CIMA P1

MANAGEMENT ACCOUNTING
COMPLETE SUBJECT NOTES
BY VERTEX LEARNING SOLUTIONS
2023
 TABLE OF CONTENTS

CHAPTER TOPIC PAGE NO.

1 Costing 2

2 Full Cost Techniques 17

3 Marginal Costing Techniques 32

4 Rationale for Budget 49

5 Budgeting Concepts 63

6 Short-Term Decision Making 87

7 Models of Decision Making 104

8 Limiting Factor Analysis 121

9 Risk and Uncertainty in Decision Making 139

10 Budgetary Control 160

11 Standard Costing and Variance Analysis 165

12 Further Variance Analysis 188

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Chapter 1 - Costing

Introduction

Businesses incur many different types of cost every day. Management

accounting helps us to understand the cost behavior, structure and cost drivers,
as well as how to classify them.

Cost information is used for many purposes to support business operations and
objectives, including inventory valuation, profit reporting and decision making.
We also have to determine how to apply costing concepts to different
organizations including potential difficulties of costing digital products as
compared with traditional products.

Internal Reporting Information

The accounting function of a business deals with providing information for both
management and financial accounting purposes. However, the type, timing and
format of the information differs.

Financial Accounting (Recording and Reporting Historical Data): It is mainly

concerned with collection and classification of historical data for the users outside
the business such as shareholders and investors in form of financial statements.

Management Accounting (Informing Strategy and Helping in realizing its

Objectives): It is all about providing information to the management of an
organization that it needs for planning, control and decision making.

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Financial Accounting Vs Management Accounting

Financial Accounting Management Accounting

Financial accounts detail the Management accounts are used to
performance of the organization over aid management record, plan and
a defined period and the state of control the organization’s activities
affairs at the end of the period. and to help in decision making
process.
Limited liability companies must, by There is no legal requirement to
law, prepare financial accounts. prepare management account
The format of published financial The format is entirely at management’s
statements is determined by local law, discretion i.e., no rules to govern the
by IAS and by IFRS. In principle the way they are prepared.
accounts of different organizations
can therefore be easily compared.
Financial accounts concentrate on Management accounts can focus on
business as a whole, aggregating specific areas of organization’s
revenues and costs from operations activities. Information may be
and are an end in themselves. produced to aid a decision rather than
to be the result of a decision
Most financial accounting information Management accounts incorporate
is of monetary nature. non-monetary measures like tons of
aluminum produced, monthly
machine hours, etc.
Financial accounts present an Management accounts are both an
essentially historic picture of past historic record and a future planning
operations tool

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Management Accounting:

Purpose of management information is to assist management in running the

business to achieve overall objective. It can be broken down into:

▪ Planning
▪ Control
▪ Decision Making

The information must be provided regularly and on timely basis, particularly for
control and can be one-off reports or information for decision making to support
tactical business decisions.

It should be noted that management accounting is forward looking hence

heavily relies on guesses and approximations to deal with future uncertainties.

Planning

It involves defining objectives and assessing future costs and revenues to set up a
budget. It is essential to help assess the purchasing/production requirements of
the business.

Control

Managers must evaluate performance to ensure that plans were executed as

intended so that they can identify and address any inefficiencies in the business
operations.

Decision Making

Decisions like which products to be produced, how many units should be

produced, what the selling price should be, are to be taken by the management.

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Strategic, Tactical and Operational Planning

R.N. Anthony suggested that management activities are of three types:

a) Strategic Planning: The process of deciding on objective of the organization,

on changes in these objectives, on resources used to attain these objectives
and in policies that are to govern the acquisition, use and disposition of these
resources.
b) Tactical Control: The process by which manages assure that resources are
obtained and used effectively and efficiently in the accomplishment of
organization’s objectives.
c) Operational Control: The process of assuring that specific tasks are carried out
effectively and efficiently.

Costing Definitions

▪ Cost Object: Anything for which cost data is desired, such as products,
product lines, jobs, customers, etc.
▪ Cost Unit: A unit of a product or a service to which costs can be attached
like table, batch of 200 loaves of bread, etc.
▪ Prime Cost: The total of direct costs.
▪ Direct Costs: Cost that are directly attributable to a particular unit of
production or service provided.
▪ Indirect Cost: Cost that are not directly attributable to a particular unit of
production or service provided.
▪ Production costs: The total of all manufacturing costs.
▪ Cost Card: A document which groups the costs of a product or service in
order to arrive at a total cost.

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• Cost Centers: A location, function or item of equipment in respect of which
costs may be ascertained and related to cost units for control purposes.
Each cost center acts as a ‘collecting place’ for certain costs before they
are analyzed further.

The two types of cost centers are:

Production Cost Center: Factory cost centers through which units of
production actually flow.
Service Cost Center: These support or service the production cost centers.

Note:

Cost centers may be set up in any way business thinks is appropriate.

Moreover, usually manufacturing costs are considered (Hence we will
focus on factory cost centers)

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Cost Classification

Cost classification is the grouping of costs under common characteristics.

Examples include direct or indirect costs and fixed or variable costs.

Direct and Indirect Cost Elements

▪ Materials
▪ Labor
▪ Expenses

Each category is further sub-divided into:

▪ Direct costs
▪ Indirect costs

Note:

Prime Cost = Direct Materials + Direct Labor + Direct Expenses

Overheads = Indirect Material + Indirect Labor + Indirect Expenses

Classification by Function

▪ Production costs (Material, Labor, expense)

▪ Administration Costs (Staff salary, legal fees)
▪ Selling and distribution costs (advertisement, distribution costs)
▪ Research costs
▪ Finance Cost (interest, dividends)

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Classification by Behavior

Costs can also be classified by their behavior, that is, how the total cost is affected
by a change in output or activity level (i.e., the number of units produced). Costs
behave in different ways when the levels of activity in the organization change.
The main classifications are:

▪ Fixed costs
▪ Variable costs
▪ Stepped costs
▪ Semi ‑variable costs

Fixed Costs:

Fixed costs are not affected by changes in production level. They remain the
same in total whether no units or many units are produced. They are incurred in
relation to a period of time rather than production level and are often referred to
as period costs.

Examples:

▪ Supervisor’s salary
▪ Factory rent
▪ Straight-line depreciation of plant and machinery

A graph of fixed costs against output level would produce a horizontal line

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In reality, fixed costs are only truly fixed over the relevant range. For example, the
rent of the factory will only remain constant provided that the level of activity is
within the production capacity of the factory. As the activity level increases, the
fixed cost remains fixed in total, but the fixed cost per unit will fall as the total cost
is split over more units.

Variable Costs:

Variable costs are costs that vary directly in line with changes in the level of
activity. Direct materials are often viewed as variable costs. The total variable cost
can be expressed as:

Total variable cost = Variable cost per unit × Number of units

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Stepped Costs (sometimes called Step-Fixed Costs)

Stepped costs are costs that are fixed over a relatively small range of activity
levels, but then increase in steps when certain levels of activity are reached. For
example, if one production supervisor is required for each 30,000 units of a
product that is made, then three supervisors are required for the production of
90,000 units, four for the production of 120,000 units etc. Stepped fixed cost is fixed
for a relatively shorter term.

Semi-Variable Costs

Semi-variable costs are costs that have a fixed element, and also a variable
element. For example, the telephone bill includes a fixed element being the fixed

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line rental for the period, and a variable element that will increase as the number
of calls increases.

The total of a semi-variable cost can be expressed as:

Total cost = Fixed element + (Variable cost per unit × Number of units)

The High/Low Method Used for Separating a Semi-Variable Cost

Total costs = Total fixed costs + (Variable cost per unit × Activity level)

Step 1

Select the highest and lowest activity levels, and their associated costs.

Step 2

Calculate the variable cost (VC) per unit:

VC per unit=
Cost at high level of activity – cost at low level of activity/
High level of activity – low level of activity

Step 3

Calculate the fixed cost by substitution, using either the high or low activity level.
Fixed cost = Total cost at activity level – (Variable cost × Activity level)

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Step 4

Use the total fixed cost and the variable cost per unit values from steps 2 and 3 to
calculate the estimated cost at different activity levels.
Total costs = Total fixed costs + (Variable cost per unit × Activity level)

Costing Applied to Different Organization Types

Manufacturing:

In manufacturing organizations, products are usually the cost objects. This makes
the directly attributable costs easy to identify. The manufacturing overhead will
include all of the other costs associated with running the factory, including rent,
depreciation of machinery and indirect production labor.

Service Costing:

Unlike manufacturing, it can be difficult to define a cost object for service

industries, which makes standard costing systems harder to use. This is because
there is no tangible output. Also, the perishable nature of services means that
there may be fluctuations in the cost depending on the availability of labor (for
example, a premium is paid to weekend waiting staff). The characteristics of
service industries which make costing harder are:

▪ Simultaneous production and consumption

▪ Heterogeneity of services
▪ Intangibility of services
▪ Perishable nature of services

Job Costing:

This is used when each output of product or service is unique or customized for
e.g., Construction projects. This creates the need to cost each job separately.

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Process Costing:

This is used when multiple items are produced simultaneously and are not
separately identifiable until the end of production process for e.g., oil refining. An
average cost per unit is used here.

Digital Cost Objects:

The explosion in the number of new digital products and services being created
has created unique issues for the cost accountant. These include:

High Fixed Costs: Digital products and services require considerable levels of
research and development. The industry is so volatile that much of this research
may need to be written off. For example, Virtual Reality as a technology has been
around for many decades – the first VR headset was launched in 1960! However,
the technology was unable to find a suitable market, so the developers had to
keep returning to the drawing board.

Low Variable Costs: The variable cost of providing a digital product or service can
be unmeasurably small. For example, once a song has been written and
uploaded to an online library, the cost of a customer downloading that song is
irrelevant.

Ongoing Development Costs: The digital software market evolves very rapidly,
with updates, upgrades and new software being released daily. Software that is
cutting-edge today is likely to require continual investment or it is likely to become
obsolete very quickly.

Security and Compliance Costs: Software is continually targeted by hackers who

seek to obtain personal or financial information for illegal benefit. Ongoing
investment is therefore required to ensure that the software has adequate
protection from the latest hackers and viruses. Furthermore, most software

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accesses personal data in some form, so software providers must ensure that they
adhere to data protection regulations.

Evolving Revenue Streams: Traditionally, digital products were purchased in one-

off transactions. In return for a one-off payment, the customer received a floppy
disk, CD-ROM or, more recently, a download code. This product could be used
indefinitely. However, many high profile digital product and service providers
have changed the revenue structure. Customers are now encouraged (or
compelled) to purchase an ongoing subscription to the product. In return for a
regular monthly or annual payment, the customer receives access to the software
(often cloud-based), including any upgrades to improve functionality or rectify
bugs.

These factors can cause challenges when it comes to determining the correct
accounting treatment for digital costs. For example, the accountant may have
to decide when and where these costs should be recognized in the accounts.

Cost Transformation and Management

‘The CGMA Cost Transformation Model is designed to help businesses to achieve

and maintain cost competitiveness. It serves as a practical and logical planning
and control framework for transforming and managing a business’ cost-
competitiveness.’ (CGMA, 2016)

Framework:

1. ‘Engendering a cost-conscious culture’

i. Continuous process of cost consciousness.
ii. Employees should be motivated to consider costs in daily duties.

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2. ‘Managing the risks inherent in driving cost-competitiveness’
i. Understand and manage risks that could prevent a business achieving
its cost transformation and management objectives.

3. ‘Connecting products with profitability’

i. Understand how their products and services create value for customers
to avoid losing customers, or having to accept a lower price.
ii. Understanding product value means the product portfolio can be
tailored.

4. ‘Generating maximum value through new products’

i. Design products for flexibility, so that features can be added or
eliminated as appropriate to appeal to new markets.
ii. Extra value should translate to a ‘willingness to pay’
iii. 80% of a product’s cost is determined before production commences
management accountants should be involved in the design process to
drive down costs and drive-up customer value

5. ‘Incorporating sustainability to optimize profits’

i. Avoiding unnecessary costs will increase profit, for example, reducing
machining steps could reduce material waste, power consumption
and tool wear.
ii. Include the cost of sustainability initiatives in product costs.

6. ‘Understanding cost drivers: Cost accounting systems and processes’

i. Reducing costs whilst simultaneously preserving or enhancing
customer value requires the right information.
ii. Regularly review cost systems to ensure the output supports the needs
of decision makers.
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This model seeks to assist business when implementing cost reduction exercises by
providing a framework, which can act as a useful starting place, however, the
framework will not work for all organizations. In fact, it may be too rigid for some
organizations which means that time will be spent considering things that are not
necessary.

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