MARGINAL AND ABSORPTION COSTING TECHNIQUES

 

Learning Objectives:

After studying this, you should be able to:

·              explain the concepts and differences between marginal and absorption costing.

·              explain the equation, advantages and limitations of marginal costing.

·              discuss the importance of contribution margin in managerial decision making.

·              use marginal costing as a technique for short-term tactical planning and decision-making.

·              make decisions on whether to make or buy a component, accept or reject an order, among others.

8.1        Marginal Versus Absorption Costing

8.1.1    Introduction

In taking short term, medium term or long term decisions, management of organisations in both the public and private sectors of the economy must adopt some tools that would aid better decision making for the achievement of organizational goals. In Accounting there are many tools to be used in guiding effective decision making by management. Two of the most popular decision making techniques are marginal costing and absorption costing.

The two techniques are expected to be appropriately used in short term tactical managerial decision making exercise that would amount to efficient management of resources for the production of income, profit and wealth. The decision to be taken would normally be about the future, which is full of risks and uncertainties. This calls for a lot of care and attention when using any of the two techniques.

This section of the chapter explains the concepts of marginal costing and absorption costing; the differences between marginal and absorption costing; and the environments for the application of marginal and absorption costing. 

COST-VOLUME-PROFIT ANALYSIS

 

Learning Objectives:

After studying this, you should be able to:

·      explain the concept of break even analysis.

·      state the assumptions behind break even analysis.

·      explain the meaning and importance of C-V-P analysis.

·      use C-V-P analysis for short run planning and decision-making.

9.1        Break-Even Analysis

9.1.1    The Concept of Break-Even Analysis

Break even is a situation of neither profit nor loss; it is about a win-win or loss- loss position as two competing things or persons are put together to realize a result. In Accounting, especially Management Accounting, break even is normally studied taken the point of intersection between cost and revenue into consideration. That point of intersection is called breakeven point and it shows a situation of neither profit nor loss.

The study of Cost-Volume-Profit relationship is frequently referred to as 'break-even analysis', but break even analysis is only incidental to the study of the relationship between cost, sales, profit/loss and sound management. Up to the point of activity where total revenues equal total expenses, the study can be termed as 'break-even analysis', while, beyond this point, it is the application of Cost-Volume-Profit relationship.

Thus, the term 'break-even analysis' may be interpreted in two senses - narrow sense and broad sense. In its narrow sense, it refers to a system of determining that level of operations where total revenues equal total expenses, i.e. the point of zero profit. Taken in its broad sense, it denotes a system of analysis that can be used to determine the probable profit at any level of operations. 

STANDARD COSTING AND VARIANCE ANALYSIS

 

 

Learning Objectives:

After studying this chapter, you should be able to:

·      explain the concept of a standard

·      explain the different types of standards

·      explain the procedure for establishing standards and standard cost

·      analyze a variance into its smallest parts

·      compute the various cost variances and sales margin variances

·      reconcile budgeted profit and actual profit, using variances

·      compute activity, capacity and efficiency ratios

·      explain the factors that influence the investigation of variances.

INTRODUCTION

In order for organisations to function effectively, it is important for them to plan ahead of time. Organisational planning is greatly enhanced when standards are established to form the basis of planning and also as a yard stick for measuring performance. When standards are set, budgeting becomes relatively easy to establish and the control process which compares the standards set with the actual achievements ensures that variances are determined and corrective action taken to remedy the deviations and drive the business closely towards its objectives.

Section 1: Standard Costing

1.1 Standard Cost as Control Mechanisms

Standards are control mechanisms which establish predetermined estimates of costs of products and services and then compare these predetermined costs with actual costs as they are incurred to ascertain variances which are analysed into their various components and investigated.

BUDGETS AND BUDGETING

  Learning Objectives

After studying this chapter, you should be able to:

·      explain the concept of budgeting

·      explain the types of budgets

·      explain the concept of principal budget factor

·      distinguish between budgeting and forecasting

·      explain the objectives of budgeting

·      explain the factors to be considered in introducing budgets for the first time

·      explain what is meant by: budget committee and budget manual.

·      explain the behavioral factors in budgeting

·      prepare functional budgets, cash budgets and the master budget.

INTRODUCTION

At the beginning of the financial period of every organisation, whether the organisation is publicly or privately owned, it needs to develop its budget to guide its operations for the year ahead. Budgeting is therefore an important process of every organisation. How effectively the budgeting process is handled in an organization could define success or failure for the organisation.

Section One: Introduction to Budget

1.1         Definition of budget

A budget is a quantitative plan of the operations of an organisation or an   individual;

it identifies the resources and the commitments required to fulfill the organization‟s

individual‟s goals for theincludesbudgetedbothfinancialand nonperiod-. financial aspects of the planned operations.

1.1.1    What a budget is:

CAPITAL BUDGETING: AN INTRODUCTION

Learning Objectives:

After studying this chapter, you should be able to:

·              appreciate the concept of capital budgeting.

·              explain the nature and role of capital budgeting decisions.

·              identify and discuss the main methods of appraising and ranking investment proposals used in practice (NPV, IRR, PI, ARR, and PBP).

·              discuss the strengths and weaknesses of the methods of ranking investment proposals.

·              appreciate the necessity of capital budgeting in long term decision making.

13.1 Capital Budgets and Decision Making

13.1.1 The Concept of Capital Budgeting

Capital budgeting is the planning of expenditure whose returns extend beyond one year; it is the process of deciding whether or not to commit resources to a project whose benefits would be spread over several time periods. It considers proposed capital outlays and their financing. The main exercise involved in capital budgeting is to relate the benefits to costs in some reasonable manner which would be consistent with the profit maximizing objective of the business. Capital budgeting decisions belong to the most important areas of managerial decisions as they involve more extended estimation and prediction of things to come requiring a high order of intellectual ability for their economic analysis.

BUDGETARY CONTROL PROCESS

 

 

Learning Objectives:

After this studying chapter, you should be able to:

·        explain the concept of budgetary control

·        explain the objectives of budgetary control

·        explain the budgetary control process

·        explain the concept of Flexible Budgeting and Fixed Budgeting

·        explain the concept of Zero Based Budgeting and Incremental Budgeting

·        explain the concept of Planning Programming and Budgeting Systems.

INTRODUCTION

Budgetary control encompasses the systems of budgeting, standard costing and other control techniques that ultimately aim at positioning the organisation to achieve its objectives. There is no point in developing budgets if no control steps will be instituted to achieve the set budgets, hence the need for budgetary control.

Section One: Introduction to Budgetary Control

1.1               The Meaning of Budgetary Control

Budgetary control is the whole system of control established in organisations to plan the activities of the activities of the organisation and take steps to achieve the set plans. The control system begins with the determination of standards, the formulation of budgets, comparing actual results with standard performance to determine variances and analyzing the variances. Material variances are then investigated and corrective action taken.

1.2               Objectives of budgetary control

The purpose of budgetary control is outlined below: 1. To aid the planning of annual operations

NOTE:               This is a work in progress.  All topics in the syllabus are covered but editing for

necessary corrections is in progress.

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2.       To coordinate the activities of the various parts of the organization and to ensure that the parts are in synchrony or harmony with each other.

3.       To communicate plans to the various responsibility center managers.

4.       To control activities

5.       To motivate employees to achieve targets

6.       To evaluate the performance of managers