Essex Business School

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Essex Business School AC303 -AUTUMN
2008/09 ADVANCED MANAGEMENT ACCOUNTING Dr.
Owolabi M. Bakre
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Introduction to AC303

• AC303 Course Organization
• Course Booklet -Reading List
• Textbooks Articles
• Lecture/Workshop
• Classes
• Course Website
• Assessment
• Office Hours
• Todays Topic
• Cost Estimation and Behaviour I

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Course Booklet -Reading List

• Course Website
• http//courses.essex.ac.uk/ac/ac303
• ??Library Website
• https//courses.essex.ac.uk/readinglists/AC/AC303-
  07.htm
• Jo Lambert(3rd Year Administrator)
• Room 5NW.5.18
• jlambert_at_essex.ac.uk
• ??Tel [phone]

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Textbooks Articles

• Main texts (Required book purchase)
• Drury, C. (2004) Management and Cost Accounting
  6th Edition, London Thompson Business Press. (a
  supporting website for students
  www.drury-online.com)
• Seal, W., Garrison, R., Noreen, E. (2006)
  Management Accounting 2nd Edition, McGraw-Hill.
  (a supporting website for students
  www.mcgraw-hill.co.uk)
• Supplementary Textbooks
• See Course Booklet -Reading List
• Articles
• See Course Booklet -Reading List

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Lecture/Workshop

• Lecture/Workshop Weekly
• Tuesdays 900-1100 am
• From week (2) to week (11)
• Week (30) Revision Lecture
• Lecture/Workshop Programme
• See Course Booklet -Reading List

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Classes

• Classes (fortnightly)
• Starting from week (3)
• see the timetable on the web http//www2.essex.a
  c.uk/academic/offices/tt/dept-tts/AC.xls
• ??Class Teachers see Course Booklet
• ??Class Programme
• ??See Course Booklet -Reading List

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Course Website

• Course Materials will be posted to CMR (Course
  Materials Repository)
• Lecture/Workshop (on Tuesdays afternoon)
• Classes (on Fridays afternoon by the end of
  every two weeks)
• http//courses.essex.ac.uk/ac/ac303/

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Course Assessment

• The course will be assessed by
• A coursework (30 weighting)
• Available to you in WK7 (Jo Lambert)
• Deadline Thurs 11 December before 4pm (Jo
  Lambert)
• A final two-hour examination (70 weighting)

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Office Hours

• Owolabi Bakre
• Mondays (1000 am 11 am)
• Thursdays (13 pm 15pm)
• Room 5NW.4.3
• E-mail obakre
• Lynne Conrad
• Office Hours (TBA)
• Room 5NW.6.11
• E- mail Iconrad
• Kelum Jayasinghe
• Office Hours (TBA)
• Room 5NW.4.6
• E-mail knjay

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Todays Topic
Cost Estimation and Behaviour I
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Introduction

• Determining how cost will change with output or
  other measurable factors of activity is of vital
  importance for planning, controlling and
  decision-making activities.
• Most of planning, control and decision-making
  activities of management (e.g. the preparation of
  budgets, the production of performance reports,
  and the provision of relevant costs for pricing
  and other decisions) depend on reliable estimates
  of costs and distinguishing between fixed and
  variable costs, at different activity levels.

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Types of Cost behaviour Patterns
Recall the summary of cost behaviour discussion
from AC202.
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Types of Cost behaviour Patterns (cont.)
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Types of Cost behaviour Patterns (cont.)
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semi-variable costs (Mixed Costs)
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Mixed Costs
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Mixed Costs
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Mixed Costs
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The Analysis of Mixed Costs and Cost Estimation
Methods
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Account Analysis

• In the account analysis or the inspection of
  accounts method, the departmental manager and the
  accountant examine each item of expense for a
  particular period and then classify it as a
  wholly fixed, wholly variable or a semi-variable
  cost.
• A single average unit cost figure is selected for
  the items that are categorized as variable,
  whereas a single total cost for the period is
  used for the items that are categorized as fixed.
  
• For semi-variable items, the departmental manager
  and the accountant agree on a cost function that
  appears to best describe the cost behaviour.

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Account Analysis (continue)
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Account Analysis drawbacks

• This method is very subjective (involves
  individual and arbitrary judgements). Therefore,
  cost estimates based on this method lack the
  precision necessary when they are to be used in
  making decisions.
• It uses the latest cost details (from the
  accounts of the most recent period) that may not
  be typical of either past or future cost
  behaviour.

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Engineering Estimates

• Engineering approach is based on the use of
  engineering analyses of technological
  relationships between inputs and outputs for
  example methods study, work sampling and time and
  motion studies.
• This approach is appropriate when there is a
  physical relationship between costs and the cost
  driver. For example, this approach is usually
  associated with direct materials, labour and
  machine time, because these items can be directly
  observed and measured.

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Engineering Estimates (cont)
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Engineering Estimates -drawbacks

• Engineering approach is not generally appropriate
  for estimating costs that are difficult to
  associate directly with individual units of
  outputs, such as overhead costs.
• Methods study, work sampling and time and motion
  study techniques can be expensive to apply in
  practice.

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The High-Low Method

• The high-low method consists of
• Selecting the periods of highest and lowest
  activity levels,
• Comparing the changes in costs that result from
  the two levels to determine variable cost per
  unit of output, and
• Estimating the fixed cost at any level of
  activity (assuming a constant unit variable cost)
  by subtracting the variable cost portion from the
  total cost.

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The High-Low Method-Example

• WiseCo recorded the following production activity
  and maintenance costs for two months

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The High-Low Method
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The High-Low Method
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The High-Low Method
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The High-Low Method
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The High-Low Method-Exercise (1)

• If sales salaries and commissions are 10,000
  when 80,000 units are sold and 14,000 when
  120,000 units are sold, what is the variable
  portion of sales salaries and commission?
• a. 0.08 per unit
• b. 0.10 per unit
• c. 0.12 per unit
• d. 0.125 per unit

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The High-Low Method-Solution
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The High-Low Method-Exercise (2)

• If sales salaries and commissions are 10,000
  when 80,000 units are sold and 14,000 when
  120,000 units are sold, what is the fixed portion
  of sales salaries and commissions?
• a. 2,000
• b. 4,000
• c. 10,000
• d. 12,000

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The High-Low Method-Solution
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The High-Low Method-drawbacks

• This method ignores all cost observations other
  than the observations for the lowest and highest
  activity levels.
• Observations at the extreme ranges of activity
  levels are not always typical of normal operating
  conditions, and therefore may reflect abnormal
  rather than normal cost relationships.
• The method, therefore, gives inaccurate cost
  estimates

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The Scatter graph Method

• This method involves
• Plotting on a graph the total costs (represented
  on the vertical axis -Y) for each activity
  (recorded on the horizontal axis X).
• Drawing a straight line through the middle of the
  plotted points by visual approximation.
• The point where the straight line cuts the
  vertical axis represents the fixed cost.
• The unit variable cost is found by observing the
  differences (in costs and activity levels)
  between any two points on the straight line.

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The Scatter graph Method
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The Scatter graph Method
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The Scatter graph Method
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The Scatter graph Method
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The Scatter graph Method-drawbacks

• This method suffers from the disadvantage that
  the determination of exactly where the straight
  line should fall is subjective (i.e. different
  people will draw different lines with different
  slopes, giving different cost estimates).

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Summary

• Different methods can be used to analyse mixed
  costs and estimate cost functions. Each method
  can be appropriate in some situations and has its
  own disadvantages. Most of these methods are
  subjective.
• The least-squares regression method is objective
  and incorporate all of the available observations
  into the cost estimate. However, it has its own
  drawbacks as well.
• The least-squares regression method is the topic
  of the next lecture.

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Workshop (1)

• See Exercises E5-1, E5-5, P5-17 (Seal et al.,
  2006)