F5 – Chapter 2: Specialist cost and management accounting techniques

Specialist cost and management accounting techniques

Key Highlights on Chapter 2

Activity-Based Costing (ABC):

• Allocates overhead costs based on activities driving them.
• More accurate than traditional methods using direct labor or machine hours.
• Provides insights for informed decision-making on pricing and resource allocation.

Target Costing:

• Sets product costs based on desired profit margins.
• Considers market demand and competitive pricing.
• Ensures products are designed and produced within a cost framework to achieve profit targets.

Life-Cycle Costing (LCC):

• Considers all costs associated with a product throughout its life cycle.
• Includes design, production, distribution, use, and disposal costs.
• Guides decisions on product design, pricing, and resource allocation for maximum profitability.

Throughput Accounting:

• Identifies and manages constraints limiting throughput.
• Maximizes the rate of generating money through sales.
• Optimizes performance of constraints for improved profitability and operational efficiency.

 Environmental Costing:

• Considers environmental costs in decision-making processes.
• Includes pollution, waste disposal, and resource depletion costs.
• Promotes sustainable and socially responsible decision-making.

Kaizen Costing:

• Involves continuous incremental improvements to reduce costs.
• Focuses on employee involvement and small, gradual changes.
• Aims for sustainable cost reductions and process improvements.

Value Chain Analysis:

• Identifies non-value-added activities within the production process.
• Eliminates or minimizes activities that do not add value.
• Improves efficiency, reduces costs, and enhances overall value creation.

Bottleneck Costing:

• Identifies and manages constraints limiting throughput.
• Focuses on optimizing the performance of constraints.
• Aims to improve profitability and operational efficiency.

Backflush Costing:

• Allocates overhead costs based on actual activity levels or triggers.
• Delays cost recognition until products are completed or sold.
• Reduces administrative burden associated with cost tracking and allocation.

Environmental Management Accounting (EMA):

– Integrates environmental costs and performance indicators into decision-making.

– Balances economic, environmental, and social considerations.

– Promotes environmental sustainability and resource efficiency.

Total Quality Management (TQM):

– Focuses on improving product quality and reducing defects.

– Involves employee involvement, customer focus, and process optimization.

– Reduces costs associated with rework, scrap, and customer complaints.

Topic 1. Activity-based costing (ABC)

A) Identifying appropriate cost drivers under ABC:

• Cost driver: A factor that causes a change in the cost of an activity.
• Examples of cost drivers:
  • Production volume: Number of units produced
  • Number of setups: Number of times a machine is set up for a new product
  • Number of customers: Number of unique customers served
  • Number of orders: Number of purchase or sales orders processed
  • Number of machine hours: Total time a machine is in operation
  • Number of labor hours: Total time employees spend on an activity

B) Calculating costs per driver and per unit using ABC:

1. Identify activities: Break down the organization’s processes into individual activities.
2. Identify cost drivers: Determine the cost driver for each activity.
3. Collect cost data: Gather information on the total cost of each activity.
4. Allocate costs to activity drivers: Divide the total cost of each activity by its cost driver to calculate the cost per driver.
5. Calculate cost per unit: Divide the total cost of an activity driver for a specific product or service by the number of units produced or services provided using that driver.

Example:

Activity: Machine setup Cost driver: Number of setups Total cost of activity: $10,000 Number of setups: 100 Cost per setup: $10,000 / 100 = $100

Product X: Requires 2 setups Cost of setups for product X: 2 setups * $100/setup = $200

C) Comparing ABC and traditional methods of overhead absorption:

• Traditional methods: Allocate overhead costs to products based on a single factor like direct labor hours, machine hours, or production volume.
• ABC: Provides a more accurate picture of product costs by considering various cost drivers.

Comparison:

Topic 2. Target costing:

A) Deriving a target cost in manufacturing and service industries:

Target cost = Selling price – Desired profit margin

Manufacturing:

• Consider manufacturing costs, including materials, labor, and overhead.
• Adjust the cost structure or product design if the target cost cannot be achieved with existing methods.

Service industries:

• Estimate future costs based on historical data and industry benchmarks.
• Focus on process improvements and innovation to achieve target costs.

B) Difficulties of using target costing in service industries:

• Intangible outputs: Difficult to measure and standardize service outputs, making cost estimation challenging.
• High labor input: Labor costs can be significant and variable in service industries, impacting cost control.
• Customer interaction: Cost behavior can be unpredictable due to client-specific needs and service variations.

C) Closing a target cost gap:

• Product design: Redesign the product or service to reduce material and labor requirements.
• Value engineering: Identify and eliminate unnecessary features or processes that don’t add value to the customer.
• Supplier negotiation: Negotiate lower prices with suppliers for materials and services.
• Process improvement: Implement efficiency measures to reduce waste and optimize operations.

Topic 3. Life-cycle costing:

A) Identifying the costs involved at different stages of the life-cycle:

Research and development: Costs of product or service design, prototyping, and testing.

• Acquisition: Costs of purchasing materials, equipment, and other resources.
• Production/Operation: Costs of running the production process or delivering the service.
• Distribution/Marketing: Costs of marketing, selling, and delivering the product or service to the customer.
• Use/Support: Costs associated with product use (e.g., customer service, warranties) and disposal at the end of its life.

B) Deriving a life-cycle cost or profit in manufacturing and service industries:

Manufacturing:

• • Calculate the total cost incurred at each life-cycle stage for a specific product.
  • Subtract the total cost from the selling price to get the life-cycle profit.
• Service industries:
  • Estimate costs for each life-cycle stage based on historical data and projections.
  • Consider potential future costs, such as customer support and technology upgrades.

Example:

Product: Mobile phone

C) Benefits of life-cycle costing:

• Improved decision-making: Provides a complete picture of costs, aiding in product development, pricing, and resource allocation decisions.
• Reduced costs: Helps identify and control costs throughout a product or service’s life cycle.
• Enhanced customer focus: Considers customer support and disposal costs, promoting sustainable practices.
• Increased risk assessment: Helps assess potential future costs associated with product liability and environmental regulations.

Topic 4. Throughput accounting:

A) Theory of constraints (TOC):

• Developed by Eliyahu M. Goldratt, TOC identifies the bottleneck (constraint) in a production process that limits overall throughput (output).
• Throughput: Rate at which the system generates saleable products or services.
• TOC focuses on:
  • Identifying the bottleneck.
  • Maximizing the utilization of the bottleneck.
  • Subordinating all other non-bottleneck activities to the bottleneck.

B) Calculating and interpreting a throughput accounting ratio (TPAR):

TPAR = Throughput / Total operating expense

• Throughput: Revenue from sales – Cost of goods sold.
• Total operating expense: All costs incurred during the operating period.
• Higher TPAR indicates:
  • More efficient use of resources.
  • Higher profitability potential.

C) Improving TPAR:

Focus on bottleneck improvement: Invest in resources and processes to increase the capacity of the bottleneck.

• Eliminate non-value-adding activities: Identify and reduce activities that don’t contribute to customer value.
• Continuous improvement: Regularly monitor and improve the overall production process.

D) Applying throughput accounting to a multi-product decision-making problem:

• Use TPAR to compare the profitability of different products.
• Focus on producing and selling products that contribute the most to overall throughput.
• Consider factors like market demand and profit margin alongside TPAR when making product mix decisions.

Topic 5. Accounting for environmental and sustainability factors:

A) Issues in managing environmental costs:

• Difficulty in measurement: Environmental costs are often intangible and difficult to quantify accurately.
• Allocation challenges: Assigning environmental costs to specific products or activities can be complex.
• Compliance costs: Organizations face ongoing costs associated with meeting environmental regulations.

B) Methods for accounting for environmental costs:

• Life-cycle costing: Captures environmental costs throughout a product or service’s life cycle.
• Environmental cost accounting (ECA): 

• Systematically identifies, measures, and records environmental costs.
• Full cost accounting: Considers all environmental costs alongside traditional cost categories.

C) Issues in accounting for environmental and sustainability factors:

• Lack of standardized methods: No universally accepted approach to environmental accounting exists.
• Integration with traditional accounting: Integrating environmental factors into existing financial reporting systems can be challenging.
• Short-term vs. long-term perspective: Environmental costs often have long-term implications, which may not be fully reflected in traditional financial statements.

D) Role of the management accountant in supporting sustainable practices:

• Develop and implement relevant accounting systems to track and report environmental costs.
• Analyze environmental data to identify areas for improvement and cost reduction.
• Provide information to support decision-making related to environmental sustainability initiatives.
• Advocate for integrating environmental considerations into the organization’s overall strategy.