AAT Level 3 - Management Accounting: Costing

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- assisting in making business decisions

What are the three main purposes of
- assisting in making plans for the future
cost accounting?
- assisting in controlling expenditure
It is the cost of the increment we are
assessing (anything from one chair to a
What is a cost unit?
meter of silk or a bag containing a 100
screws.
Anything we want to know the cost of -
What is a cost object? generally a batch production of the cost
unit, e.g. a day's production.
Costs are allocated to different areas
of responsibility. responsibility centres in-
clude:
What is a responsibility centre?
- cost centres
- profit centres
- investment centres
What is the prime cost? The total of all direct costs.
What are overheads? The total of all indirect costs.
- Element: Material, Labour or Expens-
es.
- Nature: direct or indirect costs
How are costs classified?
- Behaviour: Variable, semi-variable,
stepped or fixed.
- Function: cost centres
Variable = vary in direct proportion to the
number of units produced.
What are the following costs: Semi-variable = has both elements of
Variable fixed and variable costs.
Semi-variable Stepped = a cost that is fixed to a certain
Stepped level and then fixed again up to another
Fixed level.
Fixed = costs that don't change regard-
less of the output.

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DIRECT MATERIALS
add
DIRECT LABOUR + DIRECT EXPENS-
ES
equals
PRIME/DIRECT COST
What is the 'Total Cost Statement' equa- add
tion? PRODUCTION OVERHEADS
equals
PRODUCTION COST
add
NON-PRODUCTION OVERHEADS
equals
TOTAL COST
Trading = buying goods and storing them
What is the difference between a 'trad- for resale
ing' organisation and a 'manufacturing' Manufacturing = will hold 3 types
organisation? of inventory: Raw materials, Works in
Progress and Finished Goods.
1 - Estimation / Just in Time (JIT)
What are the various methods of plan- 2 - The two bin system
ning purchases and of inventory control? 3 - Perpetual Inventory
4 - Formula methods
Estimation/Just In Time (JIT) = small
businesses make an estimate as to how
What is the Estimation/ Just in Time (JIT)
much stock to order and when. (Pros -
method?
lower storage costs, stock is up to date.
Con -may run out of stock)
Used for small or low value items. There
are two bins of product. When one bin is
What is the two bin system?
finished, it is time to reorder.
Con - doesn't allow for speed of demand.

Items are barcoded to be scanned upon

sale. When the stock depletes to a pre-
What is perpetual inventory?
determined stock level, an order will be
placed for more stock.
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Cons: High implementation cost and staff
training of a complex system.
What are the formula methods of inven-
tory control?
1) The maximum amount of material
which can be held
2) Buffer = the materials held as a re-
What are the following:
serve for unexpected demand.
1) Maximum inventory level
3) lead time = time taken between plac-
2)The inventory buffer
ing the order and receiving the new ma-
3)The lead time
terials
4) The reorder level
4) reorder level = the point at which the
5) The reorder quantity
order for new materials should be placed
6) Stockout
(always before the buffer is reached).
5) how much to order
6) stockout = no stock left
What is the calculation for working out Re-order level - (average usage x aver-
the inventory buffer? age lead time)
What is the calculation for working out (average usage x average lead time) +
the re-order level? inventory buffer
maximum quantity = maximum inventory
What is the calculation for working out level - inventory buffer
the re-order quantity? minimum quantity = reorder level - inven-
tory buffer
The most financially efficient order quan-
What is the Economic Order Quantity
tity based on costs for storage, delivery
(EOQ)?
etc.
1) the fixed costs per order - e.g. delivery
and handling. excludes the costs of the
What are the following: goods themselves
1) the ordering costs 2) the cost of keep one unit for a year
2) the holding costs (e.g. storage, insurance, security and on
3) the annual demand occasion a percentage of the purchase
cost of the item.
3) The number of units used in a year

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Economic Order Quantity=
What is the formula for Economic Order
Square Root of ((2 x annual demand x
Quantity?
ordering cost) divided by holding cost)
Periodically = when all the items are
What is the difference between counting counted at regular intervals
inventory periodically and continuously? Continuously = selected items are count-
ed on a continuous basis
Pros - easy to understand/calculate
- old inventory will not be left until hard to
sell
- latest inventory will better reflect the
current cost
-inventory issued reflects the actual price
paid
- it is permitted under IAS2 for financial
What are the pros and cons of the FIFO statements
method?
CONS: - cannot match current cost to
current revenue
- cost of production may be understated
- in times of inflation the profit will be
higher (more tax due) because the clos-
ing inventory will be valued higher
- keeping track of large numbers of
batches is difficult
PROS:- Matching current costs with cur-
rent revenue is easier.
-easy to calculate
- cost of production is more realistic

CONS: - it rarely matches what happens

What are the pros and cons of LIFO? as oldest stock is still generally used first
- closing inventory is valued at
out-of-date pricing
- in times of inflation profit will be un-
derstated because the closing inventory
value is lower
-hard to keep track of a large number of
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batches
- not permitted under IAS 2 for financial
statements
PROS: - marked fluctuations of inventory
prices are ironed out and so will give a
more stable profit figure
-all materials issued at the same time will
have the same cost value
-more easily computerised
-permitted under IAS 2
What are the pros and cons of AVCO?
CONS: requires a new calculation each
time a batch is added
-Issues and closing inventory are valued
at prices which never existed.
-In times of inflation, profit will be higher
than FIFO as closing inventory is valued
higher (more tax to pay)
Yes, but they are unlikely to be used in
the financial accounts and are not intend-
Can double entry accounts be used in
ed for anyone outside the business. The
costing?
double entry uses Inventory/Production
accounts.
What is the Time Rate method of pay- A set amount for the time worked. (Hour,
ment? weekly, annually)
How is direct labour treated in costing? It is treated as a variable cost.
It is when production stops due to a ma-
chine breakdown or a shortage of mate-
What is Idle time?
rials. It is paid at a basic rate and treated
as an indirect cost.
Is overtime a direct or indirect cost? Indirect
- Direct / Indirect costs
How can expenses be categorised? -Fixed / Variable costs
- Capital / Revenue Expenditure
Expenses tend to be indirect, what ex-
penses are considered direct?
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- royalty payments for product designs
- hire of a special machine
- consultancy fees
The formula for working out the variable
cost of a semi variable product.
What is the high/low method?
Difference in cost divided by difference in
units = variable cost per unit.
What is the formula for working out the Total cost - fixed cost = variable cost
fixed / variable cost of a unit? Total cost - variable cost = fixed cost
The sharing of overheads over a number
What is apportionment?
of cost centres.
Direct apportionment = costs in the
non-production centres are apportioned
directly to the cost centres.

What are the methods for apportioning Stepdown method = costs of one
costs? non-production centre will be split be-
tween all remaining costs centres. Fol-
lowed by the next non-production centre
until all costs are in the production cen-
tres.
When we have accounted for a high-
er overhead absorption rate than need-
What is over-absorption of overheads? ed. This will increase profit. The over-ab-
sorption of overheads are show as a
credit in the SPL.
When we have accounted for a lower
What is under-absorption of overheads?
overhead absorption rate than needed.
This is where a percentage of the direct
labour costs will be added to cover over-
What is the direct labour percentage add heads.
on?
Total overheads / Direct labour costs x
1000 =%

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This is when costs are segregated based
on the activity that generates them. The
What is Activity Based Costing (ABC)?
groups are called cost pools. The reason
for the cost is called a cost driver.
The total of all variable costs (direct ma-
What is the marginal cost? terials + direct labour + variable over-
heads)
Marginal cost + fixed production over-
What is the absorption cost?
heads
Absorption cost + fixed non-production
What is the total cost?
overheads
Variance Analysis involves identifying
and resolving differences between bud-
What is variance analysis?
geted (targeted) and actual perfor-
mance.
Batch costing - a batch of a similar items
Service costing - may use composite
What are 3 different types of costing? cost units
Process costing - mass/continuous pro-
duction of similar items
the number of whole units represented
What are equivalent units?
by WIPs.
Normal losses - processes often 'lose'
some of the inputs (evaporation, test-
ing, rejects etc.) no value unless sold as
'scrap sales'
What are:
Abnormal losses - unexpected losses
Normal losses
valued at the same cost per unit as the
Abnormal losses
expected output (accidental damages)
Abnormal gains
Abnormal gains - more output units cre-
ated than expected (less wastage). The
balance on this account is credited to the
SPL.

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Where all fixed and variable production

overheads are apportioned to the prod-
What is absorption costing? ucts. Every product has an equal share
of the expected production overheads as
part of its cost.
Because the expense of the fixed over-
heads is not shown until the item is sold,
What is the advantage of absorption
the profits will improve if some items are
costing?
left unsold in closing inventory (increas-
ing the cost of sales).
It artificially inflates profit. The fixed over-
What is the disadvantage of absorption head expenses incurred in the period will
costing? carry over to the next period in the form
of closing inventory.
Which costing method (Absorption / Mar-
ginal) is acceptable for the valuation of Absorption costing.
inventory under IAS2?
This focuses on the profit made by in-
dividual units. The fixed production over-
heads are not included in the cost price.
Instead a contribution is created (selling
What is Marginal costing?
price - variable cost). We deduct the vari-
able cost price from the sales and then
deduct the fixed costs from the resulting
contribution for the final profit figure.
Which costing method (marginal / ab- Marginal costing because an increase
sorption) is best for short term decision in production will not be distorted by in-
making? creased fixed costs.
A budget is an estimate of income and
What is a budget? expenditure for a set period of time in the
future.

1 - Control of costs
2 - Communicate plans
What are 5 purposes of a budget?
3 - Motivation for managers
4 - Evaluation of reality against budget

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5 - Planning and decision making - ex-
plore alternate ideas
1 - Sales volume
2 - Sales revenue
What six things are needed to prepare a 3 - Direct materials
budget? 4 - Direct labour
5 - Variable overheads
6 - Fixed overheads
Fixed budgets show what costs are ex-
pected and the variance will show how
What is the difference between fixed much money had been overspent/saved.
budgets and flexible budgets?
Flexible budgets will show how well the
resources have been used.
The parameters in which a variance will
What is a tolerance level?
not be investigated.
Cost which can be influenced by the
What are controllable costs?
manager.
- A title and date
- An introduction
What 4 sections are included in a report? - A findings or discussion section
- A conclusion and recommendations
section
How do you calculate the number of units
Fixed costs / Contribution per unit
to break even?
Indicates the amount of sales above the
What is the margin of safety?
breakeven point.
What is the formula for the margin of (Current output - breakeven output) / cur-
safety percentage? rent output x 100
How do you calculate the number of units (Fixed costs + target profit) / Contribution
needed to meet target profit? per unit
The contribution sales ratio shows us
What is the contribution sales ratio (CS the relationship between sales price and
Ratio)? contribution. It can be expressed as ei-
ther a decimal fraction or a percentage.
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What is the CS Ration formula? Contribution / selling price = ratio
How do you workout the breakeven point
Fixed costs / CS Ratio = breakeven point
using the CS ratio?
How do you calculate the revenue need-
ed to achieve the target profit using the (Fixed costs + target profit) / CS Ratio
CS Ratio?
What is another term for breakeven
CVP Analysis (costs, volume, profit)
analysis?
- Payback Period
What are 3 methods of appraising capital
- Discounted Cash Flow (DCF)
investments?
- Internal Rate of Return (IRR)
This is the period of time required to get
back the money invested from the cash
inflows it generates.

Pro- easy to calculate and understand

What is the Payback period? Pros & Cons - Does not consider additional cash
Cons? inflows after payback
-Too simplistic - doesn't take not of fur-
ther cash outflows and inflows during the
life of the item.
- Doesn't consider profitability
- Doesn't consider the time value of mon-
ey
- Cost of Capital
What is the decrease in value of money
- Rate of Return
over time known as?
- Present Value Factor
1 x (100 / 100 + decrease percentage) =
What is the formula for cost of capital?
value.
What is the Internal Rate of Return It is the percentage the project will earn
(IRR)? over its lifetime.

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