P P A C I Cost and management accounting Second edition published by Emile Woolf International Bracknell Enterprise & Innovation Hub Ocean House, 12th Floor, The Ring Bracknell, Berkshire, RG12 1AX United Kingdom Email: [email protected] www.emilewoolf.com © Emile Woolf International, January 2015 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, scanning or otherwise, without the prior permission in writing of Emile Woolf International, or as expressly permitted by law, or under the terms agreed with the appropriate reprographics rights organisation. You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer. Notice Emile Woolf International has made every effort to ensure that at the time of writing the contents of this study text are accurate, but neither Emile Woolf International nor its directors or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could contain. `© Emile Woolf International ii The Institute of Chartered Accountants of Pakistan Certificate in Accounting and Finance Cost and management accounting C Contents Page Syllabus objective and learning outcomes v Chapter 1 Inventory valuation 1 2 Inventory management 21 3 Accounting for overheads 45 4 Marginal costing and absorption costing 77 5 Cost flow in production 95 6 Job, batch and service costing 133 7 Process costing 153 8 Budgeting 201 9 Standard costing 241 10 Variance analysis 253 11 Target costing 319 12 Relevant costs 331 13 Cost-Volume-Profit (CVP) analysis 343 14 Decision making techniques 367 15 Introduction to financial instruments 391 16 Time value of money 419 17 Sustainability reporting 469 Appendix 487 Index 491 © Emile Woolf International iii The Institute of Chartered Accountants of Pakistan Cost and management accounting © Emile Woolf International iv The Institute of Chartered Accountants of Pakistan Certificate in Accounting and Finance Cost and management accounting S Syllabus objectives and learning outcomes CERTIFICATE IN ACCOUNTING AND FINANCE COST AND MANAGEMENT ACCOUNTING Objective To equip candidates with techniques of cost accounting to provide a knowledge base for decision making skills. Learning Outcome On the successful completion of this paper candidates will be able to: 1 establish the costs associated with the production of products and provision of services 2 demonstrate an understanding of different costing systems 3 prepare various types of forecasts and budgets 4 apply the concepts of costing in the decision making process 5 demonstrate a functional knowledge of financial instruments 6 apply concept of time value of money 7 understand the concepts of sustainability reporting. Grid Weighting Costs associated with the production 15-20 Costing system 20-30 Budget and budgetary controls 10-15 Decision making 20-25 Financial instruments 5-10 Time value of money 5-10 Sustainability reporting 5-10 Total 100 © Emile Woolf International v The Institute of Chartered Accountants of Pakistan Cost and management accounting Syllabus Contents Level Learning Outcome Ref A Costs associated with production 1 Basis of valuation - FIFO, 2 LO1.1.1: Apply inventory valuation methods (namely, FIFO, weighted weighted average, lower of cost average, lower of cost and net and net realizable value realizable value) in simple scenarios LO1.1.2: Comment on the suitability of inventory valuation under FIFO, weighted average, lower of cost and net realizable value LO1.1.3: Compare inventory valuation under FIFO, weighted average, lower of cost and net realizable value LO1.1.4: Calculate NRVs of inventories in a given scenario. 2 Economic Order Quantity 2 LO1.2.1: Describe the economic order quantity (EOQ) and apply the concept in given scenarios LO1.2.2: Calculate the EOQ from data provided. 3 Safety stock 2 LO1.3.1: Describe safety stocks for inventories LO1.3.2: Explain the reasons for maintaining safety stock LO1.3.3: Calculate the safety stock from data provided. 4 Re-order level 2 LO1.4.1: Explain the re-order levels and the objectives of setting re- order levels LO1.4.2: Calculate re-order levels by using the data provided. 5 Manufacturing expenses - actual 2 LO1.5.1: Describe manufacturing overheads using examples and applied LO1.5.2: Compare manufacturing, administrative and selling costs LO1.5.3: Identify manufacturing overheads from data provided LO1.5.4: Describe and distinguish between actual overhead and applied overhead LO1.5.5: Calculate applied overheads using data provided. © Emile Woolf International vi The Institute of Chartered Accountants of Pakistan Syllabus objectives and learning outcomes Syllabus Contents Level Learning Outcome Ref Costs associated with production (continued) 6 Over or under absorbed overhead 2 LO1.6.1: Compare actual and absorbed overheads from data provided LO1.6.2: Analyze over or under absorption in terms of expenditure and volume variances LO1.6.3: Account for over or under- absorbed overheads. 7 Production and service 2 LO1.7.1: Identify production and departments service departments in a manufacturing facility and analyze their related cost LO1.7.2: Explain the basis of allocation of cost of service department to production department 8 Apportionment, allocation and 2 LO1.8.1: Allocate costs to absorption of service departments' production and service departments overheads to production using information provided LO1.8.2: Allocate costs of service departments to production department using data and information provided. B Costing systems 1 Marginal costing 2 LO2.1.1: Explain the concept of marginal costing and apply on given data LO2.1.2: Explain how marginal costing helps managerial decisions using examples. 2 Absorption costing 2 LO2.2.1: Describe and apply absorption costing approach in given scenarios LO2.2.2: Compare marginal costing and absorption costing. 3 Manufacturing cost accounting 2 LO2.3.1: Explain the flow of cost in cycle production process using examples. LO2.3.2: Prepare accounting entries for flow of cost. © Emile Woolf International vii The Institute of Chartered Accountants of Pakistan Cost and management accounting Syllabus Contents Level Learning Outcome Ref Costing systems (continued) 4 Job order costing 2 LO2.4.1: Describe job order costing LO2.4.2: Calculate the cost of a job and inventories by application of job order costing LO2.4.3: Prepare accounting entries under the job order costing system. 5 Process costing 2 LO2.5.1: Describe the process costing including the treatment of normal / abnormal loss / gain LO2.5.2: Calculate cost of product and inventories by application of process costing LO2.5.3: Prepare accounting entries under the process costing system. 6 Treatment of Joint and By- 2 LO2.6.1: Describe joint and by Products products using examples LO2.6.2: Allocate joint production costs using sales value, physical units, average units and weighted average methods LO2.6.3: Account for by-products using recognition of gross revenue, recognition of net revenue and replacement cost approaches. 7 Cost of services rendered 2 LO2.7.1: Explain how departmentalization in a service organization helps in cost planning and control LO2.7.2: Calculate cost of services rendered by a service organization. 8 Standard costing 2 LO2.8.1: Explain standard costing using examples LO2.8.2: Perform standard setting for material, labour and factory overhead. 9 Variance analysis-material, labour 2 LO2.9.1: Calculate, analyze and and overhead interpret various variances relating to material, labour and factory overhead. 10 Target costing 2 LO2.10.1: Describe target costing and how target cost is determined LO2.10.2: Apply the target costing tools to given scenarios. © Emile Woolf International viii The Institute of Chartered Accountants of Pakistan Syllabus objectives and learning outcomes Syllabus Contents Level Learning Outcome Ref C Budget and budgetary controls 1 Planning, forecasting and 2 LO3.1.1: Explain how budgeting budgeting of sales, cost and profit process works and how it fits into overall planning and control LO3.1.2: Prepare forecasts on given data and assumptions LO3.1.3: Identify and describe different purposes of budgeting LO3.1.4: Identify and describe the various stages in the budget process LO3.1.5: Prepare following types of budgets:  fixed and flexible budgets;  performance budgeting;  sales budget;  production budget;  direct materials budget;  direct labour budget;  manufacturing overhead budget;  inventory budget;  cost of goods sold budget;  selling and administrative expenses budget with inflation aspects;  Master/cash budget;  zero based budgets, and  capital expenditure budgets; LO3.1.6: Describe the human & motivational aspects of budgets LO3.1.7: Describe the budgeting and planning in a non-profit organisation LO3.1.8: Prepare forecast and budgets for a non-profit organisation. © Emile Woolf International ix The Institute of Chartered Accountants of Pakistan Cost and management accounting Syllabus Contents Level Learning Outcome Ref D Decision making 1 Opportunity cost 2 LO4.1.1: Describe opportunity cost using examples. 2 Relevant cost 2 LO4.2.1: Describe relevant costs using examples LO4.2.2: Identify the costs that are relevant to a particular decision in given data. 3 Breakeven analysis 2 LO4.3.1: Explain the break-even point using examples and margin of safety LO4.3.2: Calculate the breakeven point in quantity and amount from information provided LO4.3.3: Apply cost volume profit (CVP) analysis and explain its usefulness for management. 4 Make or buy decisions 2 LO4.4.1: Apply marginal and relevant costing concepts to analyze make or buy options LO4.4.2: Analyze make or buy options in case of capacity constraints LO4.4.3: Discuss using examples the importance of qualitative consideration in make or buy decisions. 5 Pricing for special orders 2 LO4.5.1: Perform incremental cost benefit analysis for a special order 6 Further processing decisions 2 LO4.6.1: Perform incremental cost benefit analysis for further processing costs. 7 Utilization of spare capacity 2 LO4.7.1: Analyze the impact of spare capacity on management decisions regarding make or buy, special order and further processing. © Emile Woolf International x The Institute of Chartered Accountants of Pakistan