MANAGEMENT INFORMATION (MA1)

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About this Study Text

This Study Text has been specifically written for the Association of Chartered Certified
Accountants' Foundations in Accountancy examination, Management Information.
It provides comprehensive coverage of the core syllabus areas and is designed to be
used both as a reference text and as an integral part of your studies to provide you with
the knowledge, skill and confidence to succeed in your examination.

How to Use This Study Text

You should start by reading through the syllabus and study guide to familiarise yourself
with the content of this exam.
The chapters which follow include the following features:

These are the learning outcomes relevant to the chapter, as published in the
Syllabus Coverage
ACCA Study Guide.

Visual Overview A diagram of the concepts and the relationships addressed in each chapter.

Terms are defined as they are introduced. Groups of terms are set out in a
Definitions
Terminology section.

These are to be read as part of the text. Any solutions to numerical Examples are
Examples
provided.

Exhibits These extracts of external content are presented to reinforce concepts and should
be read as part of the text.

Activities These should be attempted as you work through the chapter.

Key Points Attention is drawn to fundamental rules, underlying concepts and principles.

Exam advice These comments relate the content to relevance in the examination.

Chapter Summary A summary of the main points of each chapter.

Activity Solutions Answers to the Activities are presented at the end of each chapter.

Chapter 1: Business Organisations and Transactions

 Chapter 2: Introduction to Cost and Management Accounting

Chapter 3: Information for Management

Chapter 4: Cost Classification and Behaviour

Chapter 5: Calculating and Reporting Profit

Chapter 6: Cost Centres, Profit Centres, and Investment Centres

Chapter 7: Measuring Performance

Chapter 8: Coding Systems

Chapter 9: Procedures for Purchasing

Chapter 10: Procedures for Recording Labour Costs and Sales Income

Chapter 11: Accounting for Materials

Chapter 12: Accounting for Labour

Chapter 13: Employee Remuneration, Productivity and Labour Costs

Chapter 14: Accounting for Overheads

Chapter 15: Job, Batch, and Process Costing

Chapter 16: Spreadsheets: An Overview

Chapter 17: Spreadsheet Skills 1

Chapter 18: Spreadsheet Skills 2

Chapter 19: Presenting Information Using Spreadsheets

Chapter 20: Spreadsheets: Role, Design, and Limitations

 CHAPTER 1: Visual Overview

Confidence Level: highHigh

1.1 Managing Information

 1.1.1 Business Organisation
1.2 The Role of Head Office
 1.2.1 Functions of an Office
 1.2.2 Centralisation and Decentralisation
1.3 Policies, Procedures, and Best Practices
 1.3.1 Policies, Procedures, and Best Practices
 1.3.2 Systems
1.4 Transactions
 1.4.1 Sales Transactions
 \1.4.2 Purchase Transactions

 1.4.3 Payroll Transactions

 1.4.4 Authorisation of Transactions
1 Conclusion
 1 Syllabus Coverage
 1 Summary and Quiz

A. The nature and purpose of cost and management accounting

Syllabus Coverage

This chapter covers the following Learning Outcomes.

A. The nature and purpose of cost and management accounting

1. Nature of business organisation and accounting systems
1. Describe the organisation and main functions, of an office as a centre for information
and administration.
2. Describe the function and use of policies, procedures and best practices.
3.
CHAPTER 1: Visual Overview
 1.1 Business Organisation

Definitions

Organisation – an individual or group working together to achieve a common objective.

Business Organisation – an individual or group working together to achieve commercial goals.

Business organisations come in all shapes and sizes. They could include anything from
an individual trader (i.e. a self-employed barber) to a vast global corporation (such as
Ford, Google or Apple).
Some organisations (such as charities, schools and other non-commercial
organisations) are not profit-oriented and therefore have non-commercial purposes and
goals.
The focus of MA1 is on business organisations, but the techniques learnt will also apply
to managing charities and other not-for-profit organisations.

Commercial Organisations Non-commercial organisations

Car Manufacturers Government/trust hospitals

 Private schools Government institutions
Social media corporations Charities
Video game producers Political parties
Movie studios Sports associations
Pharmaceutical firms Welfare associations
Audit firms Public universities
Private Hospitals Professional associations

1.1.1 Business Organisation Functions

Several different functions are common to all business organisations. Business
functions may also be referred to as ‘parts’ or ‘departments’.

Function Description

The purchasing function ensures that the business buys products and services of the
Purchasing required quality at the best price.

The production function of a business organisation is responsible for producing the

goods or providing the services that the business sells.
For example, the assembly line is an integral part of the production function in a
motor vehicle manufacturing business.
A service business may also have a production (operation) function. For example, the
Production salon would be the primary operation function of a business that offers hairstyling
(Operations) services.

Sales and The sales function generates sales and ensures that transactions proceed as
Marketing smoothly as possible for buyers and sellers.
The marketing function aims to ensure that potential buyers know the product or
 service’s benefits and that the products and services match what customers want.

The finance function processes financial data and provides financial performance
information. The finance department also monitors the organisation’s cash, ensuring
that payments can be made on time.
A business fails because it runs out of cash, even if it is profitable. Therefore, the
finance function is essential in keeping the company afloat.
The accounting department is a part of the finance function, and its activities include
Finance and
paying employees and suppliers and recording and controlling customer receipts.
Accounting

Human The human resources function, sometimes called the personnel function, ensures the
Resources organisation contains the people and skills required to operate effectively. This
(Personnel) includes hiring and firing employees, training, health and safety, and overall welfare.
Depending on the size and purpose of the business organisation, it may also include
other functions:
 Information technology: Responsible for ensuring that the organisation uses
computing and other technology effectively
 Research and development (R&D): Responsible for identifying and developing
new products and procedures (ways of doing things)
 After-sales service/customer care: Responsible for customer satisfaction after
purchase
 Facilities: Responsible for an appropriate and orderly working environment
 General administration: Responsible for the organisation and administration of the
business.
Although specific functions are present in all organisations, how they are organised will
differ according to their size. For example, the purchasing function in a large
organisation is likely to be a dedicated team or department in large organisations. In
contrast, the purchasing function in a small organisation may be a single individual.

1.1.2 Organisation Chart

One way of showing how the different functions within a business are organised is by
using a simple organisation chart. Organisation charts are a simplified way of
demonstrating formal relationships (including levels of authority), communication flows
and reporting channels within a business organisation.

In the diagram above:

 Leadership is at the top (shown here as “Senior Management). Leadership
involves planning a course for the organisation and ensuring it remains on track. In a
small business, the owner or a dominant individual is likely to provide leadership.
However, a senior management team will provide leadership in a large organisation.
 The main functions appear below leadership, demonstrating the flow of authority
downwards through the organisation.
 The lines in the chart represent formal relationships (such as a hierarchy) and
communication flows. The relationships and flows shown here are simple but can
become more complex – for example, in large organisations with many people
carrying out functions at several locations.
Activity 1 Matching

Match the given definitions to the primary responsibility of each function:

Function:
Responsibility
Sales
Ensuring only required goods are bought.
Finance
Hiring new staff
Purchasing
Finding new Customers
Human
Resources Paying supplier invoices

Answer
Function: Responsibility

Sales Finding new Customers

Finance Paying supplier invoices

Purchasing Ensuring only required goods are bought.

Human Resources Hiring new staff

2.1 Functions of an Office

An office is a combination of personnel and infrastructure for the control and

administration of an organization. Its functions include responsibility for information and
administration.

2.1.1 Information
An office is responsible for the following information functions:
 Capture – Data relevant to the business is captured and recorded using documents
and forms, which may be physical or digital.
For example, an entity that wants to be a customer sends an email or registers
through the company’s online sales portal. The office would capture the entity’s
details to create a new customer. This may be done automatically.
Another example is when a customer sends a purchase order (PO) to the office to
buy goods via email or the company’s online sales system. The office would receive
the PO for processing through its integrated sales system.
 Storing – Captured data relevant to the business is stored for further viewing and
processing later, either physically (record or ledger books) or electronically
(customer management systems on locally hosted servers or cloud storage)
For example, the details of the potential customer filled into the new customer form
are stored in the business’s customer relationship management database for
reference in the future.
 Processing – The office processes data that has been captured into useful
information. This involves viewing, editing, and formatting data.
For example, the details of the purchase order received are transferred to internal
documents such as a purchase requisition, which authorises the goods to be picked
for sending to the customer, and a sales order, which authorises a sale in the
business’s sales system.
 Reporting/sharing – office will convert information into usable reports and
disseminate them to the internal and external stakeholders that need them.
For example, the office publishes a weekly sales report dashboard that summarises
the business’s sales performance, including a breakdown of revenue, sales
channels, and products sold, for the viewing of the sales manager.
Another example is that for processing the received purchase order, the office will
also create and send an invoice to the customer; the invoice specifies the payment
required for the purchased goods, including prices, relevant taxes, and payment
terms.
This entire process may be automated through an integrated accounting system.

2.1.2 Administration
An office would also be responsible for the administration of the business. This usually
means controlling the activities of the personnel involved in the business.
Some examples are:
 The management and control of despatch resources to send goods to customers.
 The monitoring and maintenance of credit limits of customers. Sales personnel
cannot sell goods to customers that have breached credit limits.
 The monitoring of employee performance and behaviour, such as computing
timesheets and work records.
 Enforcement of the business’s policies and procedures and arranging staff training
to uphold the standards and best practices.
 2.2 Centralisation and Decentralisation

Definitions

Centralisation – The aggregation of the functions of an organisation to be performed at a single

location. Power and authority are held by senior management.
Decentralisation – Structure where the functions of an organisation may be performed at multiple
locations. Power and authority are delegated to junior management.
Most of the functions learnt so far are office-based. In many organisations, these
functions are performed in one place or centralised, for example, at an organisation’s
head office. An organisation’s head office provides an administrative and information
centre and a focal point.
Some organisations decide not to centralise their administration function at their head
office and instead spread administration staff and authority across the organisation (a
decentralised function). This may be more applicable where an organisation is spread
over more than one geographical area or have different administration functions in
separate locations.
For instance, consider a supermarket chain – each branch manager is likely to be
responsible for recruiting staff, which is an example of decentralising some aspects of
the human resources function.
What other functions should be decentralised?
The advantages of each structure are summarised in the table below:

Centralisation Decentralisation

 Duplication of activities is avoided, so costs are

lower
 More likely to ensure a consistent approach  Those in touch with local conditions make
(standard policies, procedures and decisions
documentation)  Policies, procedures and systems can be
 Enables everyone to access the same data and adapted to fit market needs and cultural
information preferences
 Easier to co-ordinate different functions  Local staff have higher levels of responsibility,
 Encourages viewing the organisation as a which may improve motivation and staff
single, coherent entity development
 Specialist, expert staff are more likely to be  The impact of a system problem or fault is likely
employed to be reduced
Ultimately, the most appropriate approach will depend on the type and size of the
business organisation and the nature of the business it conducts.
 Example 1 The Blue Jeans Company

The Blue Jeans Company (BJC) is a clothing manufacturer with three factories and one head office, all
based in a single country.
Think about the company profile, the relative advantages of centralised and decentralised structures and
the different organisational functions.
Consider the following:
1. Is BJC’s production function centralised?
No. This business organisation has three production facilities in various locations, an example of a
decentralised function.
2. Should BJC’s purchasing function be centralised and performed at a head office?
Yes. The organisation includes three factories and one head office based in a single country.
Rather than each factory purchasing supplies separately, having a single centralised purchasing function
at the head office is more efficient and cheaper.
3. Consider the finance function for BJC. Is it recommended to have three separate finance teams
(one based at each factory) or a single finance department based at the head office?
A centralised finance function would be more efficient and would make it easier for management to
consider the whole business when making decisions, for example, about borrowing money.
4. Is BJC likely to have an extensive research and development department at its head office?
Probably not. A business that manufactures jeans is unlikely to have an extensive research and
development department. Instead, it needs to monitor customer preferences and manufacturing
production techniques. Still, in an organisation of this type and size, these responsibilities are likely to be
performed by one or two individuals rather than a large department. However, it would make sense for
these individuals to work at the head office.
Are the three factories likely to be responsible for recruiting their production staff?
Yes, they probably are. They will likely follow policies and procedures devised by a human resources (HR)
department based at their head office. HR would provide a central point of expertise while still allowing
decentralised control.

3.1 Policies, Procedures, and Best Practices

Definitions

Policy – A guide to be followed in a given set of circumstances.

Procedure – A sequence of steps for completing a specific activity. It explains how a policy should be
implemented or achieved.
Best Practice – A policy or procedure accepted as being consistently most effective.
 To help ensure consistency, efficiency and control, organisations have policies,
procedures and best practices that guide how decisions are made, how work is carried
out and how people interacting with the organisation are treated.
Policies, procedures and best practices should be documented and published to
prevent confusion and provide a central reference point for every function within an
organisation.
Consistency, efficiency and control are essential for all organisations. However,
consistency is challenging to achieve in larger decentralised organisations. Formal
policies and procedures help with this (e.g. setting limits on travel and food expenses
while working away).
An organisation's policies, procedures, and best practices may be published on the
organisation’s intranet and made available for download.
A policy may also include exceptions as well as rules. For example, the company may
not sell to customers who decline to cooperate with its due diligence procedures.
Activity 2 Policy, Procedure, and Best Practice

Identify each statement as a:

 Policy;
 Procedure; or
 Best Practice

Statement:

Overtime hours must not be worked unless a senior manager has approved.

All employees must follow the environmental management system to ensure that
environmental impact is consistently measured and improved.

Email the head of purchasing to obtain approval before placing an order of over $1,000.
The order is placed only after receiving an email confirmation to do so.

All purchases must be within the agreed budget.

To print the purchases daybook:

Step 1: Open the file pdbook [date].xlsx
Step 2: From the menu, select File > Print.

Answer

Statement:
Overtime hours must not be worked unless a senior manager has approved. Policy

All employees must follow the environmental management system to ensure that Best
environmental impact is consistently measured and improved. Practice

Email the head of purchasing to obtain approval before placing an order of over
$1,000. The order is placed only after receiving an email confirmation to do so. Procedure

All purchases must be within the agreed budgets Policy

To print the purchases daybook:

Step 1: Open the file pdbook [date].xlsx
Step 2: From the menu, select File > Print. Procedure

3.2 Systems

While it is common practice to provide a manual, some policies, procedures and best
practices may exist without being written down or documented. For example,
employees may have an informal understanding of when to take a lunch break to
ensure that the office is adequately staffed throughout the day. This level of detail may
not appear in the manual but is essential for the organisation's efficient running.
Critical considerations of maintaining documentation for policies and procedures are:
 Accountability - It is essential to document policies, procedures and best practices
so that a formal record can be compared with the conduct of employees.
For example, when an employee appears to have done something unacceptable,
the organisation’s policies will guide whether the employee’s actions were wrong
and what would be an appropriate restitution/punishment.
 Consistency - Without a written record, it is unlikely that a consistent and efficient
approach will always be followed. This is problematic because individual employees
may believe that they are being mistreated compared to other staff.
The policy manual may guide how to deal with certain employee behaviours, like
tardiness. This will make it fair for all employees and ensure that managers are
insulated from accusations of bias or favouritism.
 Review and update - Unwritten policies, procedures and best practices are
challenging to review. A written record can be analysed and reviewed regularly,
leading to progress.
 The codifying of best practices would help bring the organisation forward. The
updated policies would apply to all employees in the organisation, ensuring best
practice is consistently performed.
 Flexibility - There are many advantages to documenting policies, procedures and
best practices, but they do not always allow flexibility. A senior staff member should
be consulted for direction and advice in less clear-cut situations.
A manager often refuses to consider an action or strategy due to conflict with the
policy documentation. The context when policy documentation is written must be
considered. For example, data management policies based on physical paper would
be irrelevant if the organisation stores most of its data in the cloud.

1.4.1 Sales Transactions

4.1 Sales Transactions

Some types of transactions are likely to be performed by all business organisations.

Three important types of transactions include:
 Sales
 Purchases
 Paying employees.
All businesses complete these three transaction types.

4.1 Sales Transactions

A sales transaction involves the provision of goods or services in return for payment.
Sales transactions bring in income (or revenue) and are essential for an organisation’s
survival.

Example 2 Sales at Ravi’s Quality Bakery

Consider the example of a small bakery business to think about how sales transactions are made and
processed. The bakery’s owner is named Ravi, and his bakery is known as Ravi’s Quality Bakery (RQB).
Ravi employs two bakers in the bakery, two shop assistants, a delivery driver and an office manager who
oversees the administration and accounts.
Consider the following sales transactions that occur at RQB:

Event Description

Retail: A customer selects a cake on display Sales transactions in RQB are initiated by customers
in RQB’s retail storefront and approaches the who select goods for purchase.
counter to pay.
RQB would have a Point-of-Sale (POS) system at the
 Example 2 Sales at Ravi’s Quality Bakery

store to capture and process the sales transaction.

RQB would also have payment systems available for
Customers can pay through cash or various cash (e.g. cash register) or electronic payment (e.g. e-
electronic payment methods. wallets or credit card terminals)

RQB is in a wholesale supplier arrangement with local

shops and hospitality firms.
RQB’s arrangement with these wholesale customers
may be through credit invoicing for fixed supply.
Wholesale: RQB supplies quantities of cakes,
RQB would invoice these customers regularly.
sandwiches, and pastries to nearby
restaurants and hotels. Payment may be made through direct transfer to
These customers take a fixed quantity of RQB’s bank account, or other forms of remittance (e.g.
supply daily and pay at the end of the month. cheques or bank drafts)

How sales transactions are made and processed will depend on the type and size of the
organisation. For example, most large manufacturing organisations will have a sales
and marketing function responsible for marketing products and taking customer orders.
However, in smaller businesses (for example, retail), sales transactions may occur on
the shop floor.

Different individuals in the finance or accounting department may be responsible for

recording sales transactions and ensuring payment is made in a larger organisation.

4.2 Purchase Transactions

A purchase transaction brings goods or services into an organisation and commits that
organisation to make a monetary payment.
In business and accounting, a distinction is often made between different types of
purchase transactions:
 Transactions that involve the purchase of raw materials for use in production, or
goods for resale, are usually referred to simply as purchases
 Transactions that involve buying items that do not become part of goods or services
produced for sale, and are retained for use in the business over some time, are often
referred to as the purchase of non-current assets
  Transactions that involve buying products and services not directly associated with
producing goods for sale are often referred to as business expenses.
Example 3 Purchases at Ravi’s Quality Bakery

Let’s examine purchases at RQB:

Event Description Process

1. Staff inspect inventory levels to

determine what needs to be purchased.
2. Purchase orders may be initiated by
Ravi or someone he has authorised.
3. When the goods are delivered, shop
staff receive, document, and store them
appropriately.
4. Ravi would authorise payment
RQB would need to purchase raw according to the payment terms.
Purchases for materials and ingredients for baking, 5. An authorised person would update
production such as flour. accounts.

RQB would need to purchase non-

current assets to operate its baking
production.
Non-current assets at RQB might
include the purchase of plant,
Purchases of 1. Ravi is likely responsible for initiating
equipment and machinery, such as a
non-current purchases for non-current assets
new oven.
assets requiring significant capital.

1. Invoices are probably received on an

RQB would incur expenses in the accruals basis (meaning payment is to
operation of its business. be made after services are rendered)
2. Ravi or authorised person to initiate
RQB might include fuel for the delivery
payment voucher for invoice payment.
van, telephone charges, insurance,
Expenses 3. Invoices and payments are recorded in
and energy bills.
incurred accounts by an authorised person.

Much like sales transactions, the question of who is responsible for initiating and
processing purchase transactions will depend on the type and size of the organisation.
In a large organisation, the responsibility for selecting suppliers may fall to a specific
purchasing officer in the purchasing department. Different parts may then request
particular orders or purchases of the organisation, such as those involved in monitoring
the raw materials held in stores or the warehouse. The recording of purchase
transactions and payment of suppliers may also be the responsibility of those within the
accounting and finance function.
 4.3 Payroll Transactions

The final group of transactions to consider are payments to employees. Payments to

employees in wages and salaries involve the organisation paying employees for their
labour and expertise.
Salary and wage payments to employees are a regular commitment and are the
responsibility of the payroll function. Payroll is part of the overall finance function.
The payment initiation procedure should be part of a regular payroll routine and will
likely be automated using payroll software. Larger organisations typically pay
employees via electronic transfer from the organisation's bank account to employee
bank accounts.

4.4 Authorisation of Transactions

A business organisation must exercise control over transactions to control income and
expenditure. A critical control over transactions is to require authorisation.

Authorisation of Authorisation of transactions involves a second person agreeing or approving a

transactions transaction before it proceeds.

Sales are only beneficial to an organisation if the customer pays for them.
Procedures are required to prevent credit sales from carrying a significant risk of
not being paid. An example is credit sales to a new customer or a customer with
a poor credit history.
Authorisation for credit
sales For example, authorisation is required for new credit customers or any increase
in credit granted to an existing customer.

Authorisation for Purchases mean money leaving the organisation either at the time of purchase
purchases or later if purchased on credit.
Generally, the higher the purchase value, the greater the need for effective
control and authorisation.
 For example, authorisation would be required for individual or aggregate
(combined) purchases above a certain threshold per period.

Most business organisations' salaries and wages are large expenditure items.
Controls are required to ensure that payments are made only to genuine
employees and for work performed to avoid the risk that employees who have
left the company may continue to be paid.

Authorisation for For example, authorisation would be required for adding new employees or
payments to removing ex-employees from the system.
employees Additional approval may be needed for unusual transactions, such as overtime
or claims beyond normal working thresholds.

There is a link between authorising transactions and an organisation’s policies,

procedures and best practices.
Regular, routine transactions that follow an established procedure are less likely to
require additional authorisation.

4. Identify the main types of transactions undertaken by a business and the key people
involved in initiating, processing and completing transactions.
5. Explain the need for effective control over transactions.

Summary and Quiz

 A business organisation is an individual or group working together to achieve commercial
goals.
 Several different functions are common to all business organisations, including
o Finance
o Production (Operations)
o Sales and Marketing
o Purchasing
o Human Resources
 An organisation’s functions may be centralised (power and authority retained at senior
management) or decentralised (power and authority delegated to junior management)
 Policies, procedures, and best practices help guide decisions, how work is carried out, and
how people interacting with the organisation are treated.
 A sales transaction involves the provision of goods or services in exchange for payment.
 A purchase transaction involves the acquisition of goods or services in exchange for making
a payment.
 Payroll is the payment to individuals in employment in exchange for services (their labour
and expertise) rendered.
  Authorisation involves requiring the approval of another individual before a transaction can
be processed.

CHAPTER 2: Visual Overview

 2.1.1 Accounting Equation
 2.1.2 Double-Entry Principles
 2.1.3 General Ledger and T – Accounts
2.2 Financial and Management Accounting
 2.2.1 Differences

2.2.2 Bookkeeping
2.3 Computerised Systems
 2.3.1 Computerised Accounting Software

2.4 The Purpose of Management Information

 2.4.1 Purpose

2.5 The Limitations of Management Information

 2.5.1 Management Accounting Information

 2.5.2 Identifying and Assessing Limitations

2 Conclusion
 2 Syllabus Coverage

 2 Summary and Quiz

Syllabus Coverage

This chapter covers the following Learning Outcomes.

A. The nature and purpose of cost and management accounting

1. Nature of business organisation and accounting systems
1. Explain and illustrate the principles and practice of double-entry book-keeping.
2. Identify the key features of a computerised accounting system
2. Nature and purpose of management information
1. State the purpose of management information.
2. Compare cost and management accounting with external financial reporting.
1. Explain the limitations of cost and management accounting information.

1.1 Accounting Equation

The accounting equation represents the relationship between assets,

liability, and owner’s equity (capital) in a business organisation.
Note that the definitions below are simplified from IFRS definitions.
Definitions

Asset – An asset is a resource controlled by a business due to something that happened in the past from
which economic benefits (things that make the company better off financially) are expected to flow in the
future.
Liability – An amount owed by the business, which will result in a payment of money at some point in the
future.
Capital – The owner’s interest in the business. It is made up of the cash or assets introduced to the
business by the owner (known as capital introduced), the profits generated by the business in previous
years less any amounts that the owner has withdrawn from the business (known as drawings).
The accounting equation is:

ASSETS − LIABILITIES = CAPITAL

Examples of each are:

Assets Liabilities Capital

 Cash
 Non-current assets  Reserves
 Receivables  Trade payables  Retained earnings
 Inventory  Loans  Owner/Shareholder
 Prepayments  Accrued expenses capital
The accounting equation guides the following interactions:
 Any changes in one of the components will affect either the same component or
others.
For example, an increase in an asset will lead to a decrease in liabilities or a capital
increase.
 The accounting equation must always balance, meaning a change in one
component must lead to an equal opposite change to itself or another element.
For example, if $100 of cash (an asset) is used to buy inventory (also an asset), the
cash balance will reduce by $100, and the inventory balance will increase by $100,
balancing the equation.
Another example is if $100 of cash (an asset) is used to pay a loan (a liability), the
cash balance will reduce by $100, and the loan balance will decrease by $100,
balancing the equation.
Some other components you might come across are:
 Drawings – Withdrawals from the business by the business owner. Decreases
capital and assets.
 For example, an owner withdraws $100 from his business. This results in a
reduction in cash balance (asset) and capital of $100.
 Income (Revenue) – amounts earned from selling goods/services. Increases in
capital and assets.
For example, the business sells goods to customers for $100 in cash. This
increases cash (assets) and sales (capital) by $100.
If the goods were sold on credit, the result would be an increase in receivables
(asset) and sales (capital) of $100.
 Expenses – amounts incurred from the purchase of services/labour. Decreases
capital with a corresponding decrease in assets or an increase in liabilities.
For example, a business paid its electricity bill for $100 in cash. This decreases
cash (asset) and capital by $100.
If the expense is incurred on credit, it increases accruals (liability) by $100 and
decreases capital by $100.
An expanded accounting equation would be:

ASSETS = CAPITAL + (INCOME − EXPENSES) − DRAWINGS + LIABILITIES

1.2 Double-Entry Principles

Definition

Double-Entry – A method of recording transactions in the general ledger. Each transaction

is entered as a debit (Dr) and a credit (Cr) to reflect the duality of every action.
The components of the accounting equation are reflected in either debit (Dr) or credit
(Cr) balances. Having more of the corresponding balance means having more of that
component.

Debit Balances Credit Balances

 Assets  Capital
 Expenses  Income (Revenue)
 Drawings  Liabilities
For example, if a business has assets worth $25,000 and liabilities of $15,000, then the
capital belonging to the owners may be calculated: $25,000 − $15,000 = $10,000. The
owners have $10,000 of capital in the business.

Example 1

In the following activity, calculate and enter the missing figures to complete the accounting equation and replace t
‘?’ symbol.
 Example 1

Make sure the equation balances and remember ASSETS − LIABILITIES = CAPITAL.

Assets $ Liabilities $ Capital $

Q1 106,000 98,756 ?

Q2 29,750 ? 22,300

Q3 204,000 145,000 ?

Q4 ? 26,800 38,200
Answers:
Q1 Capital = 106,000 − 98,756 = 7,244
Q2 Liabilities = 29,750 − 22,300 = 7,450
Q3 Capital = 204,000 − 145,000 = 59,000
Q4 Assets = 26,800 + 38,200 = 65,000

Key Point

The effect of every transaction is to either increase or decrease the assets, liabilities, or capital of
a business. To record the transactions in ledger accounts, double entries are used. (Section 4)

Example 2

Consider the following transactions and their effect on the accounting equation.
Transaction 1:
The owner put $20,000 into the business. The money has been paid into the business bank account.
The accounting equation looks like this:

Assets − Liabilities = Capital

Bank $20,000 − 0 = $20,000

The cash in the bank now belongs to the business (asset), and the business has a responsibility at some
point to pay that amount back to the owners (capital).
(Asset increased, Capital increased)
Transaction 2:
The business purchased furniture for a new shop costing $1,500 and paid for it from the business bank
account.
The accounting equation now looks like this:
 Example 2

Assets − Liabilities = Capital

Bank ($20,000 - $1,500) $18,500 − 0 = $20,000

Furniture $1,500

$20,000 $20,000
The overall asset value has not changed; the equation shows $1,500 coming out of the bank account
(decreasing the bank account) and creating a different non-current asset (Furniture) at the cost of $1,500.
(Asset increased & decreased)
Transaction 3:
The business purchases some dresses from a supplier on credit for $700. The supplier agrees that the
business can pay in 30 days. The business plans to resell the dresses.
The accounting equation would now look like this:

Assets − Liabilities = Capital

Bank ($20,000 − $1,500) $18,500 $20,000

Furniture $1,500 Payables $700 − $700 expense

$20,000 − $700 = $19,300

As purchases are an expense, they reduce profits and, therefore, capital (which are profits to owners).
Liabilities have also increased because the business owes $700 to a supplier (payable) for the inventory.
(Capital decreased, liabilities increased)
Transaction 4:
The business takes dresses worth $100 out of inventory and sells them to Manisha for $300. Manisha
pays cash immediately.
The accounting equation now looks like this:

Assets − Liabilities = Capital

Bank ($20,000 - $1,500 + $300) $18,800 $20,000

Furniture $1,500 Payables $700 − $700 expense

 Example 2

$300 income

$20,300 − $700 = $19,600

As sales are a type of income, they increase profits and therefore, capital (which are profits to owners).
Cash (Asset) has increased by $300.
(Asset bank increased, Capital increased)

Activity 1: Balances

Select whether to debit or credit the account for the given transaction.
(e.g. for a decrease in Liabilities, debit Liabilities)

Transaction Debit or Credit

Increase in Assets

Increase in Liabilities

Decrease in Expenses

Increase in Income

Decrease in Liabilities

Decrease in Assets

Increase in Expenses

Decrease in Income
*Please use the notes feature in the toolbar to help formulate your answer.

Transaction Debit or Credit

Increase in Assets Debit

Increase in Liabilities Credit

Decrease in Expenses Credit

Increase in Income Credit

Decrease in Liabilities Debit

Decrease in Assets Credit

Increase in Expenses Debit

Decrease in Income Debit

1.3 General Ledger and T – Accounts

The general ledger is where all the double entries are recorded. It contains individual
accounts for a business's assets, liabilities, capital, income and expenses. These
individual accounts are also known as ledger accounts.
Financial transactions of the business are recorded in the relevant ledger accounts.
Immediately, a business can gather information overview such as:
 Cash balance in the business from the cash ledger account
 Sales generated from the sales ledger account.
Double Entries are recorded into the ledger accounts’ T-Accounts. A T-Account is a
graphical representation of a ledger account.

1.3.1 Elements of a T – Account

Activity 2: Transactions

Match the appropriate double entry for the transaction

(e.g. for payment of trade payables, debit payables (liability, reduced), credit cash
(asset reduced))

Transaction Journal Entry

Sale of goods Dr Bank

Payment received from Cr Receivables

credit customers
Dr Payables
Purchase of Materials
Cr Bank
 Dr Bank/Receivables
Cr Sales

Dr Expenses/Overheads
Cr Bank

Dr Materials/Purchases expense
Payment made to credit Cr Bank
suppliers

Payment of wages Dr Wages expense

Cr Bank
Payment of expenses

*Please use the notes feature in the toolbar to help formulate your answer.
Activity 3: Short Quiz

Indicate whether the given statements are correct or incorrect.

Note that some definitions are simplified.

Correct or
Statement Incorrect

Assets are what the business owns, liabilities are what the
business owes to others, and capital is their difference.

The main principle of double-entry bookkeeping (that every debit

entry has an equal and opposite credit entry) means the
accounting equation will always balance.

One good way of stating the accounting equation is Assets −

Liabilities = Capital.
*Please use the notes feature in the toolbar to help formulate your answer.

Statement Correct or Incorrect

Assets are what the business owns, Correct

liabilities are what the business owes to These simple definitions are
others, and capital is their difference. essentially correct.

The main principle of double-entry Correct

 Put simply, the accounting equation
bookkeeping (that every debit entry has an demonstrates that debits equal
equal and opposite credit entry) means the credits: assets (debits) = capital
accounting equation will always balance. (credit) + liabilities (credit).

Correct
This is a valid format of the accounting
equation. Capital represents funds
One good way of stating the accounting invested in the business by the
equation is Assets − Liabilities = Capital. owner(s), plus profit retained.

2.1 Differences

Accountants traditionally distinguish between the different types of accounting.

Financial accounting is the systematic recording, reporting, and

analysis of the financial transactions of a business.
Financial
Accounting The focus is on the recording of historical (past) transactions.

Financial reporting focuses on producing financial statements for

publication outside the business.
The financial statements must comply with all applicable
Financial accounting standards and regulations to ensure consistency with
Reporting other businesses and make them more accessible to readers.

Cost accounting focuses on identifying costs (a monetary

valuation or assessment) of resources and their allocation to
products, services, inventory or other items. This gives
businesses information about how much it costs to provide a
particular good or service.
Cost As with management accounting, the information produced is
Accounting used inside the organisation.

Management accounting focuses on providing information for

internal use by managers to help the organisation operate more
effectively.
Management The focus is on both past and future data and information.
Accounting
 The information may be commercially sensitive and is not made
available to external parties.

Key Point

Financial accounting is required by law for companies, whereas management accounting

is not.

2.2 Bookkeeping

Bookkeeping is one aspect of accounting. Bookkeeping is concerned with

the processing and recording of transactions. This includes entering them into an
accounting system where all transactions are initially recorded.

3.1 Computerised Accounting Software

3.1.1 Data Cycle

In accounting, computerised systems are primarily used to process transactions, create
documents (such as invoices) and produce information (such as management reports).
3.1.2 Terms
Term Description

Data files are collections of records with similar characteristics.

Examples include the general ledger, the receivables ledger and the
payables ledger.
Files

A record in a file consists of data relating to one unit of information.

A record consists of several fields.
For example, a supplier account in the payables ledger.
Records

A field is an item of data relating to a record.

For example, a supplier record includes separate fields for their account
number, name and credit limit.
Fields
 Each record in a file includes a key field – an item of data used to
identify it.
For example, this might be a unique supplier code.
Key fields

Transaction A transaction file contains records related to individual transactions,

files such as invoices.

A master file contains 'standing' or reference data (such as supplier

names and addresses) and cumulative transaction data (such as year-
Master files to-date figures)
There are many different types or brands of computerised accounting software
available. Popular systems include QuickBooks, SAP, Oracle and Sage, but many
others are available, and new products always enter the market.

3.1.3 Integrated Accounting Software Packages

Some larger computerised accounting systems include different modules for different
tasks. For example, a non-current assets module, a payables module and a general
ledger module.
These more effective, multi-module systems are often described as integrated
accounting software packages. “Integrated” refers to how the different modules are
linked and interact.
All computerised accounting software packages have several functions and features:
 Enforces accountancy rules
Computerised accounting systems allow organisations to enforce specific
accountancy rules – for example, by calculating the decrease in value of a non-
current asset. This is extremely useful.
However, it is essential to recognise that software cannot replace an accountant.
The accountant remains in control of the accounts, and the software is a tool to help
make the process as straightforward as possible.
 Separate modules
A typical accounting software package includes a general ledger module for all
assets, liability, income and expense accounts; a receivables ledger module for
individual customer accounts; a payables ledger module for individual supplier
accounts; and primary and petty cash books. The links between these modules save
time and effort.
 Real-time processing
Computerised accounting follows a data processing cycle: the data is entered (or
input) into the system, processed by the computer software according to accounting
rules and then made available (or output) for analysis.
Batch processing is the grouping and processing of data at regular intervals. Using
this method means financial records are only updated up to the date of the last batch
and do not reflect transactions that have not yet been processed.
 In modern systems, ledgers are updated immediately. This is called real-
time processing. Batch processing for high-volume, similar transactions remains an
efficient way to input data.
 Links between modules
The different modules of a computerised software package are integrated. When a
transaction is entered into the system, it feeds all the relevant accounts and records.
For example, when a purchase invoice for materials is entered into an integrated
system, it updates the relevant general ledger accounts (materials and payables),
records the invoice in the individual supplier's account in the payables ledger and
updates the inventory records in the inventory module.
 Automates period-end routines
Accounting software includes automated routines that total accounts and ledgers at
the end of an accounting period and open the next accounting period.
This automated period-end routine usually posts entries between the primary ledger
and other ledgers, reflecting the period’s activity.
 Queries and Reporting
Accounting software enables accountants to easily query the ledgers – for example,
by locating specific transactions. Computerised systems also have standard reports
for management to monitor the business.
Examples of typical reports include:
o Inventory on hand and inventory valuations
o Aged receivables and aged payables
o Trial balance
o Monthly management accounts
o Non-current assets reports (listings, additions, sales).

3.1.4 Advantages of Computerised Systems Over Manual

 Data entry is quick, using structured screens and inbuilt customer and
supplier details databases.
 Processing and calculations are automated, quick and less prone to
human error.
 Links between modules reduce the need to enter the same
transaction in several places.
Speed and  Queries are resolvable quickly, and information is easily found using
efficiency automated transaction searches.

 Computerised accounting systems enforce accountancy rules,

For example, enforcing that both sides of a double-entry transaction
are recorded.
 Automated calculations are performed accurately and are far more
likely to be error-free than manual calculations (although a correct
result relies upon the rules first being programmed into the software
Accuracy correctly).

Availability  A computerised system is accessible by different people based in

 different locations.
 Although there is one set of accounts, more than one user can work
on the system simultaneously.

Easier to  Accounting packages produce professional, presentable reports

produce almost instantly, either for paper output or another computerised file
reports for distribution.

 Computerised systems are constantly updated (real-time) compared

with manual methods that are only updated at regular intervals.
 Modern computerised systems use real-time processing, which
Up-to-date means that most information is updated immediately upon entering
information transactions.

4.1 Purpose

Definition

Management information – The information used for managers' planning, control and
decision-making.
What management information is produced depends on the organisation’s needs and
how relevant that information is to managers.
The more sophisticated and susceptible to change a business is, the more it will benefit
from timely and accurate management information.
Managers require information for three essential activities:

Managers plan a course of action rather than just “letting things happen”.
They decide on the best use of the resources under their control and state this as a plan.
Plans can be stated in financial terms, such as a budget.
Planning

Progress needs to be monitored after a plan has been developed and implemented
(through feedback information to compare the actual results against the plan). Action is
Control taken to keep progress on track or implement improvements.

Decision- Managers often face situations with more than one potential course of action, so they need
making the information to help them make informed decisions and maximise performance.
Activity 4 Ravi’s Quality Bakery

From the perspective of Ravi’s Quality Bakery (RQB), as used in previous examples,
Consider Ravi's role as the owner and manager of RQB and the information he may
need to operate his business successfully.
Classify the given information as supporting either planning, control, or decision-
making

Management Activity
(Planning, Control, or
Information Decision-Making)

A summary of suppliers’ flour prices for Ravi to use

when selecting a supplier

A report comparing the planned and actual number of

RQB employee overtime hours

A spreadsheet Ravi is preparing that contains the

budget for next year.

A report showing invoices issued to overdue

customers (have not yet been paid)

A report showing a summary of competitors’ selling

prices that Ravi uses when considering an increase in
RQB’s selling prices
 *Please use the notes feature in the toolbar to help formulate your answer.
Answer

Management Activity
(Planning, Control, or
Information Decision-Making)

A summary of suppliers’ flour prices for Ravi to use when selecting a

supplier Decision-making

A report comparing the planned and actual number of RQB

employee overtime hours Control

A spreadsheet Ravi is preparing that contains the budget for next

year Planning

A report showing invoices issued to overdue customers (have not yet

been paid) Control

A report showing a summary of competitors’ selling prices that Ravi

uses when considering an increase in RQB’s selling prices Decision-making

5.1 Management Accounting Information

Management information includes all information provided to managers and is used for
various purposes, including planning, control, and decision-making.
Management accounting information is a subset of management information and
generally refers to information related to management accounts. Typical management
accounting information includes:
 Budgets
A quantified plan of action for a future period.
Although we tend to think of budgets in monetary terms, budgets may relate to other
quantified factors, such as time.
For example, a courier may plan to drive from point A to point B within a planned or
budgeted time of 4 hours.
 Forecasts
A prediction of what might happen in the future.
For example, assumptions about traffic delays might affect the delivery time of
couriers.
 Variance analysis
An analysis of the reasons for the differences between actual and planned figures.
For example, compare actual time versus budgeted time for couriers, investigate
why some journeys took longer than expected and update plans for future trips.
 Cost accounting information.
The cost of different products, services and activities.
For example, the cost of fuel for the journey.

5.2 Identifying and Assessing Limitations

Limitations Description

Producing management information takes time, which means

it costs money.
The information provided must be cost-effective. This means
that the benefits and savings it delivers should exceed the cost
of providing the information.
However, placing an accurate value on information is difficult,
as its impact is unlikely to be predictable and measurable.
Time and Cost

Much of the information supplied to management is based on

what has happened. This is risky.
The business environment is dynamic and constantly
changes; the past might not be a reliable indicator of what will
happen in the future.
Based on past events

The information supplied to management is unlikely to be

complete.
This is because there is almost always something relevant
happening in the business environment that those supplying
the information (and the manager(s) receiving it) are unaware
of.
No way to know if
For example, a new competitor may be about to enter the
something significant
market.
is missing

Reluctance to question Computer systems produce much of the information supplied

computer system to managers.
reports
A report produced by computer systems is often presented
very professionally, which can cause managers to accept the
reports as entirely correct.
However, if inaccurate or insufficient data is input into the
computer system, the reports produced will not provide an
 accurate, complete picture.

Information for management is often based on assumptions –

for example, general economic conditions, competitors’
Based on assumptions behaviour, and customer attitudes and tastes.
that may now be
These factors are difficult to predict.
invalid

Much of the information supplied to management is financial

(based on money).
This underestimates the role of other factors.
For example, future sales may be dependent upon customer
Overreliance on
satisfaction levels.
financial information
Although the information supplied to management has limitations, this does not mean it
has no value and should be ignored. Generally, more information will lead to well-
informed decisions.

Summary and Quiz

 The accounting equation is ASSETS−LIABILITIES=CAPITAL
 Double-entry accounting means every transaction has an equal debit and credit
entry into the general ledger.
 Financial Accounting is the recording of transactions to produce financial
statements.
 Management accounting provides information for management functions.
 Computerised accounting systems hold many advantages over manual systems.
 The main management functions are planning, control, and decision-making.
 Management accounting information includes
o Budgets
o Forecasts
o Variance Reports
 Management information has various limitations related to the assumptions and
context from which it is created.
CHAPTER 3: Visual Overview
Syllabus Coverage

This chapter covers the following Learning Outcomes.

A. The nature and purpose of cost and management accounting

2. Nature and purpose of management information
1. Distinguish between data and information.
2. Describe the features of useful management information.
3. Describe and identify sources and categories of information.
1. Describe the role of a trainee accountant in a cost and management accounting
system.
 1.1 Description

Definitions

Data – Raw facts and figures.

Information – Data that has been processed to have meaning.

Data is information in a raw and unorganised form. It is the facts and figures that give
information meaning and context.
Information is data that has been sorted, summarised or otherwise made more useful or
easy to work with.

1.2 Personal and Non-Personal Data

 Personal data is about people, such as their name, address, date of birth and bank
details.
 Sensitive personal data includes racial or ethnic origin, religion, political opinions,
health, trade union membership, sexual orientation, and criminal activity. Both sets
of personal data should be kept secure and confidential.
Most countries have laws surrounding the holding and sharing personal data and
stricter rules for sensitive personal data. In many countries, individuals must consent for
sensitive data to be held.
Non-personal data is less specific, such as:
 The number of restaurants in a city
 The number of separate sales transactions made by a company in a month
 The minimum wage rate

1.3 Processing of Data into Information

By itself, data is meaningless facts and figures.

To be useful, data must be processed or placed in a context that adds meaning or aids
understanding.
Data… …processed into information… …for use in:

 Environment temperature
Guidance of measures to
readings over time
Weather forecasts for upcoming mitigate/take advantage of
 Humidity readings
periods weather conditions.
 Wind patterns

Details of sales transactions:

 Prices of goods sold
 Quantities sold
 Date of sales
Sales report detailing sales trends, Informs sales manager to
 Location/method of sale
across product lines and customers, control sales activities for sales
 Customer details
for the period. performance optimisation.
 Customer feedback

Facts concerning to stock of a

specific company:
 Change in prices over
specified periods
 News relating to the
company
 Regulatory changes in
markets the company
Analysis reports and forecasts on the Informs investment manager’s
operates in
stock performance and predicted decisions on holdings in the
 Stock trading volume over
future price movements. specified stock.
specified periods
For example, the number of separate sales transactions made by a company in a
month is helpful when compared against the figures for other months and when the
average transaction value is also included.
Data or
Item Information

60 completed customer feedback forms

A report summarises completed customer feedback forms and includes

suggestions of possible conclusions from the responses.

An aged receivables report categorises RQB's accounts receivable according to

the length of time invoices have been outstanding.

The RQB sales ledger as displayed by the accounting system.

A listing of direct transfers made by RQB for the past week, with their
corresponding authorisation codes.

A report reconciling RQB’s cash book balance with the bank statement balance

Once the relevant data is analysed, it becomes valuable information that can be used to
make informed decisions (i.e. relating to pricing).
Below are some examples of this process:
Activity 1 Ravi’s Quality Bakery

Data or
Item Information

60 completed customer feedback forms Data

A report that summarises completed customer feedback forms and contains

suggestions of possible conclusions that can be drawn from the responses. Information

An aged receivables report categorises RQB's accounts receivable according to

the length of time invoices have been outstanding. Information

The RQB sales ledger as displayed by the accounting system. Data

A listing of direct transfers made by RQB for the past week, with their
corresponding authorisation codes. Data

A report reconciling RQB’s cash book balance with the bank statement balance Information

Referring to the context of Ravi’s Quality Bakery (RQB),

Classify the items as either data or information

*Please use the notes feature in the toolbar to help formulate your answer.

1.4 Knowledge
 Together, data and information help managers make informed decisions. However,
knowledge also plays a vital role in the decision-making process.
Knowledge is the ability to use and understand information to make judgments and
decisions. For example, suppose the findings of Ravi's customer feedback survey
indicate that customers would appreciate a broader range of products for sale. How
Ravi decides to interpret and act upon this information is determined by his knowledge.
This knowledge may be gained from experience. Knowledge may also be achieved
through training, education (including professional development), and consulting with
others. An organisation may capture and distribute knowledge by incorporating findings
in policies, procedures and best practices.
For example, in the context of Ravi’s Quality Bakery, Ravi may have tried to expand
RQB’s product range in the past and found that the additional products weren’t
profitable.
The following diagram illustrates the development of knowledge from data and
experience.

Information provided to managers should be free from significant errors.

In most circumstances, an insignificant error will not affect the information's overall
adequacy, but the accuracy level needs to be sufficient for its purpose.
For example, it may be appropriate to round up in the thousands if smaller quantities are
insignificant.
Accurate

Information should include all relevant information.

Correct information which excludes something important is of little value.
Complete

The financial benefits or value of the information must outweigh the costs of obtaining
that information.
For example, the cost of additional staff time to produce the information.
However, establishing the value of information is not always easy: how do you accurately
Cost-
calculate the value of a ‘better-informed decision’?
effective

Information should be tailored to meet the needs of the recipient.

For example, some managers may require additional information on specific business
User-
areas.
targeted

Relevant Only information directly related to the decision being considered should be provided.
 Managers can suffer from an information overload, making it difficult to find and focus on
the most relevant information.

The source of information should be reputable and reliable.

For example, a rumour about a new product released by a competitor should be
investigated and verified before being accepted as accurate information.
The reliability of the source must also be considered. This is even more important
nowadays with so much information freely available online.
Authoritative

Useful information must be received in time for it to influence a decision.

Information received too late is worthless, no matter its other qualities.
Timely

Information should be concise, presented clearly, understandable and communicated

using an appropriate communication channel.
For example, relatively detailed financial information is easier to use and absorb if
communicated using a digital or paper document rather than in a spoken conversation.
Some information may be more easily understood if presented visually (i.e. in a graph).
Easy-to-use

2.1 Characteristics of Useful Information

 Management information must help managers make informed decisions or take
effective action to be of use.
Information that does not influence behaviour (including confirming that current
behaviour should continue) is of no use or value.
The mnemonic ACCURATE helps to describe useful characteristics of information.
Inevitably there will be some trade-off between these features. For example, most
managers would prefer to sacrifice accuracy for speed.
Activity 2 Ravi’s Quality Bakery (Usefulness of information)

By writing Yes or No, determine whether the given information is useful for Ravi’s
Quality Bakery (RQB).

Is the information
useful? (Yes or
Scenario No)

Ravi is handed a report detailing the amount that RQB's top ten customers have
spent over the past year. The customers are listed in the correct order, but the
biggest customer’s spend is erroneously stated as $24,657 instead of the correct
figure of $24,567.

Ravi needs next year’s sales budget to take to a meeting at the bank scheduled for
4 pm. The budget report is accurate and professionally presented. It was emailed
to Ravi at 4.15 pm.

Ravi receives an email from RQB’s delivery driver on Sunday afternoon. The
subject line of the email is ‘Hello’. Ravi doesn't read it until Monday morning. It
says that the driver will not be attending work that week.

Ravi requests that an aged receivables report be printed and handed to him within
the next hour to assess the current effectiveness of the credit controller. The report
is printed from RQB’s computerised accounting package and handed to Ravi on
time. Although the date range covered is for the previous year, it is accurate.

*Please use the notes feature in the toolbar to help formulate your answer.

Scenario Is the information useful? (Yes or No)

 Yes
This information is useful because it is
sufficiently accurate.
Ravi is handed a report detailing the amount that The error is insignificant and does not
RQB's top ten customers have spent over the past affect the overall usefulness of the
year. The customers are listed in the correct order, information.
but the biggest customer’s spend is erroneously The customers are in the correct order,
stated as $24,657 instead of the correct figure of and the total amount spent is
$24,567. approximately right.

No
This information is not useful because
Ravi needs next year’s sales budget to take to a it is not timely.
meeting at the bank scheduled for 4 pm. The It doesn’t matter whether the sales
budget report is accurate and professionally budget is accurate or well-presented if
presented. It was emailed to Ravi at 4.15 pm. it doesn't arrive in time for the meeting.

No
This is not useful information because
it was not communicated in an
Ravi receives an email from RQB’s delivery driver appropriate format – the email title
on Sunday afternoon. The subject line of the email 'Hello' did not indicate its urgency. Ravi
is ‘Hello’. Ravi doesn't read it until Monday morning. needed to understand that the
On opening the email, it says the driver will not be message required immediate attention
attending work that week. to make alternative arrangements.

Ravi requests that an aged receivables report be

printed and handed to him within the next hour to
assess the current effectiveness of the credit
controller. The report is printed from RQB’s No
computerised accounting package and handed to This is not useful information because
Ravi on time. Although the date range covered is for it is not relevant. It does not provide
the previous year, it is accurate. accurate information for the latest year.
 3.1 Internal Information

The data and information used by an organisation can be described (or categorised) in
several ways. One categorisation is based on whether the information originates from
inside the organisation (internally) or from outside (externally).

Internal Source Description

The organisation’s accounting system collects transaction data, including sales

and purchases. The system allows the organisation to monitor its financial
performance and provide information to help managers make informed decisions.
For example, managers can evaluate the sales levels of different products to
determine which products to produce in the future. They can also look at the
The accounting details of purchase orders sent to suppliers and goods received included in the
system and records inventory records to help monitor the performance of different suppliers.

Employees at all levels of an organisation interact and communicate formally and

informally while performing their duties. These interactions result in insights and
information that should be captured or obtained.
For example, document conversations during meetings and maintain a central
Employees and copy of significant email conversations. Gather information from staff through
managers interviews, internal surveys and word-of-mouth.

Production records In a manufacturing organisation, production records include information relating to

production levels.
For example, the production records would include the usage of materials, fuel
consumption, machine set-up times, machine downtimes, and the required
 maintenance.
In a service business, production records include the time spent by staff on
different clients and tasks. This information helps managers establish client fees
and assess the efficiency and profitability of operations.

Organisations record information to help them carry out operations and

administrative functions.
For example, managers can consult employee records maintained by human
resources to determine whether current employees have relevant experience and
training for a new project requiring a specific skill.
The wages and salary information held in the payroll system can help forecast the
organisation’s cash flow. The policies and procedures manual is another valuable
Administration and
internal source of information.
other records

3.2 External Information

There are also multiple different sources of information that can be gathered from
outside an organisation.
Some of this information is gathered routinely by an organisation on a formal basis:
 To ensure that the organisation complies with the rules and regulations of doing
business, they need information about tax rules and regulations.
Organisations must also be aware of financial reporting standards, environmental
legislation, health and safety regulations and employment law.
 Organisations will also need to collect marketing intelligence routinely (relevant
market information).
One source of marketing intelligence is marketing research undertaken by the
organisation or a specialist agency. Research can help a business better understand
customer needs and improve the reliability of their forecasts of future trends.
Information from external sources is also collected non-routinely on a less formal basis.
Sources of external information include:

 The government and government agencies  Journals and other reference works
 The media (newspapers, magazines, television)  Professional bodies
 Libraries and information services  Customers and suppliers
 Online resources  Bankers
 Consultancy businesses  Trade organisations.

Across all sources, much of the information gathered is now obtained in a digital format.
 Technological developments, including the advancement of computer systems and the
widespread availability of information via the internet, give managers access to more
information.

4.1 Trainee Accountant in Cost and Management

Accounting

Trainee accountants often work within an organisation’s finance function or accounting

department while studying with a professional accountancy body (such as ACCA).
Ideally, a trainee accountant will be involved in various tasks, including routine
processing and higher-level analysis, providing them with a rounded experience to help
them progress in their careers.
Some examples of trainee accountants in the workplace are illustrated below:

Scenario Duties and Responsibilities Essential Takeaways

 establishing and analysing the cost of

different financial products and
services
 answering queries from cost centre
managers.  development of
Hanna
 assist the management accountant communication skills.
trainee management
(line manager) in preparing cost and  Frequent need to explain
accountant in the finance
expenditure control reports by accounting principles to
team based at the head
comparing actual costs incurred marketing managers using
office of a global credit
against budgeted costs and simple language that a non-
card company
investigating significant variances. specialist can understand.

 calculate the value of inventory held

at the end of each accounting period
for performance measurement.
Ranjeet
 Evaluating the impact of possible  Need to treat different
trainee accountant in the
supplier price changes on costs and departments within the
finance department of a
profitability company as internal clients –
company that
 Preparing performance statements for and always provide customer
manufactures tyres
managers satisfaction.

Rachel  prepare reports comparing actual and  Duties can be time-

trainee accountant at a budgeted costs using our consuming
small customised standardised spreadsheet format  part of a company-wide
jewellery company  Investigate and document the causes initiative to start recording all
 aspects of our business by
writing up our policies and
of variances. procedures.
There is no definitive set of tasks that all trainee accountants will perform. Their
activities usually focus on providing information and preparing management reports.
Activity 3: Trainee Accountants

Which activities would NOT typically be performed by a trainee accountant?

A. Investigating a variance between actual spend and budgeted spend
B. Authorising payment of a large supplier invoice
C. Answering queries related to internal cash flow reports
D. Producing a report summarising the company’s bank balances and borrowing limits
*Please use the notes feature in the toolbar to help formulate your answer.
Which activities would NOT typically be performed by a trainee accountant?
A. Investigating a variance between actual spend and budgeted spend
B. Authorising payment of a large supplier invoice
C. Answering queries related to internal cash flow reports
D. Producing a report summarising the company’s bank balances and borrowing limits
B. Authorising payment of a large supplier invoice
A trainee accountant is unlikely to authorise the payment of a large invoice. This sort of
task is most likely to be the responsibility of a more senior manager within the
accounting department.

Summary and Quiz

 Data – Raw facts and figures.
 Information – Data that has been processed to have meaning.
 Data is processed into information
 Regulations on collecting and using personal data need to be complied with.
 Knowledge is the understanding of information to make judgement and decisions.
 The mnemonic ACCURATE describes useful characteristics of information:
o Accurate
o Complete
o Cost-effective
o User-targeted
o Relevant
o Authoritative
o Timely
o Easy-to-use
 Information may be obtained from internal or external sources.
 Trainee accountants are involved in various tasks, including information processing
and analysis.
CHAPTER 4: Visual Overview
Syllabus Coverage

This chapter covers the following Learning Outcomes.

C. Cost classification and measurement

1. Cost classification and behaviour
a. Define cost classification and describe the variety of cost classifications used for
different purposes in a cost accounting system, including by responsibility,
function, behaviour, direct/indirect.
b. Describe and illustrate the nature of variable, fixed, stepped fixed and mixed (semi-
variable) costs.
c. Describe and illustrate the classification of material and labour costs.
2. Cost units, cost centres, profit centres and investment centres
a. Explain and illustrate the concept of cost units.
 1.1 Description
Definition

Cost unit – a unit of product or service to which costs can be associated.

In cost accounting, a cost unit is a unit of a product or service to which costs can be
associated.
Different organisations use different cost units. The following are some possible cost
units for organisations:
Organisation Possible Cost Unit

Microchip manufacturer A unit of microchip

Train operator Kilometre travelled

University Full-time student

Restaurant Meal served

Bakery A loaf of bread

A cost unit is not always a single item. It might also be calculated in batches.
For example, a single cost unit might be a batch of 1,000 bricks for an organisation that
manufactures bricks.
A cost unit is linked to the product or service delivered to the customer. There is a link
between how a unit of production is costed and eventually priced.
The same organisation may also have different cost units. For example, a baker might
treat a batch of 30 loaves of bread as one cost unit and an order for a wedding cake as
another cost unit.

Key Point

An organisation may have to use different cost units to associate costs. It depends on what management wants to
examine.

Building on the previous example:

Organisation Possible Cost Unit

 A unit of Model A microchip
A unit of Model B microchip
Microchip manufacturer
(different models of output may be other cost units)

A kilometre travelled
Train operator A passenger

A full-time student
A course
A semester
University
(cost units may focus on different things)

A meal served
A table
Restaurant A customer

A loaf of bread
A wedding cake
A batch of 100 muffins
Bakery
(quantity may be in batches)

Activity 1: Cost Units

Match the business with the most appropriate cost unit

 Business Cost Unit

A laptop manufacturer A chargeable hour

A barber An operating theatre hour

An artist A laptop

A hospital A haircut

An accountant A painting

*Please use the notes feature in the toolbar to help formulate your answer.

Business Cost Unit

A laptop manufacturer A laptop

A barber A haircut

An artist A painting

A hospital An operating theatre hour

An accountant A chargeable hour

1.2 Composite Cost Units

In some situations (particularly for organisations that provide a service), it may be more
beneficial to use a composite cost unit or a cost unit comprised of two parts.
For example, the composite cost unit for a bus company might be a passenger-
kilometre (to determine the cost of carrying one passenger for one kilometre). At a
hotel, it might be a room-night (to determine the cost of providing one room for one
night).
Including two parts in the cost unit can help organisations monitor costs more
appropriately and improve cost control.
For instance, in the example of the bus company, the cost per passenger is not
particularly useful for decision-making because it will vary depending on the length of
the passenger’s journey. However, the cost of carrying one passenger for one kilometre
is not affected by the trip distance and is, therefore, more useful for monitoring and
controlling costs.
Some additional examples are:

Organisation Composite Cost Units

Airline A passenger-kilometre
Transport firm A kilogram-kilometre

Computer Centre A computer-hour

Hospital A patient-bed night

Power utility A kilowatt-hour

1.3 Cost Unit Information

Managers need to know the cost and resources required to produce cost units to make
well-informed decisions. This information can be used in several different ways.
 To determine a selling price
Managers need to know the cost of a cost unit produced to determine the selling
price required to profit.
 To decide what to produce
To determine what to produce, managers need to know how much profit each cost
unit is expected to make.
 To help with cost control
Over time, an organisation will know each cost unit's costs and production times. If
they vary from expectations (for instance, significantly higher), this will trigger an
investigation and action to bring things back on track.
 To plan and budget
 Managers need the information to help calculate a realistic budget. They need to
know how much the intended output of cost units will cost, what resources they will
need and whether the organisation can afford it.
Definition

Budget - a plan expressed in monetary or quantity terms.

There are many different types of budgets: the sales budget, the production budget, the
expenditure budget, and others.

2.1 Cost Categories

Category Description

Costs can be classified according to their related business function—for example,

production costs, sales and marketing costs, or finance costs.
Function

Costs can be classified according to the person responsible for their control. For
example, a manager might be responsible for the costs incurred at their branch.
Responsibility

Costs can be classified by their behaviour. For example, whether they increase if activity
increases (variable costs) or stay the same regardless of the activity level (fixed costs).
Behaviour

Costs can be classified by the item or activity that incurs them. For example, the costs
may relate to the work performed (labour) or the cost of items used in production
(materials).
Type

Costs can be classified by how closely they can be traced to a specific cost unit. For
example, whether it is easily traceable (direct cost) or not easily traceable (indirect cost).
Traceability
2.2 Classifying Costs

Key Point

Depending on the management's perspective, a specific cost may be classified in many ways.

It is important to note that costs can be classified using more than one category. This is
because different cost classifications look at the cost from different perspectives. For
example, fuel for a delivery van might be classified by function (as a distribution cost),
behaviour (as a variable cost) or by traceability (as an indirect cost).
Different organisations will use different cost classifications depending on how they
operate. This is a prime example of the flexibility involved in cost and management
accounting compared with financial accounting.
Activity 2: Ravi’s Quality Bakery (Cost Classification)

Revisiting Ravi’s Quality Bakery (RQB),

Determine whether the description of the cost classification is true or false.
 True or
Scenario False

Ravi classifies the cost of delivering products to local cafes as distribution costs. This is an example
of classifying costs by business function.

Ravi analyses RQB’s main production costs between the ingredients used and the wages of
employees working in the bakery. This is an example of classifying costs by responsibility.

Ravi has authorised the office manager to purchase office supplies and other products and services
required to run the office. Ravi reviews office and administration costs monthly, asking the office
manager to justify the expenditure. Ravi uses both function and responsibility to classify costs in this
situation.

*Please use the notes feature in the toolbar to help formulate your answer.

Scenario True or False

True
Ravi is grouping distribution
Ravi classifies the cost of delivering products costs together in a single
to local cafes as distribution costs. This is an classification. Distribution is an
example of classifying costs by business example of an organisational
function. function.

Ravi analyses RQB’s main production costs False

between the ingredients used and the wages Ravi classifies costs by the type
of employees working in the bakery. This is an of item they relate to (materials
example of classifying costs by responsibility. and labour).

Ravi has authorised the office manager to True

purchase office supplies and other products Ravi has grouped administration
and services required to run the office. Ravi costs (classification by function)
reviews office and administration costs and has identified these as
monthly, asking the office manager to justify costs that are controllable by
the expenditure. Ravi uses both function and the office manager
responsibility to classify costs in this situation. (classification by responsibility).
 3.1 Direct Costs

Definitions

Direct Costs – Costs that can be measured reliably and directly traced to a specific cost unit.
All other costs are indirect costs.
Prime Costs – The sum of direct costs, also known as the total direct cost.
In cost accounting, costs can be classified into direct and indirect costs depending on
whether they can be easily traced to a specific cost unit, such as the production of a unit
of product or service.
Common categories of direct costs are:

Direct materials are the materials that form part of the end product.
Direct
materials For example, the cost of flour used in bread production in Ravi’s Quality Bakery (RQB).

Direct labour is the labour involved in the production of the end product.
Direct
labour For example, the cost of the baker's wages in RQB.

Direct expenses are the expenses incurred in producing a specific cost unit.
For example, if a specialist machine had to be hired to decorate a speciality cake for a
Direct customer, the cost of machine hire would be a direct expense of the speciality cake. It can
expenses be traced directly to that specific cost unit.
The computation of prime cost is:

DIRECT MATERIALS + DIRECT LABOUR + DIRECT EXPENSES = PRIME COST

3.2 Indirect Costs

Definition

Indirect Costs – Costs that are not directly traceable to a cost unit, also known as overheads.
 Indirect costs used in production are:

Indirect materials are materials that do not form part of the end product.
For example, the cooking spray (grease) cost on each baking tray at RQB. Measuring the
Indirect quantity of cooking spray on each tray is not worthwhile because the cost is not high, so
materials the cost is not traced directly to each unit of the end product.

Indirect labour is the cost of labour required for production but is not easily traced to a
specific cost unit.
Indirect
labour For example, the cost of wages for regularly cleaning RQB's factory floor.

Indirect expenses are incurred as part of production but are not traced to a specific cost
unit.
Indirect
expenses For example, the electricity required to light the bakery and power the ovens.

Indirect costs used in production are collectively known as production overheads.

INDIRECT MATERIALS + INDIRECT LABOUR + INDIRECT EXPENSES = PRODUCTION OVERHEADS

Non-production overheads are the indirect expenses not incurred in the production
process.
For example, the office manager's wages at RQB and the cost of advertising.
To determine the total cost of producing and selling a cost unit, it will be necessary to
include these costs in the calculations.

Key Point

Non-production overheads usually include selling, distribution, and administration costs.

Activity 3: Direct and Indirect Costs

Classify the given costs to the appropriate cost category

(Place a tick in each row to the column with the appropriate cost category)
 Indirect
expenses Non-
Direct Direct Direct Indirect Indirect (production production
materials labour expenses materials labour overhead) overhead

Small amounts of
icing sugar
sprinkled on some
of the cakes.

Wages of the
factory supervisor

Vehicle rental cost

of a delivery van

Eggs

Wages of the
person who packs
the bread at the end
of the production
line

Office manager’s
wages

Business rates (a
local government
tax) bill for the
bakery

The cost of a one-

off machine set up
for a specific
customer’s order
 *Please use the notes feature in the toolbar to help formulate your answer.

Indirect
expenses Non-
Direct Direct Direct Indirect Indirect (production production
materials labour expenses materials labour overhead) overhead

Small amounts of
icing sugar
sprinkled on some
of the cakes. ✓

Wages of the
factory supervisor ✓

Vehicle rental cost

of a delivery van ✓

Eggs ✓

Wages of the
person who packs
the bread at the
end of the
production line ✓

Office manager’s
wages ✓

Business rates (a
local government
tax) bill for the
bakery ✓

The cost of a one-

off machine set up
for a specific
customer’s order ✓

Feedback
 Small amounts of icing
sugar sprinkled on some This is an indirect cost because it is not worth tracing to
of the cakes individual cost units. It is also a material.

Wages of the factory This is an indirect cost because it is not traced to

supervisor individual cost units. It is also an internal labour cost.

Vehicle rental cost of a This is not related to production, so it is a non-production

delivery van overhead.

This is a direct cost traced directly to individual cost units.

Eggs It is also a material.

Wages of the person who

packs the bread at the This is a direct cost traced directly to individual cost units.
end of the production line It is also a labour cost.

This is not related to production, so it is a non-production

Office manager’s wages overhead.

This is an indirect cost because it is not traced to

Business rates (a local individual cost units. It is also an expense related to the
government tax) bill for production activity because it would not be possible to
the bakery continue production without this expense.

The cost of a one-off This is a direct cost because it can be traced directly to a
machine set up for a particular cost unit. It is also an expense related to the
specific customer’s order production activity.

4.1 Variable Costs

Definitions

Cost Behaviour – The changes in cost according to the level of activity.

Variable Costs – Costs that change according to the level of activity
Cost behaviour is how costs react due to changes in activity level – for example, the
number of units produced.
Costs that respond to changes in activity level are known as variable costs. The costs
unaffected by changes in the level of activity are fixed costs.
 In the long term, all costs are variable because they (such as rent for the office)
inevitably change over time.

Key Point

Do not assume that all direct costs are variable costs.

A direct cost can be a fixed cost.
For example, the fixed rental fee of a specialist machine for a specific batch of products. This would be a
direct fixed cost.

Example 1: Ravi’s Quality Bakery (Variable Costs)

Ravi’s Quality Bakery (RQB) uses flour to make bread. RQB’s accountant has produced the following cost
information and graphs:
Total Cost Graph

This graph shows that the total cost of flour increases as activity increases.
 Example 1: Ravi’s Quality Bakery (Variable Costs)

This may also be expressed in a table:

Flour cost per unit ($ per

Activity Level (units) unit) Total flour cost ($)

100 0.10 10

200 0.10 20
Note that the flour cost per loaf does not change—the total cost of flour used in production changes.
For example, the cost of flour per loaf to produce 100 loaves is $0.10 (calculated as $10 / 100 loaves).
When activity increases to 200 loaves, the cost of flour per loaf remains at $0.10
(calculated as $20 / 200 loaves).
Cost per unit graph
 Example 1: Ravi’s Quality Bakery (Variable Costs)

This graph shows that the cost of flour per loaf of bread (per unit) remains the same.

Key Point

For variable costs:

 Cost per unit is usually constant within the relevant range of activity
 Total variable cost will increase as activity increases

4.2 Fixed Costs

Definition

Fixed costs – Costs that remain constant (unchanged) regardless of the level of activity

Example 2: Ravi’s Quality Bakery (Fixed Costs)

Ravi’s Quality Bakery (RQB) pays $1000 monthly for its baking premises. RQB’s accountant has produced the
following cost information and graphs:
Total cost graph
 Example 2: Ravi’s Quality Bakery (Fixed Costs)

The graph shows that the rental cost does not change within the given range of activity.
This information may also be presented in a table, with possible activity levels of units per month:

Rent cost per unit ($ per

Activity level per month (units) unit) Total rent cost ($)

1,000 1.00 1,000

2,000 0.50 1,000

Cost per unit graph
 Example 2: Ravi’s Quality Bakery (Fixed Costs)

Because the fixed cost of rent remains the same, the fixed cost per unit will decrease as more units
are produced. This is because the fixed cost of the rent is spread over more units.
The $1,000 rent per month shared out over 1,000 loaves of bread is a fixed cost of $1 per unit at this
activity level ($1,000 / 1000).
If RQB produce 2,000 loaves in a month, then the total fixed cost of rent remains at $1,000, but the
fixed cost per loaf of bread is now only $0.50 ($1,000 / 2,000)
RQB now has lower unit costs and higher profit per loaf of bread by producing more loaves while
keeping the rent cost fixed.

Key Point

For fixed costs:

Key Point

 Cost per unit will decrease as activity increases.

 Total fixed cost will remain constant regardless of activity level.
Activity 4: Fixed and Variable Costs

Determine whether the statements are correct or incorrect.

Statement Correct or Incorrect

The salary of an office manager is a fixed cost.

The wages of a delivery driver paid at an hourly rate are always a variable cost.

The cost of ingredients for a restaurant is usually variable.

*Please use the notes feature in the toolbar to help formulate your answer.

Statement Correct or Incorrect

Correct
In most organisations, the office manager is
The salary of an office paid the same amount regardless of the
manager is a fixed cost. activity level.

Incorrect
This will not always be a variable cost. It
depends on the employment arrangement.
In most cases, the driver's hourly rate is a
variable cost depending on the number of
hours worked.
The wages of a However, in some cases, the driver may be
delivery driver paid at an paid an hourly rate for a fixed number of
hourly rate are always a hours (e.g. 40 hours per week), even if fewer
variable cost. hours are worked. This would be a fixed cost.

Correct
The cost of ingredients varies depending on
The cost of ingredients the number of meals served in the restaurant
for a restaurant is usually – the total cost of ingredients increases as
variable. the level of activity increases.
 5.1 Mixed Costs
Definition

Mixed Cost - A cost with fixed and variable elements, also known as semi-variable or semi-fixed costs.

Some costs include a fixed element and a variable element. These are called mixed
costs. This means that only part of the cost is affected by activity levels.
Some examples are:
 Utilities
Some utilities like gas, electricity, and cell phone services often include a fixed
connection fee for the period and a variable charge based on usage – for example,
text messages and minutes.
 Wages
Some wage schemes may include a fixed base salary for the period and an
additional variable element linked to the output achieved.
 Machine or vehicle rental/lease
Machine or vehicle rental may include a fixed rental charge for the period and a
variable charge – for example, for each hour the machinery is in use or for each
kilometre the vehicle is driven.
Example 3: Mixed Costs

The following graph shows the total cost behaviour of a mixed cost (i.e. the variable and fixed portions
of the total cost.
Total Cost Graph
 Example 3: Mixed Costs

The total cost increases as the level of activity increases.

For example, the total cost of renting a vehicle increases as the kilometres driven increase. Note that the fixed ren
cost is still incurred even if the rented vehicle is not driven.
Consider the following example of a mixed cost:
The rental for a van for a day is $200. There is an additional fee of $1 per kilometre driven.
The table below illustrates the total cost at different activity levels (kilometres travelled in a day).

Activity level fixed cost − Total cost

(kilometres per Variable rate ($ Variable daily rental Fixed + Cost per unit ($
day) per kilometre) cost ($) ($) Variable ($) per kilometre)

0 1 0 200 200 NA

50 1 50 200 250 5
 Example 3: Mixed Costs

100 1 100 200 300 3

The following can be observed from the table:

 activity increases, cost per unit decreases.
 a zero activity level, the total cost equals fixed cost.
 activity increases, total cost increases.
Cost per unit graph

Because the total fixed cost remains the same for all activity levels, the cost per unit decreases as the activity
increases.

5.2 Stepped-Fixed Costs

 Definition

Stepped-Fixed Cost - A cost that remains fixed within an activity range. If activity increases beyond that
range, the cost will step up to another fixed level for the higher activity range.
The final type of cost behaviour is stepped-fixed costs.
Stepped-fixed costs remain fixed over a specific range of activity, but once the activity
level increases past a certain point, the cost takes a significant ‘step up’.
For example, a jeans manufacturer might have the machinery, employees and
workspace to produce 50 pairs of jeans per week. If the weekly production requirement
rises to 200 pairs, the organisation may need to invest in new machinery, hire more
employees and rent more workspace to meet this production load.
This cost behaviour, stepping up in stages, is called a step cost.

Example 4: Stepped-Fixed Costs

Total Cost Graph

Once the upper limit of an activity level is reached, a new higher level of fixed cost becomes relevant.
For example, a business hires a machine at $200 per day. This machine can produce up to 100 units per day. If m
 Example 4: Stepped-Fixed Costs

units are required, additional machines will need to be hired. At least one machine must be hired for the day.
The table below illustrates the behaviour of the machine hire cost at different activity levels:

Activity Level (units Number of machines Daily Rental Total Hire Cost per unit ($
produced) required rate ($) cost ($) per unit)

0 1 200 200 NA

50 1 200 200 4

100 1 200 200 2

150 2 200 400 2.7

200 2 200 400 2

250 3 200 600 2.4

The following may be observed from the table:

 Within a specific range (in this case, the capacity of 1 machine), the cost is fixed.
 Within this range, the cost per unit reduces
 If the activity level increase beyond this range (such as above 100 units), the fixed costs increase
to a new fixed level, which would apply to the higher range.

Key Point

The exam may require the recognition of different cost behaviours from graphs or data sets.

Summary and Quiz

 A cost unit is a unit of product or service that costs are allocated to.
 A cost unit may be a batch of products.
 Composite cost units comprise two different parts.
 The classification of costs into categories depends on what information is needed
from the management’s perspective
 Direct costs are costs that are directly traceable to specific cost units and can be
measured reliably.
 The sum of all direct costs is prime cost.
 Indirect costs are costs that are not directly traceable to cost units. Indirect
production costs are known as production overheads.
 Non-production costs include selling, distribution, and administration costs.
 Variable costs change according to the activity level.
 Fixed costs remain constant regardless of activity level.
 A mixed cost has both variable and fixed elements.
 A stepped-fixed cost is constant for an activity range; it will step up to a higher
constant for a higher activity range.
CHAPTER 5: Visual Overview

Syllabus Coverage

This chapter covers the following Learning Outcomes.

C. Cost classification and measurement

1. Cost classification and behaviour
d. Prepare and explain the nature and purpose of profit statements in absorption and
marginal costing formats.
e. Calculate the cost and profit of a product or service.
 1.1 Cost Card
Definition

Cost card – A record of the costs associated with producing and selling a single product or service.
To calculate the total cost, an organisation must first identify every part of its cost.
These cost cards are usually produced and maintained within the computerised cost
accounting system.

1.1.1 Cost Card Template

Cost Card
$

Direct materials X

Direct labour X

Direct expenses

Total direct (prime) cost X

Production overheads

Total production cost X

Non-production overheads (admin etc)

Total cost X

1.1.2 Cost Card Elements

Cost Card
Element Description

Prime cost The prime cost is useful for measuring the total cost of the main production inputs
(Total direct (direct materials, direct labour and direct expenses) needed to create an output (a
cost) unit of a product or service).
 These are the indirect costs incurred in the production process.

Production
They include indirect materials (for example, the lubricating oils for the
overheads
machinery), indirect labour (for example, the wages of supervisors) and
indirect expenses (for example, the rental cost of the factory).
These are absorbed into inventory through the overhead absorption rate.

Non-
production These are the non-production overheads incurred in making a unit of product or
overheads service ready to sell – for example, an office manager's wages.

Calculating the total cost of making and selling a single unit is essential as
many decisions depend upon the cost (and profit) of a product or service –
for example when considering an appropriate selling price.
Total cost The selling price per unit must be higher than the total cost per unit for the
organisation to make a profit.
The profit is the difference between the selling price and the total cost per
unit.

Activity 1: Ravi’s Quality Bakery (Cost Card)

Ravi’s Quality Bakery’s (RQB) best-selling product is the standard loaf, producing
10,000 units per year.
The ingredients for the standard loaf (including flour, yeast, salt and water) have a
combined cost of $0.50. Each loaf requires 2 minutes of labour, at $10 per hour.
Fixed production overheads incurred in producing the standard loaf are $1,000 per year,
while selling, administration, and distribution costs are $0.05 per loaf sold.
Complete the cost card for a unit of RQB’s standard loaf.
Standard Loaf Cost Card $

Direct materials

Direct labour

Total direct (prime) cost

Production overheads

Total production cost

 Standard Loaf Cost Card $

Non-production
overheads

Total cost

*Please use the notes feature in the toolbar to help formulate your answer.

Standard Loaf Cost Card $ Notes

Direct materials 0.50 Given

Cost of 2 minutes of labour

Direct labour
((2/60) × $10)
Sum of all direct costs
Total direct (prime) cost 0.83
($0.50 + $0.33)
Production overhead absorbed by a single unit
Production overheads
($1,000 ÷ 10,000)
Sum of all production costs
Total production cost 0.93
($0.83 + $0.10)
Non-production
overheads Given

Sum of all costs

Total cost
($0.93 + $0.05)
1.1.3 Calculating Cost of Providing a Service
Cost cards may also be used to establish the cost of providing a single service unit.
For example, a barber may use a cost card to establish the cost of providing a single
haircut.
When considering the costs of services (compared to products), the direct labour costs
(the barber’s wages) are likely to be the most substantial.
The cost of materials used (for example, hair care products) is likely to be relatively
insignificant compared to the labour cost and be classified as production overheads and
not traced to individual cost units.
A specific product purchased for a particular job (for example, if a customer requires a
specialist shampoo that is not used on other customers) would be a direct expense.

2.1 Calculating Unit Costs

 Absorption Costing Marginal Costing

Variable production costs only.

Valuation of production All production costs
(finished goods) Fixed production overheads are not
(including production overheads) included.

Treatment of fixed Absorbed into cost units

Expensed off for the period as a cost
production overheads (included in the value of finished goods) (period cost).

Relationship with the Selling price − marginal cost =

selling price Selling price − absorption cost = profit contribution.

The marginal cost of production is

the cost of making one additional
Description The total cost of production; helps set a
unit.
selling price that covers all production
costs. Useful for decision-making.

Absorption and marginal costing are two different methods of dealing with production
overheads. They produce profit figures for an accounting period that may differ from
each other.

2.1.1 Absorption costing cost card

$ per unit

Direct materials [X]

Direct labour [X]

Direct expenses [X]

Variable production overheads [X]

Fixed production cost [X]

Unit cost under absorption [X]

costing
The line “Fixed production overheads” is also known as the overhead absorption rate
(OAR)
It is the budgeted amount of fixed overheads to be absorbed by production.
 OAR = budgeted fixed production overheads / budgeted production.

2.1.2 Marginal costing cost card

$ per unit

Direct materials [X]

Direct labour [X]

Direct expenses [X]

Variable production overheads [X]

Unit cost under absorption [X]

costing
Note that the total unit cost on the marginal cost card is also the total variable
production cost.

Key Point

The total cost (value) of a unit of finished goods under absorption costing will always be higher than
marginal costing.
This is due to the fixed production overheads absorbed into the cost unit under absorption costing.
This also means inventory valuation is higher under absorption costing compared to marginal costing.

3.1 Profit Statements

A profit statement produced using the absorption costing approach will often result in a
different profit figure from a statement made using the marginal costing approach. The
statements are also presented slightly differently, with contribution emphasised in the
marginal costing statement.

3.1.1 Absorption Costing Profit Statement

Absorption Costing Profit
Statement $ $
Sales X
Opening inventory X
 Absorption Costing Profit
Statement $ $
Production (full cost) X
Less: Closing inventory
Cost of sales
Absorption costing profit
The above template assumes that actual fixed production overheads and production
volume are as budgeted.

3.1.2 Marginal Costing Profit Statement

Marginal Costing Profit
Statement $ $
Sales X
Opening inventory X
Production (marginal cost) X
Less: Closing inventory
Cost of sales
Contribution X
Fixed Overheads
Marginal Costing Profit
Definition

Contribution – Income contributed from sales to cover fixed costs after deducting variable costs.

3.1.3 Worked Example

Activity 2: The Blue Jeans Company

The Blue Jeans Company (BJC) produces 1,000 units of blue jeans per month.
On February 1, there were 80 units in the opening inventory.
Each pair of jeans requires 2 hours of labour and 2 square metres of material. Labour
costs are $10 per hour, while material costs $5 per square metre.
Fixed production overheads are $2,000 per month.
Each pair of jeans sells for $50.
February sales were 1,000 units. In March, sales were 900 units.
a) Calculate absorption costing and marginal costing profit for February and
March.
Absorption Costing Profit Statement Template

Februar
y March
Absorption Costing Profit
$
Statement $ $ $
Sales
Opening inventory
Production
Less: Closing inventory

Cost of sales

Absorption costing profit

Use an absorption costing cost card to calculate the value of a unit of blue jeans.
Marginal Costing Profit Statement Template

February March
Marginal Costing Profit
$
Statement $ $ $
Sales
Opening inventory
Production

Less: Closing inventory

Cost of sales
Contribution

Fixed Overheads

Marginal Costing Profit

Use a marginal costing cost card to calculate the value of a unit of blue jeans.
*Please use the notes feature in the toolbar to help formulate your answer.
Absorption costing cost card:
 $
Direct materials (2 × $5) 10
Direct labour (2 × $10) 20
Total direct cost 30
Fixed production overheads absorbed ($2,000 ÷
1,000) 2
Absorption cost per unit 32
Absorption costing profit statement:

February March
Absorption costing profit statement $ $ $ $
Sales
February (1,000 × $50) 50,000
March (900 × $50) 45,000
Opening inventory
February (80 × $32) 2,560
March (from February closing
inventory) 2,560
Production
(1,000 × $32) 32,000 32,000
Less: Closing inventory
February ((1,000 + 80 − 1,000) × $32) (2,560)
March ((1,000 + 80 − 900) × $32) (5,760)
(32,000
Cost of sales ) (28,800)
Absorption costing profit 18,000 16,200
Marginal costing cost card:

$
Direct materials (2 × $5) 10
Direct labour (2 × $10) 20
Marginal cost per unit 30
Marginal costing profit statement

February March
Marginal costing profit statement $ $ $ $
Sales
February (1,000 × $50) 50,000
 February March
March (900 × $50) 45,000
Opening inventory
February (80 × $30) 2,400
March (from February closing
inventory) 2,400
Production
(1,000 × $30) 30,000 30,000
Less: Closing inventory
February ((1,000 + 80 − 1,000) × $30) (2,400)
March ((1,000 + 80 − 900) × $30) (5,400)
(30,000
Variable cost of sales ) (27,000)
Contribution 20,000 18,000
Fixed overheads (2,000) (2,000)
Marginal costing profit 18,000 16,000
Feedback:
 AC and MC profit for February is the same because of no change in inventory.
 AC profit is higher in March because there is an increase in inventory, meaning more
fixed overheads are absorbed (as an asset instead of expense).

3.2 Difference Between Absorption and Marginal Costing

Profit

3.2.1 Impact of Changes in Finished Goods Inventory Level

Due to the differences in how fixed production overheads are handled in absorption
costing and marginal costing, changes in the closing quantity of finished goods would
lead to differences between absorption costing profit and marginal costing profit.
Suppose the closing quantity of finished goods is higher than the opening. In that case,
absorption costing profit will be higher than marginal costing profit, as more fixed
production overheads are absorbed into inventory (as an asset).
If the closing quantity of finished goods is lower than the opening, absorption costing
profit will be lower than marginal costing profit. This is because fixed production
overheads previously absorbed into inventory are expensed off as the cost of goods
sold.

3.2.2 Reconciling Absorption Costing and Marginal Costing Profit

 Absorption costing and marginal costing profit may be reconciled with the change in
closing inventory, multiplied by the overhead absorption rate per unit.

Marginal costing profit X

+ ([Closing inv − Opening inv] × overheads absorbed per unit) X or (X)

Absorption costing profit X

Example

Romana Inc has supplied the following information for Nov and Dec:

Februar
y March

Absorption costing profit ($)

Marginal costing profit ($)

Opening inventory (units) 900 900

Closing inventory (units) 900 1,200

The fixed production overhead absorbed per unit is calculated as $3.

b) Reconcile the absorption costing and marginal costing profit for November and December.
Absorption and Marginal costing profit reconciliation template

February March

$ $

Marginal costing profit 14,500 15,000

+ ([Closing inv − Opening inv] × overheads absorbed per

unit)

+([900 − 900] × 3) 0

+([1,200 − 900] × 3) 900

Absorption costing profit

3.2.3 Summary
 Opening vs Closing Absorption costing (AC) profit vs Marginal costing (MC)
Inventory profit

Opening = Closing AC profit = MC profit

Opening > Closing AC profit < MC profit

Opening < Closing AC profit > MC profit

3.2.4 Worked Activity

Activity 3: The Blue Jeans Company

The Blue Jeans Company (BJC) has supplied the following information for February and
March:

February March

Absorption costing profit ($) 18,000 16,200

Marginal costing profit ($) 18,000 16,000

Opening inventory (units) 80 80

Closing inventory (units) 80 180

The fixed production overhead absorbed per unit is calculated as $2.

c) Reconcile the absorption costing and marginal costing profit for February and
March.
Absorption and Marginal costing profit reconciliation template

February March

$ $

Marginal costing profit

+ ([Closing inv − Opening inv] × overheads absorbed per unit)

Absorption costing profit

*Please use the notes feature in the toolbar to help formulate your answer.
 February March

$ $

Marginal costing profit 18,000 16,000

+ (∆ Closing inventory × overheads absorbed per unit)

February ((80 − 80) × $2) NIL

March ((180 − 80) × $2)

Absorption costing profit 18,000

3.2 Difference Between Absorption and Marginal Costing

Profit

3.2.1 Impact of Changes in Finished Goods Inventory Level

Due to the differences in how fixed production overheads are handled in absorption
costing and marginal costing, changes in the closing quantity of finished goods would
lead to differences between absorption costing profit and marginal costing profit.
Suppose the closing quantity of finished goods is higher than the opening. In that case,
absorption costing profit will be higher than marginal costing profit, as more fixed
production overheads are absorbed into inventory (as an asset).
If the closing quantity of finished goods is lower than the opening, absorption costing
profit will be lower than marginal costing profit. This is because fixed production
overheads previously absorbed into inventory are expensed off as the cost of goods
sold.

3.2.2 Reconciling Absorption Costing and Marginal Costing Profit

Absorption costing and marginal costing profit may be reconciled with the change in
closing inventory, multiplied by the overhead absorption rate per unit.

Marginal costing profit X

+ ([Closing inv − Opening inv] × overheads absorbed per unit) X or (X)

Absorption costing profit X

 Example

Romana Inc has supplied the following information for Nov and Dec:

Februar
y March

Absorption costing profit ($)

Marginal costing profit ($)

Opening inventory (units) 900 900

Closing inventory (units) 900 1,200

The fixed production overhead absorbed per unit is calculated as $3.

b) Reconcile the absorption costing and marginal costing profit for November and December.
Absorption and Marginal costing profit reconciliation template

February March

$ $

Marginal costing profit 14,500 15,000

+ ([Closing inv − Opening inv] × overheads absorbed per

unit)

+([900 − 900] × 3) 0

+([1,200 − 900] × 3) 900

Absorption costing profit

3.2.3 Summary
Opening vs Closing Inventory Absorption costing (AC) profit vs Marginal costing (MC) profi

Opening = Closing AC profit = MC profit

Opening > Closing AC profit < MC profit

Opening < Closing AC profit > MC profit

3.2.4 Worked Activity
Activity 3: The Blue Jeans Company

The Blue Jeans Company (BJC) has supplied the following information for February and
March:

February March

Absorption costing profit ($) 18,000 16,200

Marginal costing profit ($) 18,000 16,000

Opening inventory (units) 80 80

Closing inventory (units) 80 180

The fixed production overhead absorbed per unit is calculated as $2.

c) Reconcile the absorption costing and marginal costing profit for February and
March.
Absorption and Marginal costing profit reconciliation template

February March

$ $

Marginal costing profit

+ ([Closing inv − Opening inv] × overheads absorbed per unit)

Absorption costing profit

*Please use the notes feature in the toolbar to help formulate your answer.

February March

$ $

Marginal costing profit 18,000 16,000

+ (∆ Closing inventory × overheads absorbed per unit)

February ((80 − 80) × $2) NIL

March ((180 − 80) × $2)

Absorption costing profit 18,000

 4.1 Advantages

Advantages of absorption costing Advantages of marginal costing

 The inventory value complies with the relevant

accounting standards for external financial
reporting.
 Considers all costs, providing a better  Highlights contribution, which helps
understanding of the whole picture. management focus on a decision’s short-term
 More appropriate when considering long-term financial impact.
decisions because it considers long-term fixed  Focuses on the immediate and direct impact of
costs. an action or decision.
For example, the company may need to move  More appropriate for short-term decision-
offices if a factory is not profitable over the long making because it focuses on the costs likely
term because of high fixed costs such as rent. to change in the short term due to the decision.

4.2 Disadvantages

Disadvantages of absorption costing Disadvantages of marginal costing

 The inventory value produced is

unsuitable for financial accounting (as it
does not comply with the relevant
 Overemphasises the importance of costs that do not accounting standards).
change regardless of the course of action, which may  By ignoring fixed costs, decisions' long-
lead to inappropriate decisions, especially in the short term impact and broader implications are
term. not considered.
 4.3 Practice

Activity 4; Characteristics of Absorption and Marginal Costing

Classify the statements as relating to absorption costing (AC) or marginal costing

(MC).

Statement AC or MC

Fixed costs are charged against the profit of the period in which they are incurred.

Closing inventory value includes a share of fixed production costs.

Considered more appropriate for short-term decision making

Produces an inventory valuation suitable for use in the external financial accounts

Results in the higher inventory valuation of the two methods

Results in a higher profit figure for the period when inventory volumes decrease

Focuses on the importance of contribution to fixed overhead and profit

*Please use the notes feature in the toolbar to help formulate your answer.

AC or
Statement MC

Fixed costs are charged against the profit of the period in which they are incurred. MC

Closing inventory value includes a share of fixed production costs AC

Considered more appropriate for short-term decision making MC

Produces an inventory valuation suitable for use in the external financial accounts AC

Results in the higher inventory valuation of the two methods AC

Results in a higher profit figure for the period when inventory volumes decrease MC

Focuses on the importance of contribution to fixed overhead and profit MC

Summary and Quiz

 A cost card records the costs of producing and selling a single product or service.
 Absorption costing values inventory (finished goods) at total production costs,
including fixed production overheads absorbed into the cost units.
 Marginal costing values inventory at variable production costs only. Fixed costs are
expensed for the period.
 Contribution is income from sales to cover fixed costs after deducting variable costs.
 The inventory value under absorption costing will always be higher than marginal
costing.
 The difference between absorption costing and marginal costing profit is the change
in inventory multiplied by fixed production overheads absorbed per unit.
 Absorption costing is suitable for long-term decision-making and financial reporting.
 Marginal costing is suitable for short-term decision-making.

CHAPTER 6: Visual Overview

Syllabus Coverage

This chapter covers the following Learning Outcomes.

C. Cost classification and measurement

2. Cost units, cost centres, profit centres and investment centres
b. Explain and illustrate the concept of cost centres.
c. Explain and illustrate the concept of profit centres.
d. Explain and illustrate the concept of investment centres.
1.1 Responsibility Accounting

Definitions

Responsibility accounting – Accounting method for costs according to the manager responsible for
those costs.
Responsibility centre - An activity or area of responsibility in an organisation a manager is responsib
for and has control over.
Controllable cost – A cost that is within the control of a manager.
Uncontrollable cost – A cost that is beyond the control of a manager.
Each manager’s responsibility centre needs to be identified to evaluate the manager’s
performance.
When evaluating the performance of a responsibility centre and the person (or people)
responsible for it (such as a manager), a distinction should be made between
controllable and uncontrollable costs.
The principle of responsibility accounting is that managers should only be judged or
held accountable for costs they can influence or control.
For example, rental costs for the whole factory may be shared across multiple
responsibility centres (such as production or logistics) and are outside the control of the
 managers of those responsibility centres. It should not be considered when judging the
performance of those managers.
Information provided to the responsibility centre manager and those judging his
performance should distinguish between controllable and uncontrollable costs.

2.1 Cost Centres

Definition

Cost centre – An activity or area of responsibility in an organisation that generates costs but is not responsible for
generating revenue or producing direct profit.

A cost centre only incurs costs, which must be collected and analysed.
Examples of cost centres:

Item Description

Many organisations treat functions (or departments) as cost centres – i.e.

Function production, information technology, human resources and finance.
 An activity within an organisation can be treated as a cost centre – for example,
Activity the storekeeping activity.

Project Projects may also be cost centres – for example, developing a new product.

A person might be a cost centre – for example, a finance director. Costs might
Person include the director's salary or the running costs of their company car.

A process can be treated as a cost centre – for example, the finishing process
Process in a bespoke furniture manufacturer.

Production or service locations may also be treated as cost centres – for

Production or example, the mixing department in the factory of a food manufacturer
service location (production location) or head office (service location).

A specific item or group of equipment or machinery can be treated as a cost

equipment or centre – for example, the paint spraying machine in the factory of a car
machinery manufacturer.

2.2 Cost Centres and Cost Units

A cost centre is responsible for accumulating costs, whereas a cost unit is a unit of
production that costs are calculated for.

Activity 1: Ravi’s Quality Bakery (Cost Centres)

Indicate whether the following elements of Ravi’s Quality Bakery (RQB) are cost
centres or not.
Mark “Yes” if the element is a cost centre; Mark “No” if it is not.

Element Cost centre?

Yes or No

The baking department

The sales function, including the RQB shop

The delivery department

Finance and administration

*Please use the notes feature in the toolbar to help formulate your answer.

Element Cost centre?

 Yes or No

Yes
The baking department is a cost centre at RQB. The baking
The baking department incurs costs but is not responsible for revenue. Although
department the baking department produces the products that will be sold, selling
RQB products is not their responsibility.

The sales function,

including the RQB No
shop At RQB, the sales function is responsible for maximising sales of RQB
products and, therefore, generating revenue. It is not a cost centre.

Yes
If RQB provides its delivery service free of charge, there is no revenue
The delivery associated with the delivery department, so it is a cost centre.
department However, if RQB charges a fee for delivery and revenue is earned this
way, then RQB's delivery service is not a cost centre.

Yes
Finance and The finance and administration function is a cost centre. The finance
administration and administration function incurs costs but is not responsible for
revenue.

2.3 Impact of Cost Centres

Cost centres accumulate costs but have no income or revenue attributed to them. This
can result in cost centres being:
 Perceived negatively and viewed as hurting profit while failing to contribute to the
value of an organisation
 Targeted for cutbacks and redundancies when an organisation is under pressure to
reduce costs.
Cost centre managers often find it difficult to justify expansion – for example, the need
to invest in additional employees, training or equipment. The emphasis on costs makes
it difficult to demonstrate the positive impact these investments may bring.
Despite these difficulties, cost centres can positively impact an organisation. Although
cost centres do not earn income, they help the organisation earn income.
For example, there would be no products to sell without the production function, and
without the human resources function, employees would not be as well equipped to
perform well.
 2.4 Coding Costs to Cost Centres

Cost centres play an essential role in an organisation by providing the basis to track
expenditure.
Each cost centre will have a unique code (usually a combination of numbers and
letters) to help identify, process, and allocate cost transactions to the correct cost
centre. This allows an organisation to measure, budget and control costs for each cost
centre in an organisation.
Some transactions and expenditures are relatively easy to identify with a specific cost
centre.
For example, salary payments for the human resources team staff can be allocated to
the human resources department.
Some costs need to be shared across more than one cost centre, such as the utility bills
for heating and lighting. Therefore, correct coding is required to ensure that cost is
spread correctly across the relevant cost centres.
Activity 2: Ravi’s Quality Bakery (Cost Codes)

The baking department of Ravi’s Quality Bakery (RQB) is a cost centre with a cost code
of BA.
All costs directly attributable to RQB’s baking department should be marked with its cost
code.
Costs that are shared would be marked with the shared cost code SH.
Indicate whether Ravi’s Quality Bakery (RQB) cost elements are directly
attributable to the baking department or shared.
Mark “BA” if the element is directly attributable to the baking department; Mark “SH” if it
is shared.

Element BA or SH

Salaries of the employees in the baking department

Electricity charges

The purchase cost of new bakery overalls

Purchases of flour and other ingredients

Rental for the RQB premises

*Please use the notes feature in the toolbar to help formulate your answer.

Element BA or SH

Salaries of the employees in the baking department BA

Electricity charges SH

The purchase cost of new bakery overalls BA

Purchases of flour and other ingredients BA

Rental for the RQB premises SH

3.1 Profit Centres

Definition

Profit centre – An activity or area of responsibility in an organisation to which costs and revenue can
be attributed.

Identifying profit centres allows profitability to be measured as a product of costs and

revenues, which is impossible for a cost centre.
Examples of profit centres might include an individual health club in a chain of clubs
owned by a company, a salesperson, or a restaurant in a large hotel.
 Like cost centre managers, profit centre managers are accountable for the costs under
their control. However, they are also responsible for the sales revenue earned by their
centre and thus for the profits of the areas they manage.
The profit centre manager should have control (or, at the very least, influence) over the
centre’s revenue and costs.
Some key features of profit centres are:

In the hierarchy of an organisation, profit centres generally sit higher than cost
Organisational centres, and there are often several cost centres within a profit centre.
hierarchy Some profit centres also consist of individual members of staff – for example, a
sales representative whose generated income can be traced.

Profit centres tend to cover a significant area of operations.

The seniority of profit

For example, a profit centre might cover an entire division of an organisation.
centre managers Profit centre managers are expected to generate income and control or minimise
the costs incurred. The role is broad and demanding and attracts a high level of
seniority.

Profit centres can generate revenue externally or internally (by selling to other
External and internal parts of the organisation).
revenue It is not essential where the source of revenue originates as long as it is recorded
and the profit is measurable and controllable.

It is possible for a cost centre to become a profit centre – for example, if a

delivery driver becomes a general courier service used by other organisations or
From cost centre to if an internal service function starts charging for the services it provides.
profit centre For instance, if the information technology function generates an internal revenue
by charging other functions for the work carried out, it would become a profit
centre.

Activity 3: Cost and Profit Centres

Classify the elements as either a cost centre or a profit centre.

Element Cost centre or profit centre
 The research and development function

A hand car wash service

A ‘factory shop’ attached to the factory selling directly to the public.

A local branch of a cell phone retail organisation

The finance function

*Please use the notes feature in the toolbar to help formulate your answer.

Element Cost centre or profit centre

The research and development function Cost centre

A hand car wash service Profit centre

A ‘factory shop’ attached to the factory selling directly to the public Profit centre

A local branch of a cell phone retail organisation Profit centre

The finance function Cost centre

4.1 Investment Centres

Definition

Investment centre – An activity or area of responsibility in an organisation to which costs and revenue can be
attributed and capital deployment.
 The distinguishing feature of an investment centre is that its manager is also
responsible for making investment decisions regarding the assets available for use
(asset investment), such as the purchase and sale of non-current (long-term) assets.

Definition

Business unit – A particular activity or area of responsibility in an organisation that has a degree of autonomy in
deciding plans and processes for generating profits.

Therefore, an investment centre is a business unit controlling costs, revenue, and

capital investment.

Cost centre Profit centre Investment centre

Generates costs ☑ ☑ ☑

Generates revenue ☑ ☑

Non-current asset procurement ☑

A business unit might be an internal function in an organisation or a subsidiary company

with its separate legal identity and ownership structure.

5.1 Responsibility Centre Structure

Activity 4: Responsibility Centres

Classify each statement to the responsibility centre it most applies to.

Statements may apply to more than one responsibility centre.

Cost centre, profit centre, or

Statement investment centre

The manager has responsibility for both costs and sales.

The manager has the authority to make capital

expenditure decisions.

The manager is not responsible for revenue.

The responsibility centre does not generate any revenue.

The responsibility centre provides a basis for control at a

very senior level.

The responsibility centre generally the lowest within the

organisational hierarchy.

*Please use the notes feature in the toolbar to help formulate your answer.
 Cost centre, profit centre, or
Statement investment centre

The manager has responsibility for both costs and sales Profit centre
Investment centre

The manager has the authority to make capital expenditure

decisions. Investment centre

The manager is not responsible for revenue Cost centre

The responsibility centre does not generate any revenue. Cost centre

The responsibility centre provides a basis for control at a

very senior level. Investment centre

The responsibility centre generally the lowest within the

organisational hierarchy. Cost centre

Summary and Quiz

 Responsibility accounting is a method of accounting for costs according to the
manager responsible for those costs.
 A cost centre is an activity or area of responsibility in an organisation that generates
costs but is not responsible for generating revenue or producing direct profit.
 A profit centre is an organisation's activity or area of responsibility to which costs and
revenue can be attributed.
 An investment centre is an organisation’s activity or area of responsibility to which
capital deployment, costs and revenue can be attributed.