ACCOUNTING THEORY

DEPRECIATION

-Why depreciate?
All fixed assets have a limited useful life
These assets lose value over a number of years
Loss in value is an expense charged to the P+L
If depreciation is not charged, profits will be overstated and the
balance sheet will not show the true value of the assets

-Why does an asset depreciate?

Use/wear and tear
Passage of time
Obsolescence

-Estimating Depreciation (4 factors)

Cost of the asset
Estimated life of the asset
Estimated residual/scrap value of the asset
Selection of an appropriate method

-Calculating Depreciation
STRAIGHT LINE METHOD
Reduces value of the asset by same amount each year
Means depreciation in P+L is the same each ear
Normally calculated by using percentage of cost of asset, or by
dividing the cost by the number of years of its expected life
REDUCING BALANCING METHOD (BOOK VALUE)
This reduces the value of an asset by a smaller amount each
year
Calculated by applying a fixed percentage to the cost of the
asset in year 1, and thereafter to the NBV

Depreciation- EXAM QUESTIONS

2013 Q2 (d) (i)
Q- Why does a company charge depreciation when
calculating profit?
A- Depreciation is an expense. Failure to include depreciation in
final accounts will result in profits being overstated and the net
assets on the balance sheet will not show true value
2013 Q 2 (d) (ii)
Q- Why would a company choose one method of
depreciation for another?
A- This is due to its policy on depreciation and ensuring the
consistency concept is applied when preparing accounts
Straight line method - Same amount each year,
appropriate for assets that lose value slowly e.g
buildings
Reducing balancing method- Reduces value by smaller
amount per year, appropriate for assets that lose value
fast e.g vehicles
2010 Q3 (d)
Q- Explain what is meant by depreciation
A- Depreciation is the measure of the wearing away or loss in
value of a fixed asset, as a result of wear and tear, passage of
time or obsolescence
2005 Q5 (d)
Q- What factors are taken into account when arriving at
the annual depreciation charge?
A- Cost of asset
Estimated life of asset
Scrap value of asset
Method of depreciation
DEPRECAITION THEORY CAN COME UP IN A REVALUATION QUESTION

CONTROL ACCOUNTS
-Purpose of control accounts
Check the accuracy of double entry book-keeping
Helps locate errors quickly
Ensure accuracy with creditors and debtors ledger
Find out quickly amounts owed by debtors and amounts owing to
creditors
-Preparation of control accounts
-Debtors
The figures used in Debtors ledger control A/C are taken from
the totals of the books of first entry i.e Sales, Sales returns,
Journal Entries, analyzed receipts + lodgments books, which
are all entered in the general ledger
The list of debtors is taken from individual balances in the
debtors ledger
The balance from the control A/C and the balance when all the
individual debtors are added up should be equal
-Creditors
Figures used in creditors control A/C are taken from the total
of the books of first entry i.e Purchases, Purchases returns,
Journal entries and analyzed receipts cash payments book
The list of Creditors is taken from the individual personal
balances in the creditors ledger
-The advantages/importance of Control accounts
The act as a check on the accuracy of the postings and totals of the
individual ledger accounts
They allow amounts owed by debtors/owed to creditors to be
ascertained quickly by simply balancing the control accounts
They enable errors to be localized and found more speedily
The are useful when preparing accounts from incomplete records
-Some elements of control accounts
Opening small balance how does it arise?
(in a debtors control account)
When a debtor pays for sales, but sometimes later returns
some of the goods
An overpayment of a debt
Full payment was made, and then a discount was granted
(in a creditors control account)
When a payment has been made to a creditor and later goods
have been returned
An overpayment of a debt
Full payment has been made, and then a discount was granted
-Contra Entries
A contra entry occurs when a firm is both the supplier (creditor) and
a customer (Debtor)

 For example, a firm may both sell and purchase from the same firm
A contra entry has the effect of reducing the amount owed by
debtors while also reducing the amount owed to creditors

-Bills Payable
These reduce creditors
They will appear in the debit side of the personal account and the
debit of the control account
-Bills Receivable
These reduce debtors
They will be shown in the credit of the debtors personal account and
the credit of the control account

Control accounts- EXAM QUESTIONS

2013 Q2 C
Q- Which books of first entry are used in the production of Debtors
Control Accounts?
A- Sales, Sales returns, Journal Entries, Analyzed receipts lodgements
Q- Explain the importance of Control accounts
Ao They act as a check on the accuracy of the postings and totals
of the They individual ledger accounts
o They allow amounts owed by debtors/owed to creditors to be
ascertained quickly by simply balancing the control accounts
o They enable errors to be localized and found more speedily
o The are useful when preparing accounts from incomplete
records
2010 Q4 C
Q- Give reasons why the balance in the creditors control accounts
may not agree with the balance in the schedule of creditors
A- Errors in either the control account or in the schedule but not in
the other
Failure to complete the double entry/error in the ledgers
Incorrect totaling of subsidiary books sent to Control A/C
2007 Q2 C
Q- Explain Contra Item
A- See Notes
Q- Explain how opening balance of 530 could arise

A- See notes (in debtors account)

2005 Q2 C
Q- Explain why Creditors control accounts are prepared
A- Check the accuracy of double entry book-keeping
Helps locate errors quickly
Ensure accuracy with creditors and debtors ledger

CORRECTION OF ERRORS IN SUSPENSE ACCOUNTS

-Errors revealed by Trial Balance
Mathematical errors- Errors in addition or subtraction
Double Entry errors- An entry on the debit without a corresponding entry on
the credit
Misplaced Entries- an entry entered on the incorrect side
(all of these errors will cause a suspense to arise)
-Errors not revealed by trial balance
1. Errors of original entry
2. Errors of omission
3. Errors of commission
4. Errors of principle
5. Compensating errors
6. Complete reversal of entries
1-Errors of original entry
These are errors that were made in the books of original entry, which were
then posted to the appropriate ledgers e.g cash sales 207 entered as 702 in
both Cash and Sales accounts
2- Errors of omission
This is where the entries have been completely left out, hence nothing has
been entered on the debit side or credit side of the relevant accounts
3- Errors of commission
These arise when the correct amount is posted to the correct side of the
incorrect account
4- Errors of principle
These are entries that are on the correct sides but in the wrong type of
accounts i.e repairs debited to the delivery vans account
5- Compensating errors
This is where one error cancels another error e.g payment of 600 for cleaning
entered as 60 in debit of cleaning account and on the credit side of the cash
account
6- Complete reversal of entries
This is where the correct accounts are used but both entries are on the
incorrect sides of the accounts.

-Suspense accounts
-When a trial balance fails to balance, the difference of both sides is placed
temporarily in an account called the Suspense Account, therefore the suspense
account is included as an account in the trial balance and draft final accounts
can now be prepared
-When all of the errors have been found + corrected, the balance in the
suspense account will be eliminated and all of the ledger accounts will be
correct

Correction of errors in suspense accounts- EXAM

QUESTIONS

2012 Q2 C
Q- What is the purpose of preparing a trial balance?
A- A trial balance is prepared in order to test the accuracy of the
double entry bookkeeping before preparing Final Accounts. A trial
balance should have the same total of debits and credits and have
the same accounts because under double entry bookkeeping every
debit entry should have a corresponding credit entry
Q- State and explain any two types of errors not revealed by the
trial balance
A- See notes
2010 Q7 E
Q- Identify three different types of errors that affect the balancing
of a trial balance
A- Entering one amount on the debit side of one ledger account and
entering a different amount on the credit side of another ledger
account
Mathematical errors= figures and additions
Posting only one side of the double entry

CLUB ACCOUNTS
- Clubs, societies and non-profit making organizations are set up for the
benefit of the members rather than making of a profit
- Income comes from fundraising and subscriptions
-Club treasurer duties
Ensures subscriptions and other funds are collected
Makes payments of the day to day recurring costs of the club
Makes regular lodgments to the bank
Maintains proper records i.e. analysis receipts and payments
account, receipts and payments summary accounts and final
accounts
Produces treasurers report and analysis at AGM
Produces cash flow projections
Advices members on implications of future planned expenditure like
building a new clubhouse
The accounts of a club
1- Analysis Receipts and Payments book
This book is used to record the day to day receipts and payments of
the organization
2- Summary of Receipts and Payments Account
This is a summary of the organizations daily receipts and payments
of cash for the period covered by the account
The entries from this account come from the totals of the analysis
columns in the analyzed receipts and payments book
Disadvantages of Receipts and Payments account-

 It doesnt give a true financial position of the club as amounts

due and prepaid are not included
It doesnt distinguish between capital and revenue
expenditure
It does not show whether there is enough income to cover
expenditure (doesnt show profit or loss)
3- Income and expenditure account
The I+E account shows the difference between all income and all
expenditure for the financial period
It is similar to a P+L account as it must only take into account the
actual income and expenditure for the year
It must be adjusted for accruals and prepayments

Advantages It reveals the true financial position of the club showing a

surplus or deficit
It adjusts for accruals and repayments
It reveals whether or not the club has enough income to pay
for its activities
4- Accumulated Fund
This is a statement showing the list of assets less liabilities at the
beginning of a financial period.
It allows us to calculate the capital at the start of the period for the
club

5-Special Purpose Profit + Loss account

Sometimes non-profit making organizations such as a club
prepare a p+l account for
activities that are carried out to make a profit like running a lotto,
bingo or disco, or restaurant
All expenses and revenue relating to that particular activity are
entered into a special profit and loss account and the profit is
transferred to the I+E account
6- Balance sheet
This shows the Assets and Liabilities of a club for a financial
period

Special Club receipts

1- Life Membership
-This entitles a member to use the facilities of a club for the
remainder of their life
-The money received is credited to a membership account
(shown as a long term liability in balance sheet and transferred
in installments into the I+E account)
2- Levies
-A levy is a payment made to a club by its members to fund a
special project such as an extension
-It is treated as a long term liability in the balance sheet as it is
due to the members until it is used

SERVICE FIRMS
-People who provide services to the community must keep accounts e.g.
doctorsm solicitors, dentists, accountants
-They should keep records for the following reasons
To find the profit or loss of the business
To keep records of the amounts owed to them and by them
To find the value of assets and net worth of the business
To present to financial institutions/revenue commissioners
To make comparisons with previous years
To facilitate budgeting + planning
-Characteristics of Service Firms
They have few fixed assets
Main sources of income is the fees they charge
They maintain a small stock of products which they use for their
profession, e.g. shampoo in a hair salon
Not likely to prepare a trading account, as they are not involved in buying
and selling

Service Firms- EXAM QUESTIONS

2012 Q6 (e)
Q- The Company wishes to purchase equipment for the new extension.
Advise the company on how to fund the expected cost of 150,000.
A- My advice would beSell investments 40,000
Sell remaining shares 50,000
Borrow
60,000

Total

150,000

The company would be able to pay back the loan quickly as they
had a surplus of 151760 in 2011 and the company is generating
through cash. Even though it owes the bank 108,600, it has paid
out amounts up to 310,000 in non recurring and non trading items
2010 Q6 (e)
Q- The management of the nursing home is considering a increase of 10%
in the clients fees. What advice would you give? Explain why.
A-Raising the clients fees by 10% would increase income by
33,950.Tehre is no need to increase fees for viability or profitability purposes.
The company is profitable at 18.4% return on capital employed in the current
climate. The company is generating enough cash. It has repaid a loan of
40,000, purchased equipment 15,000 and contributed 35,000 to a new
mini bus. In the current climate there is increased competition and as such,
charges should not be increased.

FARM ACCOUNTS
-Reasons why they are prepared
To calculate the profit or loss of the farm
Calculate net worth of the farm
Establish amounts owed to/by the farm
Establish performance of each section of the farm e.g sheep,
cattle
To apply for grants
To apply for loans
Facilitate planning and budgeting
-The Accounts
Receipts and payments account
Statement of capital
Enterprise analyze account
This is a trading/Profit and loss account for particular
enterprise
The balance/gross profit is transferred to the General P+L of
the farm
Examples of enterprises are Cattle and milk, Sheep, Pigs,
Crops, orses, Poultry, Deer
General P+L account (to ascertain profit or loss of the farm)
Balance sheet (statement of assets and liabilities)

-Terms associated with farm accounts

Conacre this is a payment of rent made by a farmer to a
land owner for use of land. Can be revenue or income
Single Payment payment to farmers made by EU under
Cultural Agricultural Policy 2005. It is a system of direct
payments
Rural environment protection scheme (REPS) These
payments are made to farmers to protect the environment
within their own farms
Drawings This is the farmers consumption of farm produce
for private uyse e.g. beef, milk, vegetables, L+H. it is treated
as drawings and also as a sale of that particular item.

INCOMPLETE RECORDS
2013 q7 (C)
Q- What additional information would be available to Kelly if he
used the double entry system to record financial transactions

AGeneral nominal ledger accounts

Trial Balance
Total sales figure
Bank balance
Capital and Drawings
Bad debts, expenses due/prepaid
Discounts allowed/received

2011 Q4 (b)
Q- What advice would you give to OHagan in relation to record
keeping?

A- OHagan should keep a detailed cash book and general

ledger supported by subsidiary day books. This would enable O
Hagan to prepare an accurate trading, and profit and loss
account + balance sheet, and therefore avoid reliance on
estimates
2007 Q 7(c)
Q-(i) explain the term accounting concept
(ii) name two fundamental accounting concepts
(iii) Illustrate an accounting concept applying to the
accounts of P. Lynch
A- Accounting concepts are accounting practices or rules that are
applied in the preparation of financial accounts
Accruals, Going Concern, Consistency and Prudence are
accounting concepts
Accruals concept- all expenses incurred in a particular period
must be included in the accounts of that period regardless of
whether they are paid or not. Similarly, all revenue income
must be included in the accounts of that period whether
received or not. E.g. electricity due for the current year must
be included in the accounts, although the bill may not be
paid until the following year as the expense refers to the
current year. Insurance prepaid should not be included in the
current years accounts as the payment refers to the
following year.

PUBLISHED ACCOUNTS
All companies, irrespective of size, must by law produce company
accounts and reports annually.
A companys annual report will include
A directors report
An auditors report
Financial statements, which include the published profit and loss a/c,
balance sheet (with notes) and a cash flow statement
The Directors
Responsibility of directors
1. Keep a proper set of records which enable a P+L account and balance
sheet to be prepared in accordance with the companys acts

2.
3.
4.
5.
6.
7.

Safeguard the assets of the company

Prepare annual financial statements
Select suitable accounting policies
State whether applicable accounting standards have been followed
Make sure all financial statements are signed by two directors
Convene AGMs

Directors report must contain

1. Dividends recommended for payment
2. Amount to be transferred to the reserves
3. A report of any changes to the nature of the companys business during
the year
4. A fair review of how the business developed during the year, and of the
position at the end of the year
5. Any likely future developments of the business
6. Any activities in the field of research and development
7. Significant changes in the fixed assets
The Auditor
The role of the auditor is to express an opinion on the financial statement.
The auditor will decide and report on whether the statements give a true
and fair view of the state of affairs of the company and whether they
comply with the companys acts
An audit
This is an independent examination of a companys financial statements
and the espress of an opinion on the preparation of accounts
The purpose of an audit is to enable the auditor, in keeping with the
requirements of the companies act, to show that the truth and fairness
shown by the P&L and balance sheet, and any other information required
to be disclosed in the balance sheet.

True and fair view

The accounts of a business will give a true and fair view if the auditor is
satisfied that
1- All info necessary to complete the audit and required by the companies
act is available and included
2- The fundamental accounting concepts have been adhered to when
preparing the accounts
3- The accounts have been prepared in a way that is consistent with the
previous accounting period
Note: Companies acts do not require the auditor to certify that the
accounts are correct, but that they give a true and fair view of the
financial position of the business. It is not the function of the auditor to

correct errors or fraud. However if fraud is detected, it is the duty of the

auditor to report it

Auditors report
1- Auditors report must show
The financial statements give a true and fair view of the state of affairs of
the company at the end of the year
The financial statements are prepared in accordance with the companys
acts
All the information necessary for the audit was available
the info given by the directors (directors report) is consistent with the
financial statements
The Net Assets are more than 50% of the called up capital

2-Unqualified report VS qualified report

An unqualified report, often referred to as a clean report is when the
auditor can report that in his opinion, the above conditions have been met
An unqualified report is when an auditor states that in his/her opinion the
accounts of the company do not comply with all of these conditions above
i.e the financial statements do not give a true and fair view of the
companys state of affairs

PUBLISHED ACCOUNTS- EXAM QUESTIONS

2013 Q6 (b) (i)
Q- Name the bodies/institutions that regulate the
productions.content and presentation of company
financial statements
A- The government- legislation

The European Union- directives

Accounting standards bodies- FRSs and SSAPs
The Stock Exchange
(ii)
Q- What is an audit? explain a qualified auditors report
A- An audit is an examination of the financial statements
of an enterprise by an
appointed auditor
-The audit is conducted by an auditor who is independent
-The auditor expresses an opinion and certifies whether
the accounts give a true and fair view of the financial
position of the business
-The companies acts require the auditor to certify that the
accounts give a true and fair of the financial position of
the business

A Qualified Auditors Report is when an auditor is not

satisfied or is able to conclude that The financial statements are prepared in accordance with the
Companies Act
The financial statements give a true and fair view of the state
of affairs of the company at the end of the year
All the info necessary for the audit was available
The information given by the directors is consistent with the
financial statements
The net assets are more than 50% of the called up capital
The report will state the elements of the accounts that are
unsatisfactory
2011 Q3 (b) (i)
Q- State how a company should deal with a contingent
liability which is probable?
A-When a contingent liability is probable, the estimated
amount should be provided for in the accounts and a
note should show the nature of the loss
(ii)
Q- Explain the difference between an auditors qualified
and unqualified report
A- An unqualified report is often referred to as a clean
report. A report is unqualified if the auditor is satisfied
that the following apply- see list in 2013(5 points)

2008 Q4 (b) (ii)

Q- What regulations must accountants observe when
preparing financial statements for publications?
A- Accountants must observe regulations laid down by;
The Companies Acts
The Financial Reporting council/ Accounting Standards Board
The Stock Exchange

2009 Q4 (b) (ii)

Q-Explain the term exceptional item and give an
example
A- This is a material item of significant size. It is a profit or
loss that must be shown separately in the profit and loss
account because of size. Example: Profit or Loss on the
sale of a fixed asset or large bad debt
1999 Q6 (b)
Q- State the criteria that determine the size of a public or
large private company.
A- To be classified as a public or large private company, 2
of the 3 of the following must apply Balance sheet total must be greater than 7.62 million euro
Annual income must be greater than 15.42 million euro
Average number of employees must be greater than 250

CASH FLOW STATEMENTS

-Cash Flow Statements are concerned with describing and
evaluation the true inflows and outflows of cash that lead to
the change in cash figures from theone balance sheet to the
next

Purpose To assertain cash inflows and outflows during the period

To assist in predicting future cash inflows
To aid financial planning
To provide information for assessing liquidity
To highlight profit isnt always equal to cash
To comply with legal requirements
Cash inflows Profits
Decrease in stock
Decrease in Debtors
Increase in Creditors
Interest paument
Dividemnts/ investment income recieved
Sale of fixed assets
Capital introduced/the issue of shares
Loans recieved/ Debentures issued
Tax refunds
Cash Outflows Losses
Increase in stock
Increase in debtors
Decrese in creditors
Interest paid
Dividents paid
Purchase of fixed asset
Drawings
Repayment of loans
Tax paid

Non cash items- No cash items in the profit and loss account
affect profit but dont change the cash figure
Dereciation
Profit or loss on sale of fixed asset
Increase/decrese in provision for bad debts

Cash doesnt always equal profit It is important to realise that profit cash i.e some
transactions will affect cash but not profit such as the
purchase or sale of fixed asset or capital
introduction/withdrawl
Financial Reporting Standard 1- (FRS1)
-The FRS1 revised in 1996 rquires large companies to
prepare cash flow statements for each accounting period

-It also requires that cash flow statements should be

entered under certain standard headings according to the
activity that gave rise to them
Operating activities
Return on investment and servicing of finance
Taxation
Capital expenditure and financial investment
Equity Dividends paid
Management of liquid resourses
Financing
CASH FLOW EXAM QUESTIONS

2012 Q7 (b) i
Q- Explain why earning profit doesnt always result in an
increase in cash balances. Use figures to support answer
A- The accounts and cash flow statement show an
operating profit of 337,000, but the incrse in cash was
53,000.
B- Reasons Credit sales dont affect cash but increase profit
Non cash gains/losses affect profit but not cash
(profit on sale of fixed asset/depreciation)
Sale/Purchase of fixed assets affects cash but not
profit (receipts 100000, payments 160,000 +
119,000)

 Introduction/withdrawl of capital increases cash

but not profit (receipts 220,000 payments 50,000)
(b) ii
Responsibility of directors To comply with copmanies act
To keep proper accounting records for stetements to
be prepared
Prepare annual financial statements
Sign Financial statements
Select suitable accounting policies
Safeguard assets of company
2010 Q2 (b) i
Q- Outline benefits of preparing a cash flow statement
Shows cash inflow/outflow over the year
Shows profit doesnt always equal cash
Used to predict future cash flows
Provides info to assess current liquidity
(b)ii
Q- Distinguish between a Cash Expense and a non-cash
expence
A- Cash expense reduces profit and cash- wages
Non-Cash expense reduces profit but not cashdepreciation
2008 Q6 (b)ii
Q- Prepare a note on the Accounting Standards Board
A- -The accounting standards board issues new accounting
standards called FRPs. It also ammends and withdraws
old ones
-FRS1 which was issued in 1991 and emmended in
1996 requires large companies to prepare cash flow
stements for each activity period.
-It requires that individual cash flows should be entered
under standard headings according to the activity that
gives rise to them

PRODUCT/JOB ABSORPTION COSTING

2012 Q8 (iv)
Q- explain why it is necessary to transfer Service Department costs
to Production Departments 1 and 2
A- service departments cant recover costs. Service departments
are secondary to production departments and as a result, service
dpsrtments costs must be transfered to production departments
on an equitable basis e.g machine hours. Overheads can only be
recovered through production i.e they are included as a cost of
production.
2012 Q8 (b)iii
Q-Explain with examples controllable and uncontrollable costs.
A- Controllable costs are costs that can be controlled by the
manager at a cost centre. He will make the decision about
theamount of the cost or if the cost should be incurred, and can
be held responsible for cariances in the costs e.g all variable
costs are controllable. Commission to sales personel can be
controlled by the sales manager.
Uncontrollable costs are costs over which the manager of a
cost centre has no control, and therefore cannot have
responsibility for variances in these costs. E.G rates to the local
authority are uncontrollable.
2011 Q8(f) ii
Q- List and explain two limiatations/assumptions of marginal
costing.
Explain what is meant by a step fixed cost. Roughly sketch a graph
of step fized costs using the following rental payments
A Variable costs are assumed to be completely variable at all
levels of output. However variable costs may decrease due to
economies of scale or may increase because of increased
costs.
It is assumed that in marginal costing fixed costs remain the
same although most fixed costsare step-fixed and are only
fixed within a relevant range.
It is assumed that all mixed costs are easily separated into
fixed or variable. The High Low method can be used for this
purpose but it is not always possible to do this.
It is assumed that the selling price per unit is constant and
does not allow for discounts.
Production in a period usually equals sales. Fixed costs are
charged in total to a period and are not carried forward to
next period.

Step fixed costs are costs that are fixed within a certain range of
activity but change outside of that range. E.g. Rent could be
fixed up to a certain level of production. However, if production
increases and results in the rental of more factory space, then
the rent would increase to a new level. Thus the fixed costs
would increase in steps.

2009 Q8 (d) (ii)

Q- Outline two differences between Management and Financial
accounting
A-

Management Accounting
Concerned with planning for the
future and provides information for
planning and budgeting
Has an internal focus and furnishes
information to aid decision making
Is not governed or restricted by
legistlation or legal requirements
Reports prepared as often as the
manager requires them
Reports are prepared or costs
centres and departments

Financial Accounting
Concerned with recording past
events. Information is provided in
the form of a P+L account, balance
sheet and Cash Flow statement
Has both an internal and external
focus and furniches information to
stakeeholders such as managers,
shareholders and creditors
Is governed and regulated by both
legislation and accounting
standards such as FRSs
Reports are made usually once a
year
Reports are prepared about the
whole business

2007 Q8 (a) iv
Q- Explain what is meant by re-apportionment of overheads
A- reapportionment of overheads i the term used where service
department costs are re-appointed between production
departments because overheads can only be recovered by being
included as part of the cost of production

(a )v
Q- Illustrate and explain over absorption of overheads
A- Overabsorption of overheads is when costs are recovered,
budgeted costs are greater than actual costs e.g the cost of fuel
was reduced and was lower than planned.
2005 Q8 (d)
Q- Name 3 overhead absoroption rates and state why they are
based on budgeted rather than actual figures
A-Absoroption rates Per Labour hour
Per Machine hour
Per Unit
Per perventage of price cost
Overhead absorption rates are based on budgeted rather than
actual costs because actual costs may not bek nown util the end of
the year and the business may not wait until then to decied the cost
of the product as they need a dfinite selling price to charge
2003 Q8 (b)ii
Q- State 2 reasons why product costing is carried out and explain
each one
to control costs- budgeted vs. Annual
To help planning and decision making

To ascertain the value of closing stock in order to prepare final

accounts

MARGINAL COSTING
Cost Volume Profit Analysis
This is the study of the relationship between costs and volume
(level of output) and the effect on profit and various levels of
activity
Used for decision making by managers
Marginal costing is an alrternative method of costing to absorption
costing. Both are used in CVP analysis
Principles of marginal costing
Total cost of a product can be divided into fixed costs and variable
costs
Fixed costs or period costs are not affected by volume of output
If production is increased by one unit, costs will increase only by
the variable costs of that one unit
When one extra unit of a product is sold, income will increase by
the amount of sales value of the unit sold
Costs will increase by the variable costs of producing and selling
that extra unit

Contribution is the amount each unit of sales contributes towards

covering the fixed
costs and profit, in other words, the contribution
earned goes initially to cover fixed costs, and when fixefd costs have
been recoveredm all further contributions are profit.
Contribution to sales ratio
This is another formula used to calculate the break-even point.
It is used to find B.E.P in sales revenue
It is a emasure of the rate at which profit is being earned; it is used
in marginal costing where the variable cost per unit and sales
revenue are not available
It is used in calculating:
Break even point
Level of sales required to reach target profit
Margin of Safety
This is the amount by which sales can fall before break even point is
reached
Break Even Charts
The relationship between revenuse, variable costs, fixed costs and
profit/loss can be represented in graph form with a break-even
chart. The break-even point is the point at which the total cost line
interescts the revenue line. From graph, you can see the break-even
point in units and in
Sensitivity Analisys
This is a technique that can be used by a management accountant
to examine the effect on profit brought about by a change in any of
the following
1. Selling price
2. Direct Material costs
3. Labour costs
4. Variable overheads

Limitations and assumptions of Marginal Costing

Variable costs: It is assumed that variable costs are completely
variable at all levels of output. However, variable costs may
decrease due to eceonomy of scale or may increase because of
increased costs.
Fixed Costs: It is assumed that in marginal costing fixed costs
remain the same, although most fixed costs are step-fixed and are
only fixed within a relevant range.

Mixed costs: It is assumed that all mixed costs are easily

separated into fixed or variable. The high/low method can be used
for this purpose but it is not always possible to do so.
Selling Price: It is assumed that the selling price per unit is
constant. It does not allow for sales price variations due to discounts
given for bulk sales.
Sales Volume: It assumes that production in a period usually
equals sales and that there is no closing stock. Fixed costs are
charged in total to a period and are not carried forward to the next
period when valuing closing stock.
Product mix: CVP can only be applied to a single product or to a
constant mix of products.
Comparing marginal costing and absorption costing
1. In marginal costing, fixed costs are charged in full to the
period in which they have arisen, whereas in absorption
costing, a share of fixed costs is carried forward into the next
accounting period (i.e closing stock)
2. Clsoing stocks are valued higher under absorption costing
because of the element of fixed costs and so accounts show
higher profits
3. Absorption costing must be used for financial accounting to
comply with regulation
4. Marginal costing is a very useful technique for decision
making purposes. This is because the contribution concept is
a great aid to profit planning

BUDGETING
Capital budget
This budget deals with any planned capital expenditure, e.g
purchase of fixed assets, and planned capital receipts, such as

the sale of fixed assets, share issues, and borrowing. Decisions

relating to these matters are the responsibility of the board of
directors.
Preparation of Capital Budget is the responsibility of the
financial controller.
Cash Budget
This budget is a plan that summarises the expected
inflows and outflows of cash, usually on a monthly basis.
Highlights monthly surplises and deficits
Helps management to plan in advance for investing short
term surpluses, or arrange a source of finance to cover
short term deficits.
Aims/advantages:
Ensures always sufficient cash is available to meet
the levels of operations of the company
To anticipate periods of cash surpluses for short-term
investment
To anticipate periods of cash deficits so alternative
sources of finance can be arranged, e.g. bank
overdraft
Master Budget
Once all the budgest have been prepared, a master budget is
then prepared to provide an overview of the planned
operations of the company for the budgeted period. It consists
of a budgeted profit+loss account and a budgeted balance
sheet. In the case of a manufacturing company, a master
budget will comprise of a budgeted manufacturing account, a
budgeted trading account, a budgeted p+l account and a
budgeted balance sheet.