F5

Performance
Management
 Contents
Part A – Cost and Part C – Budgeting and
management accounting control
techniques Quantitative analysis in
Costing techniques budgeting
ABC Budgetary systems (types
Target costing of budget)
Life cycle costing Variances
Throughput accounting
Environmental accounting

Part B – Decision
making techniques Part D – Performance
measurement and
Cost – volume – profit
analysis control
Limiting factor analysis Financial and non-financial
indicators
Pricing decisions
Divisional performance
Short-term decisions
Not for profit organization
Risk and uncertainty
 The examiner’s key concerns
• Students need to be able to interpret any numbers they
calculate and see the limitations of their financial analysis.
• In particular financial performance indicators may give a
limited perspective and NFPIs are often needed to see the
full picture.
• Questions will be practical and realistic, so will not dwell on
unnecessary academic complications.
• Many questions will be designed so discussion aspects can
be attempted even if students have struggled with
calculation aspects.
 Chapter 1: Costing
I. Using absorption costing to deal with the problem of
overhead
1. Reason for using absorption costing
2. Revision of absorption costing
II. Using marginal costing to deal with the problem of overhead
1. Difference between marginal costing and absorption
costing
2. Comparison of total profits
Note: Reference to F2
 Reasons for using absorption costing

- Inventory valuations (FA)

- Pricing decisions (cost plus pricing)
- Establishing the profitability of different
products
Revision of absorption costing
 Revision of absorption costing
Three steps in absorption costing
Allocation
Apportionment and re-apportionment
Absorption
Methods use for Apportionment
Direct method
The reciprocal (repeated method)
Using algebra
 Revision of absorption costing
Over and under absorption of overheads???

Overhead Absorbed – Actual = Negative ----- Under Absorption

Overhead Absorbed – Actual = Positive ----- Over Absorption

 Example
Brick by Brick (BBB) is a business which provides a range of building
services to the public. Recently they have been asked to quote for
garage conversions (GC) and extensions to properties (EX) and have
found that they are winning fewer GC contracts than expected.

BBB has a policy to price all jobs at budgeted total cost plus 50%.
Overheads are currently absorbed on a labour hour basis.

A typical GC costs $3,500 in materials and takes 300 labour hours to

complete. A GC requires only one site visit by a supervisor and needs
only one planning document to be raised. The typical EX costs $8,000
in materials and takes 500 hours to complete. An EX requires six site
visits and five planning documents. In all cases, labour is paid $15 per
hour. (total OH = $400,000, total lalour hrs = 40,000 hrs)

Question: Calculate cost per unit for GC and EX using AC

technique.
 Example (cont’)
The company is considering moving to an activity
based cost approach. You are provided with the
following data:

Question: Calculate the cost and the quoted price of a

GC and an EX using activity based costing (ABC)?
 Practice absorption costing
Case 1

X plc produces desks. Each desk uses 3 kg of wood at a cost

of $4 per kg, and takes 4 hours to produce.

Labor is paid at the rate of $2 per hour

Fixed costs of production are estimated to be $700,000 p.a.

The company expects to produce 50,000 desks p.a.

Calculate the cost per desk

 Practice absorption costing
Case 2

X plc produces desks and chairs in the same factory.Each

desk uses 3 kg of wood at a cost of $4 per kg, and takes 4
hours to produce.Each chair uses 2 kg of wood at a cost of
$4 per kg, and takes 1 hour to produce. Labor is paid at
the rate of $2 per hours. Fixed costs of production are
estimated to be $700,000p.a.... The company expect to
produce 30,000 desks and 20,000 chairs p.a. (Overheads
are to be absorbed on a labour hour basis)

Calculate the cost per unit for desks and chairs

 Practice absorption costing
Case 3

X plc produces desks and chairs in the same factory. The factory has two
departments, assembly and finishing. Each desk uses 3kg of wood at a cost of
$4 per kg., and takes 4 hours to produce – 3 hours in assembly and 1 hour in
finishing. Each chair uses 2kg of wood at cost of $4 per kg., and takes 1 hour
to produce - ½ hours in assembly and ½ hours in finishing. All labor is paid at
the rate of $2 per hour. Fixed costs of production are estimated to be
$700,000 p.a...Of this total, $100,000 is the salary of the supervisors – 60,000
to Assembly supervisor, and $40,000 to Finishing supervisor. The remaining
overheads are to be split 40% to Assembly and 60% to Finishing. The
company expects to produce 30,000 desks and 20,000 chairs. (Overheads to be
absorbed on a labor hour basis)

Calculate the cost per unit for desks and for chairs
 Practice absorption costing
Case 4
$
Factory rent 20,000
Factory heat 5,000

Processing Dept – supervisor 15,000

Packing Dept – supervisor 10,000

Depreciation of equipment 7,000
Factory canteen expenses 18,000

Welfare costs of factory employees 5,000

Processing Dept Packing Dept Canteen

Cubic space 50,000 m³ 25,000 m³ 5,000m³
NBV equipment $300,000 $300,000 $100,000

No. of employees 50 40 10

Required: Allocate and apportion production overhead costs between

the three departments using a suitable basis
 Practice absorption costing
Case 5

Reapportionment of service cost centre overheads

Factory cost centers can be broken down into two types:

PRODUCTION COST CENTRES these make the cost units.

these do work for the production cost

SERVICE COST CENTRES
centers and one another.

No Inter Service Work Done

If there is just one service department, or if there is more than one

service department but there is no work done by one service
department for another, then reapportionment is done using a suitable
basis (e.g. canteen costs by the number of employees). Reapportion the
canteen cost in Example 4 to the production cost centers.
 Practice absorption costing
Case 6
Production Depts Service Centres

X Y Store Maintenance

$ $ $ $

Allocates and apportioned overheads 70,000 30,000 20,000 15,000

Estimated work done by the

Service centers for other

Departments:
Stores 50% 30% 20%
Maintenance 45% 40% 15%
Reapportion service department costs to departments using:

(a) Repeated distribution method; and

(b) Algebraic method

II. Using marginal costing to deal
with the problem of overhead
Marginal cost is the cost of one unit of a
product/service which could be avoided if that unit
were not produced/ provided. (…)

Contribution is the difference between sales revenue

and variable (marginal) cost of sales.

Marginal costing is an alternative to absorption

costing. Only variable costs (marginal costs) are charged
as a cost of sales
 Difference between marginal
costing and absorption costing

Marginal costing Absorption costing

Closing stock valued at Closing stock valued at full

marginal production cost production cost

Fixed Costs are absorbed to

Fixed costs are period cost
unit costs

Cost of sales does not included Cost of sales includes share of

share of fixed overhead fixed overhead.
 Practice marginal costing
A company manufactures chairs, presents the following
data for 2019:
Opening inventory (for chairs) 0 units
Sales 8,000 units
Production 10,000 units
Closing inventory (for chairs) 2,000 units
Variable cost per unit
- Dir. Materials $240
- Dir. Labor $280
- Variable production OH $100
- Variable non-production OH (selling, distribution,..) $40
Fixed OH
Fixed production OH $1,200,000

Required: calculate the unit product cost under:

(i) Absorption costing system
(ii) Marginal costing system
 Solution:
Absorption costing Marginal costing

- Dir. Materials $240 $240

- Dir. Labor $280 $280
- Variable production OH $100 $100

- Fixed Production OH $120* -

Cost per unit $740 $620

[*] = $1,200,000 / 10,000 units = $120 per unit

Sales price: $1,500 per unit. Calculate profit?

Under Absorption costing:
Under Marginal costing:
Δ Profit = OAR x changes in Inventory
Profit (MC) = Profit (AC) +/- OAR x changes in Inv
 Comparison of total profits
Arguments for Absorption costing Arguments for Marginal costing

It is fair to share fixed production costs

Simple to operate/ No apportionment
between units of production as such
of fixed cost. Under/ Over absorbed
costs are incurred in order to make
OH avoided
output

In compliance with IAS (valuation of Fixed cost = period cost unchanged at

closing stock) different levels of activity? should be
fully charged into the period

Easier to determine the profitability of Closing stock valued at realistically.

several product by charging a share of More relevance for decision making
fixed overheads to them process