Management Training ACCOUNTING TRAINING FOR TRAINEES

Compiled by: Prof. Rashied Small, Prof. Jade Jansen, Prof. Yaeesh Yasseen, Zuhayr Dollie & Lucinda Smidt

Management Accounting Training 2 Introduction

Management Accounting Training 3 & Management Accounting

Management Accounting Training 4 Management Accounting

Management or managerial accounting is the process of identifying, analysing, recording and presenting financial information that is used internally by management for planning, decision-making and control.

Management Accounting Training 5 Cost Classification & Cost Behaviour

Management Accounting Training 6 Cost Classification - Content

▪ Overview of cost classification

▪ Defining the cost object

▪ Identifying direct and indirect

▪ Identifying variable and fixed costs

▪ Separate costs for mixed costs

Management Accounting Training 7 Cost Classification - Overview

Management Accounting Training 8 Cost Object

Cost Object: Any activity for which a separate measurement of cost is undertaken

Cost Unit: Cost Centre: A production or service A unit or product or location, function activity service in relation to or item of equipment for which costs are which a cost can be ascertained ascertained

Management Accounting Training 9 Cost &

Management Accounting Training 10 Cost & Expenses

Management Accounting Training 11 Direct & Indirect Costs

Management Accounting Training 12 Direct & Indirect Costs

Management Accounting Training 13 Direct & Indirect Costs

Direct costs Materials used in the manufacture of products (bricks, sand & cement used in construction) Salaries & wages paid to the production staff – actively involved in the manufacturing process (construction employees)

Indirect costs Cost who administers all the products undertaken by the Salaries paid to the project manager who supervisors a number of projects in the construction industry

Management Accounting Training 14 Cost Behaviour

Cost Cost Behaviour Material Material costs changes as the number cost of units produce changes – direct relation between materials used and output

Factory Rental for the factory will not be rent affected by the number of units produced – floor space has not relationship to output Salaries Salaries is challenging when paid determine cost behaviour as it is affected by the basis of payment – if the basis in not linked to output then it does not change in relation to changes in output

Management Accounting Training 15 Variable Cost

Management Accounting Training 16 Testing for Variable Costs

Management Accounting Training 17 Fixed Costs

Management Accounting Training 18 Testing for Fixed Costs

Management Accounting Training 19 Maximisation

Management Accounting Training 20 Profit Maximisation

Management Accounting Training 21 Profit Maximisation

Management Accounting Training 22 Mixed Cost

Management Accounting Training 23 Testing for Mixed Costs

Units 5,000 10,000 20,000 Total cost 20,000 30,000 50,000 Average cost per unit 4.00 3.00 2.50 Based on the average cost per unit, the cost is not a variable cost as the average cost per unit changes in relation to the level of output – variable cost is fixed per unit

Change in output 100% 100% Change in average cost 33% 20%

Based on the change in the output and change in average cost per unit, the cost is not a fixed costs as there is not a direct relationship between the change in output and change in cost – changes in fixed cost represent an inverse proportionate change in output and cost

Management Accounting Training 24 Mixed Cost – Separation of Costs

Management Accounting Training 25 Mixed Cost – High-Low Method

Selecting Determine the Calculating the information for the difference between average per unit higher & lowest the outputs and based on the periods costs differences

Highest Lowest Difference

Output 60,000 80,000 20,000

Total cost 580,000 640,000 60,000

Average cost per unit 3.00

Total variable cost 180,000 240,000

Total fixed cost 400,000 400,000

Total cost 580,000 640,000

Management Accounting Training 26 Absorption & Marginal Costing

Management Accounting Training 27 Absorption & Marginal Costing - Content

▪ Job and process costing ▪ Allocation fixed costs ▪ Activity-based costing ▪ Absorption and marginal costing ▪ Under/over absorbed costs ▪ Reconciliation of profits

Management Accounting Training 28 Job and Process Costing

Job Costing Process Costing

▪ One or more jobs/work in a ▪ Work-in-progress for process account each department ▪ Costs are determine for each ▪ Costs are determined by the job department ▪ Job cost sheet is the primary ▪ Production cost report is the document primary document ▪ Unit cost is computed by ▪ Unit cost is computed by accumulating the costs accumulating the department incurred for the job costs

Management Accounting Training 29 Process Costing Systems

Management Accounting Training 30 Allocation of Production Costs

Management Accounting Training 31 Allocation of Production Costs

Management Accounting Training 32 Basis of Allocating Costs

Management Accounting Training 33 Basis of Allocating Costs

Management Accounting Training 34 Basis of Allocating Costs

Labour Intensive Capital Intensive

Overhead costs 562,500 Overhead costs 562,500

Labour hours 90,000 Machine hours 100,000

Pre-determine overhead Pre-determine overhead rate 6.25 rate 5.62

Actual labour hours 50,000 Actual machine hours 50,000

Applied overhead costs 312,500 Applied overhead costs 281,250

Management Accounting Training 35 Activity-based Costing (ABC)

Management Accounting Training 36 Traditional Costing & ABC

Management Accounting Training 37 Allocation of Service Department Costs

Management Accounting Training 38 Allocation of Costs – Direct Method

Management Accounting Training 39 Allocation of Costs – Step-Down Method

Service 1 Service 2 Dept. A Dept. B Total cost 120,000 200,000 250,000 390,000 Dept. A 30% 60% Dept. B 50% 40% Service 2 20% Service 1 (120,000) 24,000 36,000 60,000 Subtotal 224,000 Service 2 (224,000) 134,400 89,600 Product cost nil nil 420,400 539,600

Management Accounting Training 40 Product Costing

Management Accounting Training 41 Absorption & Marginal Costing

Management Accounting Training 42 Absorption & Marginal Costing

Cost Absorption Marginal

Direct material costs 25.00 25.00

Direct labour costs 10.00 10.00

Variable overhead costs 3.00 3.00

Fixed overhead costs 5.00 -

Product cost 43.00 38.00

Management Accounting Training 43 Absorption & Marginal Costing

Management Accounting Training 44 OAR – Using Normal Capacity

Basis of calculating the overhead absorption rate:

▪ OAR – represents the standard costing base of allocating overhead costs for a specified period. ▪ Normal production capacity is used to reflect the rate that should be allocated for the specified period – constant and consistent rate must be applied. ▪ If the budgeted or actual capacity changes significantly from the normal capacity then the normal capacity must be reviewed and adjusted if necessary. ▪ However if the change is due to special circumstances, such as a special order, then the normal capacity should not be adjusted.

Management Accounting Training 45 Under/Over Absorbed Costs

Under/over absorbed costs

▪ Under absorption costing is measured based on the total cost – including the overhead absorption rate. ▪ Profit is calculated based on the actual overheads incurred for the period. ▪ Variance between the applied costs (inventory ) and the actual costs represents the under/over absorbed costs. ▪ Applied costs is calculated by applying the overhead absorption rate to the actual output (flexible ). ▪ Under/over absorbed costs can be treated as: (a) set-off to the (b) Treated as an operating or income

Management Accounting Training 46 Under/Over Absorbed Costs

Management Accounting Training 47 Under/Over Absorbed Costs

Reasons of absorbed cost variances ▪ Errors in estimating the overhead expenses ▪ Errors in estimating the normal capacity/output ▪ Unforeseen changes in the production capacity ▪ Seasonal fluctuation in the overhead expenses ▪ Overhead rate may be applied to the normal capacity which may be less than the full operating capacity

Management Accounting Training 48 Reconciliation of Profits

Management Accounting Training 49 Reconciliation of Profits

The OAR was R5.00 and the variable production costs were R25.00. The actual production was 100,000 units of which 20,000 were unsold; and the total fixed production costs of R480,000.

Absorption Marginal Sales (selling price of R 50,00) 4,000,000 4,000,000 Variable production costs 2,500,000 2,500,000 Fixed production costs (applied) 500,000 NIL Inventory on hand (R30.00 & R25.00) (600,000) (500,000) Gross profit 1,600,000 2,000,000 Manufacturing costs NIL 480,000 Over absorbed costs (500,000 – 480,000) 20,000 NIL Profit 1,620,000 1,520,000 OAR including in inventory (20,000 x 5) 100,000

Management Accounting Training 50 Reconciliation of Profits

Management Accounting Training 51 Production Wastages

Management Accounting Training 52 Production Wastages

Management Accounting Training 53 Operating

Management Accounting Training 54 Operating Budget - Content

▪ Introduction

▪ Using budgets to improve performance

▪ Risks and budget failures

▪ Budgeting methods

▪

▪ Operating budget

▪ budget

Management Accounting Training 55 Introduction

▪ Budgeting is a planning tool used by management to quantify the action plans of the organisation – . ▪ Budgeting is a is a tool used by management to allocate resources to achieve the goals of the organisation in the most effective and efficient manner. ▪ Reasons for Budgeting: • Control – control the implementation of budget and activities • Allocation of resource – facilitate the allocation of resources as the budget is adjusted • Monitoring – tracking the progress towards achieving goals • Evaluation – evaluate performance of staff and departments • – facilitate the mismanagement of resources and wasteful expenses

Management Accounting Training 56 Introduction

▪ Purpose of Budgeting: • Resource planning – allocation of resources to achieve goals economically and efficiently. • Financial planning – financial forecasting and activities. • Financial control – control over the costs for the activities of the business. • Communication – facilitate the organisation wide communication of the strategies & goals. • Motivating staff – motivation for staff to achieve performance levels (agreed KPI). • Conflict resolution – facilitate resolving conflict between departments and groups in the organisation.

Management Accounting Training 57 Budgeting – Improving Performance

Management Accounting Training 58 Risks Associated with Budgets

Pressure from senior management – affected by budgetary process

Internal conflict – conflict between departments and management for budget approval

Lack of alignment with strategic goals – operational conflict and budget reductions

Over-budgeting – providing for wasteful expenses (inflate budgets) to absorbed possible reductions

Management Accounting Training 59 Causes of Budget Failures

Reasons Budgets Fail

• Lack of clear purpose of budgets – performance measure vs strategies planning. • Unrealistic expectations – lack of detailed planning in setting budgetary goals. • Improper communication – lack of information about the budgetary process and the budgets. • Improper metrics – lack of proper monitoring and evaluation processes. • Top-down cost allocation – cost are allocated with negotiations or agreement. • Fixed budget – budgets are viewed as cast in stone and cannot be changed (agility of budgets).

Management Accounting Training 60 Budgeting Process

Management Accounting Training 61 Effective Budgeting Process

Structure: Strong organisational structure promotes authority, responsibility & accountability

Research: research and analysis of data and environment promotes goal driven operations

Approval: acceptance of budgets at all levels promotes commitment and motivation to implement

Monitoring: regular and continuous monitoring and evaluation ensures risks are identified and action taken

Management Accounting Training 62 Budgeting Techniques

Incremental Budgeting: Traditional Budgeting: Current budget is prepared by Current budget is based on making adjustments to the previous budgets as a previous budget or actual baseline, while adjustments results by considering inflation are made for inflation rate, and economic factors market situation, demand, etc.

Budgeting Methods

Activity-based Budgeting: Zero-based Budgeting: A budgeting method where the Current budget is prepared budget based on the cost from scratch without drivers and requires an in considering previous budget or depth analysis of the business results activities

Management Accounting Training 63 Forecasting Techniques

Management Accounting Training 64 Master Budget

Sales Budget

Production Budget O p B e u Direct materials Direct labour Manufacturing r d Budget Budget overheads Budget a g t e i Selling & Administrative t n expense Budget g

Budgeted Financial Budget Cash Budget Budget Budget Management Accounting Training 65 Sales Budget Process

Market share & competition

Historical performance & Market trends & changes in product life cycle technology

Advertising & Price sensitivity & promotion substitute strategy products

Management Accounting Training 66 Production Budget

• Production budget is based on the costs associated with the manufacturing process (variable and fixed costs) • Production consists of a resource requirements budget as well as a cost budget • Materials and labour cost budgets must take into account the normal wastages occurring in the production process

Management Accounting Training 67 Production Budget - Inventory

• Inventory budgets should be based on the inventory management strategy of the organisation • Inventory budgets is driven by the sales strategy of the organisation • Inventory budget must account for the risk associated with the warehouse management

Units Sales volume budget XXX Add: Closing inventory plan XXX Add: Inventory shrinkage/loss XXX Subtotal XXX Less: Opening inventory XXX Inventory purchase/production requirement XXX

Management Accounting Training 68 Cash Budgeting

Statement of Cash Budget

Report on management of the past Planning of the cash flow for the cash flows coming period

Report on the effective Planning of cash flows for management of cash flows in operating & transactional activities strategic areas

Used to review the cash flow Used to plan cash flows and performance of the business utilisation of resources to achieve the operating goals

Used to evaluate the performance Used to monitor and evaluate of management is controlling the utilisation of cash to maintain the liquidity risk of the business liquidity status of the business

Management Accounting Training 69 Cash Budgeting

• Conversion of operating and capital expenditure budgets to a periodic cash flow plan. • Excludes all non-cash transactions such as , bad debts and . • Transactions are inclusive of VAT and the payment of VAT is treated as a separate. • Cash flows from customers and suppliers is based on the payment terms.

Management Accounting Training 70 Break-even Analysis (Cost – Volume-Profit)

Management Accounting Training 71 Break-even Analysis - Content

▪ Introduction

▪ Difference between profit and contribution

▪ Calculation of break-even point

▪ Break-even points with targeted profit

▪ Break-even points for multiple products

▪ Break-even points with production constraints

▪ Preparation of a production plan

Management Accounting Training 72 Profit vs Contribution

Management Accounting Training 73 Break-even Analysis

Management Accounting Training 74 Beak-even Point

Management Accounting Training 75 Break-even with Target Profits

Total Target Profit: ▪ The total target profit is treated similar to the fixed costs when calculating the break-even point (Total fixed costs + Target profit) Contribution per unit

Target Profit per Unit: ▪ The target profit per unit is treated similar to variable costs when calculating the break-even point Total fixed costs (Contribution per unit – target profit)

Management Accounting Training 76 Break-even – Multiple Products

▪ If the fixed costs are maintained separately for each product, then the break-even point can be determined independently. ▪ If the fixed costs are not maintained separately for each product, then the break-even point should be determined based on the weighted average contribution per unit ▪ The basis of allocating weights to each product depends on the product/sales mix, nature of operations, resources used, etc. Total fixed costs Weighted average contribution

Management Accounting Training 77 Break-even with Constraints

Production without Constraints: ▪ Profit is maximised by producing and selling products with the highest . ▪ Products are ranked based on their contribution – profitability ranking.

Production with Constraints: ▪ When there are production constraints then the planned production may not be achieved – scarce resources. ▪ Products are ranked based on their contribution per constraint (contribution per usage of the scarce resource).

Management Accounting Training 78 Break-even with Constraints

Resource Allocation: ▪ Under conditions of production constraints, the resources are allocated to products based on their contribution per constraint

Contribution per Constraint: ▪ The contribution per constraint measures the profitability based on the utilization of the scarce resource. Contribution per unit Usage per constraint

Management Accounting Training 79 Relevant Costing

Management Accounting Training 80 Relevant Costing - Content

▪ Introduction

▪ Types of relevant costs

▪ Applying to make investment and operating decisions

▪ Applying relevant costing methods for material costs

▪ Applying relevant costing methods for labour costs

Management Accounting Training 81 Introduction

▪ Relevant costing attempts to determine the objective cost of a business decision. An objective measure of the cost of a business decision is the extent of cash outflows that shall result from its implementation. Relevant costing focuses on just that and ignores other costs which do not affect the future cash flows.

▪ The principle of relevant costing is primarily applicable where decisions have to be made - inclusion of irrelevant information during the process, could lead to the incorrect decision being made.

Management Accounting Training 82 Relevant Costs

Management Accounting Training 83 Decision-Making – Differential Costs ▪ Make or Buy decision ▪ Compare relevant costs for the alternatives ▪ Only recognise the differential costs ▪ Consider the opportunity and avoidable costs

▪ Discontinuing decisions ▪ Determine the opportunity and avoidable cost ▪ Identify the irrelevant costs

Management Accounting Training 84 Identifying Relevant Costs

▪ Any costs that is a future cost or cash flow ▪ Any cost that differ amongst alternatives and that will influence the outcome/decision ▪ Future costs and that differ amongst alternative options ▪ Compare to indicate how they differ under each alternative ▪ Sunk costs are never relevant costs ▪ Any cost that is avoidable

Management Accounting Training 85 Relevant Costing - Assumptions

▪ All variable costs are relevant costs ▪ All fixed costs are sunk costs ▪ Unit costs: ▪ Based on absorption costing and include irrelevant costs ▪ Unit costs are fixed irrespective of the level of production – economies of scale

Management Accounting Training 86 Relevant Costing - Material

Management Accounting Training 87 Relevant Costing - Materials

Management Accounting Training 88 Relevant Costing - Labour

Management Accounting Training 89 Questions?

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Management Accounting Training 91