Budget and Management of Financial

Performance

Class 2

1
Class Date Time start Time end Topics Class Activity Home Activity
PART I - Introduction to Management Accounting & Control
. Scope and objectives of Management Accounting Group
Readings
1 08-Nov 09:30 13:00 . Profession of controller and interactions/communications with other Discussion on
Home Quiz
departments Assessment
. IT, Business Analysis, Control/Management Accounting
PART II - Terms, concepts and classifications of costs
. Costs classification
2 10-Nov 09:30 12:30 . Relevant costs and revenues Case
. Cost concepts in manufacturing companies: cost of goods manufactured
and cost of goods sold
PART II - Terms, concepts and classifications of costs Readings
3 10-Nov 14:00 16:00 Case
. Applications and Exercises Home Quiz
PART III - Information for Decision-Making
. Cost-volume-profit analysis
4 11-Nov 09:30 12:30 Case
. Full costing
. Measuring Performance in Investment Centres
PART III - Information for Decision-Making
. Cost-volume-profit analysis Game Readings
5 11-Nov 14:00 16:00
. Full costing Home Quiz
. Measuring Performance in Investment Centres
Mid-Term Exam
PART IV - Working with the Planning and Control department
Budgeting Readings
6 15-Nov 09:00 13:00 Case
. The planning process Home Quiz
. Objectives and importance of budgeting
. Sales and Operating Budgets
Standard costs and variance analysis
Case Study
. Calculation and interpretation of simple variances
7 17-Nov 09:30 13:00 Case Submission
. Identification of the causes of variances and the corrective actions to
Home Quiz
implement
Case Study Presentation
8 18-Nov 14:00 16:00 2
Module conclusion
1. Allocate costs between cost of goods sold and inventories for profit reporting

2. Provide relevant information for decision-making

▪ Profitability analysis
▪ Product pricing
▪ Make or buy (Outsourcing)
▪ Discontinuation decisions
▪ Product/service-mix decisions

3. Provide information for planning, control, performance measurement and continuous improvement
▪ Long-term and short-term planning (budgeting)
▪ Periodic performance reports for feedback control and performance measurement

Costs should be assembled in different ways to meet the three functions

Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant
Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant
Does the cost occur in the factory while being produced?

Headquarters

Factory

Non-manufacturing Costs
Manufacturing Costs
- Selling Costs
- Direct Materials - General and Administrative Costs
- Direct Labour - Financial Costs (net of financial
- Manufacturing Overheads revenues)
 Direct Materials
Prime Cost
Direct Labour
Conversion Cost
Factory Manufacturing Overheads

Manufacturing Costs
Direct Materials
E.g.: plastic used as a raw material by Hewlett-Packard in its personal computers

Direct Labour
E.g.: Assembly line workers at Toyota, carpenters at a home builder

Manufacturing overhead
E.g.: Indirect materials (glue…), indirect labour (supervisors, night security..), maintenance and repairs, heat
and light, property taxes, depreciation, insurance on manufacturing facilities

Selling Costs
E.g.: advertising, sales travel, sales commissions, salaries of sales personnel

General and Administrative Costs

E.g.: Executive compensation, general accounting, public relations
 ORGANISATION

Manufacturing Administrative
area area

Commercial/
Selling/ Financial area
Marketing area
Marketing or selling costs
Costs necessary to get the order and deliver the product.

Administrative costs
All executive, organisational and clerical costs.
Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant
Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant
 Is the cost related with the products in inventory?

Product costs are those costs that are attached to the product and that are included in the
inventory valuation for finished goods (or for work in progress)
•Exist in both manufacturing and merchandising sector companies
•These costs are treated as expenses (i.e. cost of goods sold) only when the products are sold

Period costs are those costs that are not included in the inventory valuation and as a result are
treated as expenses in the period in which they are incurred (e.g. selling and administrative costs)
 Headquarters

Factory

Non-manufacturing Costs
Manufacturing Costs
- Selling Costs
- Direct Materials
- Direct Labour - General and Administrative Costs
- Financial Costs (net of financial
- Manufacturing Overheads
revenues)

Product Cost Period Cost

Unsold Sold

Recorded as an asset (inventory) in Recorded as an expense in the P&L in

the balance sheet the current accounting period
Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant
 Can we identify the cost to a specific cost object?

Direct costs can be traced easily and accurately to a cost object. The more direct costs that can be
traced to a cost object, the more accurate is the cost assignment.

Indirect costs cannot be traced to cost objects. An estimate must be made of the resources
consumed by cost objects using cost allocations.
 Direct Materials The distinction between direct and
Direct Costs indirect costs depends on the cost object.
A cost can be treated as direct for one cost
Direct Labour
object but indirect in respect of another.

Manufacturing and Non- E.g.: the salary of the factory manager is

Indirect Costs indirect to the different products produced
manufacturing Overheads
in the factory, but direct to the
Overheads = Indirect Costs manufacturing division (as a cost object).
Cost Object Examples of Direct Costs Examples of Indirect Costs
Product: Table manufactured Materials (wood and metal) Rent for manufacturing plant. Rent is paid by
by a Furniture Company used to assemble the table the company, which manufactures 90
different types of furniture.
Activity area: Document Paper and ink used by the Electricity used to run machine. Electricity
photocopying by a consulting photocopying machine metered to company but not to individual
firm machines
Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant

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 How do costs behave when the level of activity (volume) changes? Are they fixed or variable?

Fixed Costs: Remain unchanged in total as the level of activity varies

As activity increases, total fixed costs do not change, but unit fixed cost declines
E.g.: straight-line depreciation, insurance, property taxes, rent, supervisory salaries, administrative
salaries, advertising

Variable Costs: Change in total in direct proportion to a change in activity

A variable cost per unit is constant
E.g.: direct materials, direct labour, electricity, commissions, shipping costs
Variable costs are activity based
Examples of activity base: labour-hours, machine-hours, units produced, units sold, miles driven by salespersons,
number of beds occupied in a hospital.
* Note that this classification of costs depends on the time period involved (the relevant range). In the short term some costs
are fixed, but in the long term all costs are variable.
FIXED COSTS VARIABLE COSTS
TOTAL
PER UNIT
Step-fixed costs: Remain fixed over a wide range of activity
levels but jump to a different amount for
levels outside that range

Semi-variable costs: Has both fixed and variable

components (e.g. telephone charges)

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Type In Total Per unit
Variable 1 2
costs

Fixed Costs 3 4

A) Cost Increases as the B) Cost decreases as the

volume goes up volume goes up C) Remains the same
(positive association) (negative association)
Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant

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 Will the cost change the decision under consideration? Is the cost relevant?

Relevant costs (and revenues) are those future costs (and revenues) that will be changed by a
decision

Irrelevant costs (and revenues) are those that will not be changed by a decision

To be RELEVANT a cost or a revenue must meet these conditions:

• Must DIFFER from one possible decision outcome to the next
• Must relate to the FUTURE
• Have an effect on the wealth (cash flow) of the business.

Note that the notion of sunk cost is also important for decision-making, but not all irrelevant costs are sunk costs

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Business Function
*Manufacturing (raw material, labor, other manufacturing costs)
*Non-Manufacturing: (marketing, distribution, customer service, legal, financial)
Cost in relation to inventory valuation
*Product and *Period Costs
Assignment to Cost Object
*Direct and *Indirect Costs
Cost behavior in relation to Output
*Fixed and *Variable Costs
Costs in relation to a specific decision
*Relevant and *Irrelevant
 • Accumulation of costs by classifying them into certain
categories (e.g. labour, materials and overheads)
1

• Assignment of costs to cost objects

2
Any activity for which a separate measurement of costs is desired

Anything for which one wants to measure the cost of resources used
(e.g. making a product, providing a service, serving a customer, operating a department)
Merchandising organizations
-Purchase and then sell products without changing their basic form
Service-sector companies
- Provide services or intangible products to their customers
- Do not hold finished goods inventories, but some may have work in progress
Manufacturing organizations
- Purchase materials and convert them into various finished goods
- Types of inventories held:
- Direct materials inventory
- Work-in-progress inventory
- Finished goods inventory
Manufacturing
costs

Sales
(COGS)
Inventory of
FACTORY Finished Goods

WIPi WIPf
FGi FGf

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 Costs incurred during a certain period regardless of whether goods were fully
completed during that period

Manufacturing Costs = Direct Materials Costs + Direct Labour Costs + Manufacturing Overheads Costs

▪ Consumption of
Direct Materials
▪ Direct Labour
▪ Manufacturing
Overheads

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▪ Those manufacturing material costs that can be specifically and exclusively
identified with a particular cost object

▪ Direct materials costs include acquisition costs of direct materials

Example: raw materials consumption

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Opening Stocks + Purchases = Consumption of Raw Materials + Closing Stocks

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▪ Those manufacturing labour costs that can be specifically and exclusively identified
with a particular cost object

▪ Physical observation can be used to measure the quantity of labour used to

produce a specific product or service

▪ Direct labour costs include charges over salaries (social security, etc.)

Example: cost of the machine operators engaged in the production process

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▪ All other manufacturing costs which cannot be specifically and exclusively
identified with a particular cost object
▪ Also known as indirect manufacturing costs
Examples:
• Indirect manufacturing labour (e.g. factory supervisors)
• Indirect materials
• Depreciation of factory buildings and machinery
• Rent of the factory
• Insurance of the factory

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Cost of good brought to completion regardless of if they were started before or
during that period
COGM = Manufacturing Costs + Opening Stocks of WIP – Closing Stocks of WIP

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Cost of the fully finished goods sold by the company during that period

COGS = COGM+ Opening Stocks of Finished Goods – Closing Stocks of Finished Goods

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Opening Stocks + Production = Closing Stocks + Sales

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Types of inventory:
- Materials
- Finished goods

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Manufacturing Costs = Direct Materials Costs + Direct Labour Costs + Manufacturing Overheads Costs

▪ Consumption of
Direct Materials
▪ Direct Labour
▪ Manufacturing
Overheads

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COGM = Manufacturing Costs + Opening Stocks of WIP – Closing Stocks of WIP

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COGS = COGM+ Opening Stocks of Finished Goods – Closing Stocks of Finished Goods

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