflict of objectives when it comes to transfer pricing basicly :
a. • To Provide info. to make good economic decisions : motivate the divisional managers , to
the advantage of the company or group as a whole (goal congruence).
If you add too much profit to a transfer, you might price yourself out of the market in a
divisionalised structure, whereas in a centralized structure you would not have done this. So it must
just be done properly.
b. • To Measure correctly divisional & management performance :To ensure equity the internal
transfer price should ensure that each division’s performance is reasonable, measurable and
comparable.so if you add too much profit, it may affect both divisions profit performance and be
unfair to one and too fair to the other.So to “make good economic decisions” must sometimes
be weighed against “ fair performance/profit measurement” and this means
4. There are 5 different methods of transfer pricing:
a. MARKET BASED TRANSFER PRICES:
i. When a “PERFECTLTY COMPETITIVE” market exists for a product, it is mostly optimal for
A)decision+ B)performance evaluation to use market prices.
ii.Definition: “PERFECTLTY COMPETITIVE” market is :( homogenous product, no buyer/seller
can affect market prices)
iii.Compare to outside firms: divisional performance can be compared direct to otsiude firms
doing same product
iv.Only where selling & marketing & distribution costs can be avoided it is much more
profitable to sell INTERNALLY than EXTERNALLY!!, as a choice!
b. MARGINAL COST TRANSFER PRICES:(no fixed overheads included eg rent)
i. This method leaves out fixed overheads and also no profit.
ii.Economic theory dictates that where capacity constraints do not exist, the actual CORRECT
price for transfer pricing is the marginal cost of producing the product.
iii.The reason for this is that if you start adding fixed costs like rent or even profit to the
transfer price, then the buying company will produce less total units , since as marginal costs
per unit produced increase the zero profit point will be reached sooner( theory is from the
economics profit graph which goes up then starts to go down later from bottlenecks & too
much labour etc – mal & complex)
iv.Problem is : performance is not measured correctly, since seller gets no profit & buyer gets
a lot of profit(extra) , and (2) FIXED COSTS ARE often marginal/variable in the long run so
one should have incuded them.
c. FULL COST TRANSFER PRICING: (fixed overheads incl.)
i. This method is same as ‘marginal’ but includes fixed overheads. Most companies go for this
because it shows the long-run marginal cost better – ie fixed costs are mostly variable in the
long run!
ii.It may be best to use ABC costing here because it gives a better approximation of fixed
overheads apportionment than traditional absorbtion method- it is more accurate!!!
iii.This method DOES NOT provide an incentive for supplying division though- this is a problem.
d. COST PLUS A MARK-UP TRANSFER PRICING
i. They may use cost plus profit on a marginal or absorbtion basis.
ii.It leads to the same complex economic problem explained in (b) above – less units may be
produced ‘economics graph–wise’
iii.If many divisions are involved the final markup may be enormous.
e. NEGOTIATED TRANSFER PRICING.
i. THIS IS best where market imperfections exist for intermediate product ie : where different
selling costs for internal & external sales or where several different market prices exist. So
managers must be able to bargain and sell outside as well to stop any imperfect performance
meassurment / and stop mis-allocation of resources.
ii.Can be very motivational and increase profits.
iii.If no outside market exists is may be impossible to negotiate.
iv. Disadvantages :
1. “Bargaining powers” are involved , so the final price may not be optimal
2. And then performance measures will not be correct either
3. Can lead to conflict , needing top mngmnt mediation.
4. Can be time – wasting
f. MATERIAL COST PLUS OPPORTUNITY COST.
i. Opportunity foregone by supplying internally, plus marginal cost.
ii.This basicly works out to exactly the same as ‘market price’ .
iii.Can be difficult to apply in imperfect market conditions.
PROPOSALS FOR RESOLVING TRANSFER PRICING CONFLICTS:

1. DUAL RATE TRANSFER PRICING SYSTEM:
a. You simply let the selling division get an imaginary price ie: profit + costs , and let buying division
get it at another price ie: only marginal costs. So then each ones performance systems work
properly, as well as economic decision making systems. But the real ‘accounts’ are just done in a
consolidated fashion – leave out imaginary parts.
2. MARGINAL COSTS PLUS A FIXED LUMP SUM FEE:
a. U this is just that a fixed fee per year eg 200000 is charged for the privilege of getting the goods at
a marginal cost price from the supplying division. This fee should cover opportunity costs & fixed
costs like rent portion etc of seller. Then the marginal cost can be used by buyer to calc. any
economic decisions, and the fixed cost is looked at separately as a ‘fixed cost’ for the buyer in this
regard.
DOMESTIC TRANSFER PRICING RECOMMENDATIONS:

This is basicly all the above points really.
INTERNATIONAL TRANSFER PRICING:

Moe than 60% of world trade is transfers between multinational organizations.
Here it is just that the tax issues about how much profit is reported and taxable by each separate countrys gov.
due to international transfers between eg subsidiaries. So one can try to get a tax benefit out of it. But due to this
the OECD- organization for economic co-opertaion and development made a policy thing where it is outlined how
trandsfer pricing ouht to be done. Their findings are basicly-
1) comparable uncontrolled price method : ie between unrelated parties – so market value.
2) if this is not possible, then there is resale price method –deduct % from final price to allow for profit
3) or the cost plus method
PRICING DECISIONS AND PROFITABILITY
ANALYSIS CH 11 DRURY.
EXAM TIPS
The following section on mark-up and margin is included here as it often features in cost based
pricing strategies:
Margin Vs Mark – up
• The concept of mark up and margin features in the determination of selling prices (Pricing policy).
MARK UP:
Selling Price = Cost + Mark up %
• Mark up is the profit % on cost. Mark – up will therefore only be applied to a cost base in the
determination of selling price or profit.
o If Cost is say = R100 AND the mark – up is 10%
o Selling price will be = R100 + (10% of R100) = R110
MARGIN:
Cost = Sales - Margin %
• Margin is the profit % on sales. Margin will therefore only be applied to a sales base in the
determination of profit or cost of sales.
o If Sales = R100 AND the margin is 10%
o Cost will be = R100 - (10% of R100) = R90
DIPAC26/104
19
WARNING
• Margin works only with sales. Where a question featuring sales quotes a mark up % - You will need
to change the mark up % to a margin % before calculating profit.
• Mark-up works only with cost. Where a question featuring cost quotes a margin % - You will need to
change the margin % to mark up % before calculating profit.
BASICS
1. There are 2 different type of pricing for firms :
a. PRICE SETTING FIRM: they are either market leaders or sell very differentiiaed or customized
proiducts, so they can set own price
b. PRICE TAKING FIRM : they are dependant on what the market is willing to pay,so they cannot
influence their price much.
PRICE SETTING FIRM :
PRICE SETTING FIRM FACING SHORT TERM PRICING DECISIONS

1. This is basicly ‘special once off orders’ from relevant costing where a special order is received from eg
overseas and all fixed costs are already paid for by local orders. So the company can decrease its price to
ONLY variable costs & relevant costs. Any EXCESS CONTRIBUTION is welcome.
2. INCREMENTAL /MARGINAL costs : only 1- direct materials +2- EXTRA overtime / casual / etc Labour
+3 extra electricity /maintenance etc.
3. ISSUES :
a. Must not affect future selling prices / nor to old customers nor these new ones
b. Sufficient capacity
c. Capacity only used short term so more profitable business that may come along is not maybe lost.
PRICE SETTING FIRM FACING LONG TERM PRICING DECISIONS

PRICING CUSTOMISED PRODUCTS
1. Full cost OR long run cost : this is the total resources that are needed to make a product in the long term –
may incl. or excl. facility sustaining costs.
2. If underprice : loose profit , if overprice ; loose customers.
3. It is best to use ABC costing for these products , so you get your pricing just right.: an ABC system may
have : unit level (dirct costs) batch level (eg set up costs) product sustaining(engineering) + customer
sustaining(marketing) costs for its ABC costs.
4. Facility sustain costs MUST be reported separately, and may be incl. in the calc.of product price but in a
SEPARATE category, as it is an arbitrary, and not cause & effect allocation. – signal to mngmnt.
a. Activity base to use for fixed costs: either something you wishg to encourage eg no. of parts if you
want to reduce parts held(encourage standard parts in designs) OR else the most neutral base there
is.
b. If these costs are not added, then an appropriate extra % is added to profit mark up to cover it,
5.
PRICING NON-CUSTOMISED PRODUCTS
PRICING NON-CUSTOMISED PRODUCTS USING TARGET COSTING

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CONTENTS :

SPECIAL FORMULAS TO LEARN :................................................................................................................11

RECORDING RAW MATERIALS PURCHASE & RETURNS

DR Stores Ledger Control Account R5000

DR Creditors Control Account R5000

RECORDING ISSUE OF MATERIALS

place of last question

1. Overheads – term used instead of indirect costs sometimes

THE PRODUCTION POINT OF INDIFFERENCE, :

Direct and Indirect Costs

i) In manufacturing organisations traditional product costs accumulated as follows – ( developed

Relevant and Irrelevant Costs:

Avoidable or Unavoidable costs:

-Incremental /or Differential- and Marginal Costs

Job Costing and Process Costing systems:

ABSORPTION COSTING AND VARIABLE COSTING:and STANDARD

FOR ABSORBTION COSTING THRE ARE 2 WAYS OF VALUING STOCK:1-BUDGET AND 2-

COST ABSORBTION RATE :

VARIABLE COSTING (OR MARGINAL OR DIRECT COSTING)

Maintaining a cost database:

Fixed and Variable Production Overheads : and Cost Behaviour of

UNITS vs VARIABLE COSTS GRAPH

PROFIT vs VARIABLE COSTS GRAPH.

UNITS vs FIXED COSTS GRAPH

PROFIT vs FIXED COSTS GRAPH

SEMI-VARIABLE (OR MIXED COSTS) :

“STANDARD PROFIT STATEMENT”:

INCREMENTAL OR DIFFERENTIAL COSTS :

SEMI-FIXED (OR STEP-FIXED COSTS) :

SEMI-VARIABLE (OR MIXED COSTS) :

i) In manufacturing organisations traditional product costs accumulated as follows – developed

TOTAL MANUFATURING COST :

Relevant and Irrelevant Costs:

Avoidable or Unavoidable costs:

-Incremental /or Differential- and Marginal Costs

UNITS vs VARIABLE COSTS GRAPH

PROFIT vs VARIABLE COSTS GRAPH.

UNITS vs FIXED COSTS GRAPH

PROFIT vs FIXED COSTS GRAPH

SEMI-FIXED (OR STEP-FIXED COSTS) :

Maintaining a cost database:

Fixed and Variable Production Overheads : and Cost Behaviour of

ASSIGNMENT OF : DIRECT AND INDIRECT COSTS

THE TWO STAGE BUT 4 STEP ALLOCATION PROCESS FOR COSTS

3. FIRST STAGE ALLOCATION BASES :

Property tax, Water&lights Area of factory

4. ALLOCATION BASES ADDITIONALLY USED BY ABC COSTING

EXTRACTING RELEVANT COSTS FOR DECISION MAKING

BUDGETED OVERHEAD RATES

UNDER + OVER RECOVERY OF OVERHEADS

DIFFERENCE BETWEEN VOLUME EXPENDITURE DIFFERENCE.

iii.Expenditure variance - underspent -: (called a Deferred Expenditure Variance)you must

MAINTAINING THE DATABASE AT STANDARD COSTS

4) Mathematical principles applying to cost estimation methods:

6. PROBLEMS WITH HIGH/LOW METHOD.:

7. CONTRIBUTION : HIGH – LOW METHOD TO GET IT FROM THE INCOME STATEMENT.

Rent R0 120000-(60000 *0) ….. 120000

Power R3 200000-(60000 *3) …. 20000

5-LEAST SQUARES METHOD

6)relevant range and non-linear functions:

7)summary of steps involved in estimating cost.

8)MULTIple regression analysis:

C- LIMITATIONS OF THE LEARNING CURVE