CIMA Official Learning System Relevant for Computer-Based Assessment C1— Fundamentals of Management Accounting CIMA Certifi cate in Business Accounting Janet Walker CIMA Publishing is an imprint of Elsevier Linacre House, Jordan Hill, Oxford OX2 8DP, UK 30 Corporate Drive, Suite 400, Burlington, MA 01803, USA First edition 2008 Copyright © 2009 Elsevier Ltd. All rights reserved No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means electronic, mechanical, photocopying, recording or otherwise without the prior written permission of the publisher Permissions may be sought directly from Elsevier’s Science & Technology Rights Department in Oxford, UK: phone ((cid:2) 44) (0) 1865 843830; fax ( (cid:2) 44) (0) 1865 853333; e-mail: [email protected]. 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British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloguing in Publication Data A catalogue record for this book is available from the Library of Congress 978-1-85617-792-4 For information on all CIMA publications visit our website at w ww.elsevierdirect.com Typeset by Macmillan Publishing Solutions. www.macmillansolutions.com Printed and bound in Italy 09 10 11 11 10 9 8 7 6 5 4 3 2 1 Working together to grow libraries in developing countries www.elsevier.com | www.bookaid.org | www.sabre.org Contents The CIMA Learning System xi How to use your CIMA Learning System xi Guide to the Icons used within this text xii Study technique xii Computer-Based Assessment xiv Fundamentals of Management Accounting and Computer-Based Assessment xv Learning Outcomes and Indicative Syllabus Content xvi 1 Basic Aspects of Cost Accounting 1 Learning Outcomes 3 1.1 Introduction 3 1.2 Why organisations need costing systems 3 1.3 What is meant by ‘ cost ’ ? 4 1.4 Cost units 4 1.4.1 Composite cost units 5 1.5 Cost centres 6 1.6 Cost objects 6 1.7 Classifi cation of costs 7 1.7.1 Classifi cation of costs according to their nature 7 1.7.2 Classifi cation of costs according to their purpose: direct costs 8 and indirect costs 1.8 Elements of cost 9 1.9 Cost behaviour 12 1.9.1 Fixed cost 12 1.9.2 Variable cost 14 1.9.3 Semi-variable cost 15 1.9.4 Analysing semi-variable costs 16 1.9.5 Using historical data 18 1.9.6 The importance of time scale in analysing cost behaviour 18 1.10 Summary 19 Revision Questions 21 Solutions to Revision Questions 27 2 Accounting for the Value of Inventories 31 Learning Outcomes 33 2.1 Introduction 33 2.2 Valuing inventory at cost 33 2.3 First in, fi rst out (FIFO) 34 2.4 Last in, fi rst out (LIFO) 35 2.5 Cumulative weighted average (AVCO) 35 iii iv FUNDAMENTALS OF MANAGEMENT ACCOUNTING C1 S 2.6 Comparison of FIFO, LIFO and AVCO 36 T N E 2.6.1 Historical cost compared with economic cost and economic value 37 T N 2.7 Inventory valuation and the effect on gross profi t 37 O C 2.8 Periodic weighted average 38 2.9 Materials documentation 39 2.9.1 Perpetual inventory system 39 2.9.2 Recording the receipt of goods 39 2.9.3 Recording the movement of inventory items 39 2.10 Summary 40 Revision Questions 41 Solutions to Revision Questions 45 3 The Analysis of Overhead 51 Learning Outcomes 53 3.1 Introduction 53 3.2 What is an overhead cost? 53 3.2.1 Defi nition 53 3.2.2 Functional analysis of overhead costs 54 3.3 Overhead allocation and apportionment 54 3.4 Absorption of overheads into saleable cost units 56 3.4.1 General principles 56 3.4.2 Applying the overhead absorption rate 57 3.4.3 Other absorption bases 57 3.4.4 Selecting the most appropriate absorption rate 58 3.5 Predetermined overhead absorption rates 59 3.5.1 Under- or over-absorption of overheads 59 3.5.2 The reasons for under- or over-absorption 61 3.5.3 The problems caused by under- or over-absorption of overheads 61 3.6 Illustrative example 61 3.6.1 Solution 62 3.7 Reciprocal servicing 64 3.7.1 Taking account of reciprocal servicing 64 3.7.2 The usefulness of reapportioned service centre costs 65 3.8 Activity-based costing (ABC) 66 3.9 The use of cost information in pricing decisions 66 3.9.1 Marginal cost pricing 66 3.9.2 Full cost-plus pricing 67 3.9.3 Example: full-cost pricing to achieve a specifi ed return on sales 67 3.9.4 Example: full-cost pricing to achieve a specifi ed return on 68 investment 3.9.5 Second example: full-cost pricing to achieve a specifi ed return 68 on investment 3.10 Summary 69 Revision Questions 71 Solutions to Revision Questions 79 FUNDAMENTALS OF MANAGEMENT ACCOUNTING v 4 Cost–Volume–Profi t Analysis 85 C O N Learning Outcomes 87 T E 4.1 Introduction 87 N T S 4.2 Breakeven or cost–volume–profi t analysis 87 4.2.1 The concept of contribution 88 4.2.2 Calculating the breakeven point 88 4.3 The margin of safety 88 4.4 The contribution to sales (C/S) ratio 89 4.5 Drawing a basic breakeven chart 90 4.6 The contribution breakeven chart 92 4.7 The profi t–volume chart 92 4.7.1 The advantage of the profi t–volume chart 93 4.8 The limitations of breakeven (or CVP) analysis 94 4.9 The economist’s breakeven chart 95 4.10 Using CVP analysis to evaluate proposals 96 4.11 Limiting factor analysis 98 4.11.1 Decisions involving a single limiting factor 98 4.12 Summary 102 Revision Questions 103 Solutions to Revision Questions 111 5 Standard Costing and Variance Analysis 117 Learning Outcomes 119 5.1 Introduction 119 5.2 What is a standard cost? 120 5.3 Performance levels 121 5.3.1 A standard 121 5.3.2 Ideal standard 122 5.3.3 Attainable standard 122 5.3.4 Current standard 122 5.4 Setting standard costs 122 5.4.1 Standard material price 122 5.4.2 Standard material usage 123 5.4.3 Standard labour rate 123 5.4.4 Standard labour times 123 5.4.5 Variable production overhead costs 123 5.5 Updating standards 123 5.6 Standard costing in the modern business environment 124 5.7 What is variance analysis? 124 5.8 Variable cost variances 124 5.8.1 Direct material cost variances 125 5.8.2 The direct material price variance and inventory valuation 126 5.8.3 Direct labour cost variances 127 5.8.4 Variable overhead cost variances 128 vi FUNDAMENTALS OF MANAGEMENT ACCOUNTING C1 S 5.9 Sales variances 129 T N E 5.9.1 Sales price variance 129 T N 5.9.2 Sales volume contribution variance 130 O C 5.10 Summary 130 Revision Questions 131 Solutions to Revision Questions 137 6 Further Standard Costing 143 Learning Outcomes 145 6.1 Introduction 145 6.2 Reconciling actual contribution with budgeted contribution 145 6.3 Idle time variances 148 6.4 Interpreting variances 149 6.4.1 The reasons for variances 149 6.4.2 The signifi cance of variances 150 6.5 Standard hour 152 6.6 Labour incentive schemes 153 6.6.1 Bonus schemes 153 6.6.2 Piecework systems 154 6.6.3 Guaranteed minimum wage 155 6.6.4 Differential piece rate 155 6.6.5 Piecework hours 156 6.6.6 Group incentive schemes 156 6.7 Summary 157 Revision Questions 159 Solutions to Revision Questions 163 7 Integrated Accounting Systems 169 Learning Outcomes 171 7.1 Introduction 171 7.2 An integrated accounting system 171 7.3 Accounting for the cost of labour 172 7.3.1 Deductions from employees ’ wages 172 7.3.2 Overtime premium 172 7.3.3 Bonus earnings 173 7.3.4 Idle time 173 7.3.5 Example: analysis of labour costs 173 7.4 Integrated accounts in operation 174 7.4.1 Example: the main accounting entries in an integrated system 174 7.4.2 Accounting for under- or over-absorbed overheads 176 7.4.3 Example: integrated accounts 177 7.5 Standard cost bookkeeping 184 7.6 Recording variances in the ledger accounts 184 7.6.1 General rules for recording variances 184 7.6.2 The income statement 185 7.7 Standard cost bookkeeping: an example 185 7.8 Valuing material inventory at actual cost 192 7.8.1 Which inventory valuation method is generally preferred? 193 FUNDAMENTALS OF MANAGEMENT ACCOUNTING vii 7.9 Summary 193 C O N Revision Questions 195 T E N Solutions to Revision Questions 203 T S 8 Specifi c Order Costing 207 Learning Outcomes 209 8.1 Introduction 209 8.2 Job costing 209 8.2.1 Job cost sheets and databases 210 8.2.2 Collecting the direct costs of each job 210 8.2.3 Attributing overhead costs to jobs 212 8.2.4 A worked example 213 8.2.5 Preparing ledger accounts for job costing systems 214 8.3 Batch costing 218 8.3.1 Example: batch costing 218 8.4 Contract costing 220 8.4.1 Architect’s certifi cates and progress payments 220 8.4.2 Retention money 220 8.4.3 Contract accounts 220 8.4.4 Accounting for contract materials 221 8.4.5 Accounting for plant used on the contract 221 8.4.6 Cost classifi cation in contract costing 221 8.4.7 Calculating contract profi t and preparing balance sheet entries 222 8.4.8 Contract costing: a worked example 222 8.4.9 Accounting for a loss-making contract 226 8.4.10 Contract costing: a second example 227 8.4.11 Contract costing: a fi nal example 230 8.5 Summary 232 Revision Questions 233 Solutions to Revision Questions 239 9 Process Costing 245 Learning Outcomes 247 9.1 Introduction 247 9.2 Process accounts 247 9.3 Losses in process 249 9.4 Abnormal losses and gains 250 9.5 Closing work in progress: the concept of equivalent units 252 9.6 Previous process costs 256 9.7 Opening work in progress 256 9.8 Process costing: a further example 258 9.9 Contrasting process costing and specifi c order costing 260 9.10 Summary 260 Revision Questions 263 Solutions to Revision Questions 271 viii FUNDAMENTALS OF MANAGEMENT ACCOUNTING C1 TS 10 Presenting Management Information 279 N TE Learning Outcomes 281 N O 10.1 Introduction 281 C 10.2 Subjective and objective classifi cation 281 10.2.1 Responsibility centres 282 10.2.2 Reporting management accounting information 282 10.3 Coding of costs 282 10.3.1 Composite codes 282 10.3.2 The advantages of a coding system 283 10.3.3 The requirements for an effi cient coding system 284 10.4 Preparing fi nancial statements that inform management 284 10.4.1 Value added 284 10.4.2 Contribution 285 10.4.3 Gross margin 286 10.5 Managerial reports in a service organisation 287 10.5.1 Establishing a suitable cost unit 287 10.5.2 Establishing the cost per unit 287 10.5.3 The instantaneous and perishable nature of services 287 10.5.4 Managerial reporting in a charity: example 291 10.6 Summary 292 Revision Questions 293 Solutions to Revision Questions 297 11 Financial Planning and Control 301 Learning Outcomes 303 11.1 Introduction 303 11.2 The purposes of budgeting 303 11.2.1 Budgetary planning and control 304 11.2.2 What is a budget? 304 11.2.3 The budget period 304 11.2.4 Strategic planning, budgetary planning and 305 operational planning 11.3 The preparation of budgets 305 11.3.1 Coordination: the budget committee 306 11.3.2 Participative budgeting 306 11.3.3 Information: the budget manual 306 11.3.4 Early identifi cation of the principal budget factor 307 11.3.5 The interrelationship of budgets 307 11.3.6 Using computers in budget preparation 308 11.3.7 The master budget 308 11.4 Preparation of functional budgets 309 11.4.1 Budget interrelationships 311 11.5 The cash budget 311 11.5.1 Preparing cash budgets 312 11.5.2 Interpretation of the cash budget 313 11.6 A complete exercise 315 11.7 Rolling budgets 322 FUNDAMENTALS OF MANAGEMENT ACCOUNTING ix 11.8 Budgets for non-operating functions 322 C O 11.8.1 Incremental budgeting 323 N T 11.8.2 Zero-based budgeting 323 EN T 11.9 Budgetary control information 323 S 11.9.1 Budget centres 324 11.9.2 Budgetary control reports 324 11.10 Fixed and fl exible budgets 325 11.10.1 Flexible budgets: an example 325 11.10.2 Preparing a fl exible budget 325 11.10.3 The total budget variance 327 11.10.4 Using fl exible budgets for planning 328 11.10.5 Flexible budgets: another example 328 11.10.6 Extrapolating outside the relevant range 331 11.10.7 Example: producing a fl exible budget control statement 331 11.11 Using budgets as a basis for rewards 333 11.11.1 Example 333 11.11.2 Factors to consider in the design of budget reward 333 schemes 11.12 Summary 334 Revision Questions 335 Solutions to Revision Questions 343 Preparing for the Assessment 351 Format of the assessment 353 Revision technique 353 How to tackle the assessment 355 Revision Questions 357 Solutions to Revision Questions 389 Mock Assessment 1 423 Mock Assessment 2 451 Index 479