Prime = DM + DL
Conversion = DL + MOH
Relevant Costs: Those costs that will be affected by a decision may be
referred to as relevant costs, while others are non-relevant and should be
ignored in the analysis.
Zero-based budgeting: ZBB requires each cost element to be specifically
justified, as if the activities to which the budget relates were being
undertaken for the first time. The budget is kept zero unless justified and
approved.
Responsibility centre: a part, segment, or a subunit of an organisation
whose manager is accountable for a specified set of activities. Cost centre
(responsible for costs of the sub-unit only e.g. a bank’s back office
departments) – Revenue centre (responsible for revenues only e.g. hotel
restaurant; pharmacy of a hospital) – Profit centre (responsible for costs
and revenues e.g. sales department with sales staff salaries) – Investment
centre (responsible for all of the above and to make capital expenditure;
therefore responsible for assets also)
Transfer price: the price one sub-unit charges for a product or service
supplied to another sub- unit of the same organisation
Creates revenues for the selling sub-units and purchase costs for the
buying sub-unit, affecting each of the two sub-units’ operating profit.
Opportunity cost implicaitons. Align activities of divisional managers
objectives with the overall strategy and objectives of the organisation.
Balanced Scorecard: Integrates financial and non-financial measures. 4
aspects of performance: customer, internal (what processes must we
excel at to achieve our financial and customer objectives), innovation and
learning, financial.
Capital rationing: a company has a limited amount of capital to invest in
potential projects, such that the different possible investments need to be
compared with one another in order to allocate the capital available most
effectively.
ROI = pre-tax profit/net assets x 100
Residual Income = Income – required rate of return x investment
EVA = NOPAT – (WACC (weighted average cost of capital) × Net assets)
ARR = Accounting Profit (e.g. Cash flow – Depreciation charge)/Initial
Investment x 100
, Absorption Costing
Advantages
- Improved managerial awareness of total costs sustained by cost
centres; can be helpful for product mix
- Selling prices can be established to cover full product cost
- Must be use for external reporting
Disadvantages:
- Costs are absorbed based on budgeted overhead absorption rate
under/over absorption adjustment
- If production > sales, absorption costing will post higher profits; if
production < sales absorption will post lower profits
- In the long term total reported profit will be the same
- Full costing enables manager to increase operating profits in a
specific period by increasing production schedule. (even if customer
demand is zero undesirable stock build up)
Marginal Costing
Advantage
- Management attention concentrated on the more controllable
measure of contribution. Argued by proponenets of marginal costing
that apportionment of fixed production overheads to individual units
is carried out on a purely arbitraty basis. Not useful for decision
making
- Easy to use and operating
- Hard for managers to gamify
Disadvantage
- Elimnatin of fixed costs renders cost comparison of jobs difficult
especially because cannot calculate exact cost of one unit
- Very difficul to determine degree of variability in semi-variable costs
- Have to use absorption for external
CVP Analysis
Conversion = DL + MOH
Relevant Costs: Those costs that will be affected by a decision may be
referred to as relevant costs, while others are non-relevant and should be
ignored in the analysis.
Zero-based budgeting: ZBB requires each cost element to be specifically
justified, as if the activities to which the budget relates were being
undertaken for the first time. The budget is kept zero unless justified and
approved.
Responsibility centre: a part, segment, or a subunit of an organisation
whose manager is accountable for a specified set of activities. Cost centre
(responsible for costs of the sub-unit only e.g. a bank’s back office
departments) – Revenue centre (responsible for revenues only e.g. hotel
restaurant; pharmacy of a hospital) – Profit centre (responsible for costs
and revenues e.g. sales department with sales staff salaries) – Investment
centre (responsible for all of the above and to make capital expenditure;
therefore responsible for assets also)
Transfer price: the price one sub-unit charges for a product or service
supplied to another sub- unit of the same organisation
Creates revenues for the selling sub-units and purchase costs for the
buying sub-unit, affecting each of the two sub-units’ operating profit.
Opportunity cost implicaitons. Align activities of divisional managers
objectives with the overall strategy and objectives of the organisation.
Balanced Scorecard: Integrates financial and non-financial measures. 4
aspects of performance: customer, internal (what processes must we
excel at to achieve our financial and customer objectives), innovation and
learning, financial.
Capital rationing: a company has a limited amount of capital to invest in
potential projects, such that the different possible investments need to be
compared with one another in order to allocate the capital available most
effectively.
ROI = pre-tax profit/net assets x 100
Residual Income = Income – required rate of return x investment
EVA = NOPAT – (WACC (weighted average cost of capital) × Net assets)
ARR = Accounting Profit (e.g. Cash flow – Depreciation charge)/Initial
Investment x 100
, Absorption Costing
Advantages
- Improved managerial awareness of total costs sustained by cost
centres; can be helpful for product mix
- Selling prices can be established to cover full product cost
- Must be use for external reporting
Disadvantages:
- Costs are absorbed based on budgeted overhead absorption rate
under/over absorption adjustment
- If production > sales, absorption costing will post higher profits; if
production < sales absorption will post lower profits
- In the long term total reported profit will be the same
- Full costing enables manager to increase operating profits in a
specific period by increasing production schedule. (even if customer
demand is zero undesirable stock build up)
Marginal Costing
Advantage
- Management attention concentrated on the more controllable
measure of contribution. Argued by proponenets of marginal costing
that apportionment of fixed production overheads to individual units
is carried out on a purely arbitraty basis. Not useful for decision
making
- Easy to use and operating
- Hard for managers to gamify
Disadvantage
- Elimnatin of fixed costs renders cost comparison of jobs difficult
especially because cannot calculate exact cost of one unit
- Very difficul to determine degree of variability in semi-variable costs
- Have to use absorption for external
CVP Analysis
