CIMA P1 Notes

104 Pages·2016·1.87 MB·English

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Contents

1.
Traditional Costing Methods
3

2.
Activity Based Costing
7

3.
Limiting Factor Analysis
11

4.
Environmental Management Accounting
15

5.
Modern Manufacturing Environment
19

6.
Linear Programming
25

7.
Standard Costing and Basic Variance Analysis
27

8.
Advanced Variances
33

9.
Budgeting
39

10.
Forecasting Techniques
47

11.
Risk and Uncertainty
55

12.
Relevant Costing
61

13.
Cost Volume Profit Analysis
67

14.
Answers to Examples
73

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Chapter 1

TRADITIONAL COSTING METHODS

1.
Introduction

The collective term traditional costing methods refers to:

๏
Absorption Costing

๏
Marginal costing

These costing methods will be familiar to you from previous studies.

You will need to understand traditional costing methods in order to compare and contrast
their differences. From here you will be able to consider their strengths or weaknesses
against modern alternatives such as ABC costing.

Important to this section is the concept of marginal costing contribution which links to many
other parts of CIMA P1 syllabus for example, limited factor analysis, variance reconciliations
and cost volume profit (CVP) techniques. (see later chapters)

2.
The purpose of calculating a cost per unit.

Exercise 1

Why do we need to obtain a cost per unit?

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3.
Features of Absorption costing

Includes a share of production overheads in the product cost.

Acceptable method of inventory valuation as per IAS 2.

Results in a FULL product cost per unit.

Overheads are allocated apportioned then absorbed across all units using a single cost driver
(usually machine or labour hours).

Suitable costing system for mass produced, homogeneous products - where overheads are
largely volume driven.

4.
Strengths and weaknesses of Absorption Costing

5.
Features of Marginal Costing

Useful for internal, short term decision making.

Only variable costs are included in product cost.

Overheads are classed as period costs.

Focus is on CONTRIBUTION earned (which is not distorted by overhead costs) and can be
used to evaluate decisions relating to incremental units.

Contribution = Selling Price less Variable cost.

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6.
Strengths and weaknesses of Marginal costing

7.
Reconciliation of profits, Absorption Vs Marginal Costing

Absorption and Marginal costing result in different reported profits in the short term. This is
because inventory includes or does not include a charge for fixed overheads.

When production in the period is not equal to sales (inventory decreases or increases) there
will be a different profit figure reported under each costing system.

The reconciliation required is below:

๏
ABSORPTION PROFIT
$ X

Change in inventory levels in period x OAR
(X / (X))

๏
Marginal Costing Profit
$X

To determine the direction of the adjustment - a useful mnemonic is SIAM

When Stocks Increase Absorption (profit) is More

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Exercise 2

Sales in period 12000 units.

Production volume 13500 units

Selling price $150

Variable costs $65 per unit

Fixed production costs per unit $30

The company above uses a marginal costing system.

Calculate the difference in reported profit under absorption costing?

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Chapter 2

ACTIVITY BASED COSTING

1.
Introduction

Traditional absorption costing systems share overheads across all products based on a single
cost driver (usually machine or labour hours).

It is argued that a modern manufacturing environment requires a more sophisticated and
intelligent costing system.

Under ABC costing, overhead costs are given greater attention and visibility because they are
assigned to different products based on the extent to which each product ‘drives’ or causes
that cost.

This costing system can be relatively time-consuming and costly to implement but can be
useful, if manufacturing overhead expenditure is significant and a diverse product range
exists. ABC can also be applied to costing within service industries.

2.
The steps to be followed are as follows:

๏
Identify the major ‘activities’ that give rise to overheads (e.g. quality testing, ordering
costs etc)

๏
Determine what causes the cost of each activity – the cost driver (e.g. number of
inspections, number of orders)

๏
Calculate the total costs for each activity – the cost pools.

๏
Calculate a cost per cost driver.

๏
Allocate the overhead costs to products based on their usage of cost driving activities.

๏
Calculate the overhead cost per unit for each item of output.

NOTE on CIMA new objective test exams.
It is unlikely that objective tests questions will require you to complete all steps from
beginning to end. However, it is important to be familiar with the entire process before you
can answer questions on isolated areas of the sequence.

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Exercise 1

Una manufactures three products: A, B, and C.

Data for the period just ended is as follows:

A
B
C

Production (units)
20,000
25,000
2,000

Sales price ( per unit)
$20
$20
$20

Material cost (per unit)
$5
$10
$10

Labour hours (per unit)
2 hours
1 hour
1 hour

(Labour is paid at the rate of $5 per hour)

Overheads for the period were as follows:

Set-up costs
90,000

Receiving
30,000

Despatch
15,000

Machining
55,000

$190,000

Cost driver data:

A
B
C

Machine hours per unit
2
2
2

Number of set-ups
10
13
2

Number of deliveries received
10
10
2

Number of orders despatched
20
20
20

(a)
Calculate the cost (and hence profit) per unit, absorbing all the overheads on the basis
of labour hours.

(b)
Calculate the cost (and hence profit) per unit absorbing the overheads using an Activity
Based Costing approach.

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3.
ABC Cost Hierarchy

ABC costing classifies costs into the following categories.

๏
Unit level cost – are incurred with each unit of output -e.g. power is used by factory
machines each time a unit is produced.

๏
Batch level costs –increase with each ‘batch’ of output -e.g. equipment set-up costs are
incurred each time a new batch is processed.

๏
Product Sustaining costs – this type of cost does not increase in relation to batches or
units produced but are necessary costs to support particular product types – e.g. design
costs.

๏
Facility level costs – General manufacturing overheads these can not easily be traced
to production activity e.g. admin staff salaries.

4.
Strengths / Weaknesses of ABC Costing

Exercise 2

Explain the benefits, which can be gained from changing to a more effective costing system?

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Chapter 3

LIMITING FACTOR ANALYSIS

1.
Introduction

Limited Factor analysis can be used to determine optimum production levels when faced
with scarcity of a single resource (a limiting factor).

The limiting factors, in exam questions will often take the form of a shortage of a particular
raw material or an insufficient number of labour hours being available.

Management are faced with a decision of what quantities and mix of products to
manufacture in order to maximise profits given this constraint.

In a marginal costing environment, the concept of contribution can be used to plan
production in a manner which will maximise profits.

Following this, we find solutions to limiting factor scenarios in a throughput costing
environment.

2.
Traditional Limiting Factor Analysis

When faced with a shortage in production resources, management can use a contribution-
focussed approach to help them identify an optimum production plan.

The marginal costing model provides information on the contribution level of all products. In
the short term, fixed costs do not change – so profits can be maximised through following a
production plan that maximises contribution.

In a situation where there is a scarcity of a particular resource, the products competing for use
of that resource can be ranked in terms of their contribution earned per unit of limited
resource. For example, a shortage of labour hours will require products to be prioritised
based on those which earn the most contribution per each scarce labour hour used.

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Exercise 1

Pi plc manufactures 2 products, A and B.

The cost cards are as follows:

A
B

Selling price
25
28

Materials
8
20

Labour
5
2

Other variable costs
7
2

Fixed costs
3
2

23
26

Profit
$2
$2

Machine hours p.u.
2 hrs
1 hr

Maximum demand
20,000 units
10,000 units

The total hours available are 48,000.

Calculate the optimum production plan and the maximum profit using conventional limiting
factor analysis.

3.
Theory of Constraints and Throughput

Goldratt’s Theory of Constraints is an important management methodology which can be
applied to systems that are unable to meet their goals (usually maximising profit) due to a
constraint. Management should ensure that efforts are focussed on making the best possible
use of this limitation. Ideally the constraint will need to be eliminated in the longer term,
meanwhile Goldratt recommended reorganising all other system activities around the
constraint to ensure its use is optimised. The constraint in manufacturing is referred to as a
bottleneck.

Goldratt refers to Throughput as a key performance measure. The main concepts of
throughput accounting are given below.

๏
Throughput is the rate at which the system generates money. It is measured in
monetary terms and links directly to profitability therefore the objective is to maximise
throughput values or throughput flow.

Throughtput ($) = Sales Revenue less Direct Material Costs

๏
In the short run, ALL costs (except direct materials) are viewed as being fixed. This
includes LABOUR as Fixed cost. The sum of all these production costs including labour is
called TOTAL FACTORY COSTS.

๏
The constraint on production is referred to a Bottleneck.

๏
Throughput accounting can be used in a Just-in-time environment.

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4.
Key formulae:

Throughput ($)

=

Sales revenue – Direct Material costs

Total factory costs

=
ALL production costs (except materials)

1
Return per factory hour =
Throughput per Unit $
1
Return per factory hour =

Time per unit in bottleneck resource (hrs)

2
Cost per factory hour =
Total factory cost (inc labour +overheads)
2
Cost per factory hour =

Total time available in Bottleneck (ALL hrs)

3
Throughput accounting ratio (TPAR)=
Return per factory hour (1)
3
Throughput accounting ratio (TPAR)=

Cost per factory hour (2)

4.1. Interpretation of TPAR ratios:

The TPAR ratio should be greater than 1 for the product to be classed as financially viable.
Priority should be given to the products which generate the highest TA ratios.

Products with a TPAR ratio less than one should be discontinued.

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