Task 1- Discuss the cost concepts that apply to the decision making process

1.1 Price of a product or service refers to the value or utility that the customers expect from it.
More the price, more the value: a most typical concept for a customer to determine the
utility of a particular product. Cost and price are directly related with each other because
price of a product or service can be set only after determining the total cost of manufacturing
or developing that product or service, which typically includes cost of work in process, cost
of manufacturing overhead and other non manufacturing costs.
When a company can offer fewer prices than its competitors that provide somewhat same
products, it can achieve a competitive advantage over them. But fewer prices do not mean
sacrificing with the quality but making sure that the manufacturing process is highly effective
and efficient enough to reduce cost.
Cost of a product or service can be classified as fixed cost and variable cost. Variable costs
can be covered by increasing the volume of sales. To cover fixed cost, the price of the product
should be set in such a way that it goes higher than the variable cost of producing the product,
because now each unit of sale will make contribution to fixed cost. It is very essential to set
the appropriate price of a product because if it is too pricey, the product might fail and if it is
narrowly priced, the company might lose potential profit.

1.2 A costing system is needed to understand the depth of each and every cost behind a
product or service. Costing system typically includes forms, controls, reports that facilitate
the work of both managers and accountants.
The purpose of costing system is not to replace the accounting system but to assist to retrieve
useful information quickly to make decision. A costing system is not bound to create report
according to the GAAP or IFRS standards because reports are used for internal purposes only.
There are two main types of costing systems: Job costing system and process costing system.
Company producing homogenous products for a long length production time uses process
costing system. This system is useful when the organization is dealing with homogenous
products that flow through the production process on a continuous basis. Job order costing is
used in situations where many different of products are produced each period. This system is
1

useful when organization is dealing with different types of products, unique and sometimes
custom made such as construction projects or greetings cards.
A newly invented costing system is activity based costing system, where every activity
associated with producing an item is identified and a cost is allocated to the activity. This
system is useful because it gives more accurate result by eliminating irrelevant costs to a
product.

Both manufacturing and nonmanufacturing costs which has clearly defined

boundaries are identified to products in ABC system.

An organization can use any of these costing systems according to their purpose and type of
business or use a hybrid system to best meet its needs. For example, in some organization
process costing can be used for direct materials and job order costing can be used for direct
material and factory overhead.

1.3 To improve the costing and pricing systems used by a organization, we need to first
determine whether the existing system is obsolete or not. Below are some characteristics of
an obsolete costing system:
a) When organization uses many different costing systems. For examples, the official
system may use direct labor hours as a base for allocating cost, the individual depts.
may use different allocation bases.
b) when profit margins are hard to explain
c) when managers want to drop certain products and services which were considered
profitable in the first place
d) when managers are having trouble to set a price for their product or service to get
potential profit
e) when products which are hard to make show big profits
f) when the competitors can offer somewhat same product at a significantly lower cost
An organization can put its attention in certain parts of the system to make improvements:
a) Using the cause-effect relationship: For example, when determining the recruitment
cost, the HR dept. can ignore the process of allocating cost based on the number of
employees but rather use the time that the HR dept. needs to hire new employees.
b) Using target costing system: Target costing is a tool to reduce cost of a product and
applied during the planning and design stage of products life cycle. In this system,
pricing is considered long before the actual production.
2

c) Producing units in larger batches will reduce cost and make efficient use of factory
equipments. Increased activity of production will show a more accurate result of
manufacturing cost per unit.
d) Modifying the variances to get accurate results of the different parts of the production.

Task 2-Discuss forecasting techniques to obtain information for decision making

2.1 There are many forecasting techniques that the managers may use to make cost and
revenue decisions in an organization.

Unit costing method: Unit costing method suggests us to use historical data to create
a cost model for producing one new unit. This single functional unit will serve as a
multiplier, with which the number of units needed to be manufactured will be

multiplied. The result will give us an overall cost estimate.

Correlation coefficient method: Correlation coefficient method is used to measure
whether two variables are linked with each other and if there is a link, whether the
link is direct or inverse. For example- Marketing analysis use correlation method to
understand the relationship between consumer behavior and consumption of their

products.
Cash flow forecasts: Cash flow forecasts tells how efficiently the cash moves on
throughout the organization. This technique tells us whether the profit can cover up
the operating costs. They also help us to determine whether an organization can

remain profitable by using existing business activities.

Judgmental forecasting: It is a method of forecasting future outcomes based on
previous conditions such as economical, incidental, historical, behavioral etc.
Judgmental forecasting is often used when quick decisions are needed to be taken and
provides good results only when it is done by experienced forecasters.

2.2 There are several sources from where the organization can collect funds:

i.

Sales revenue: When companies can sell their product in profit, extra money is
earned which is the fundamental source of fund by which a company can expand
further.
Bank loans: When organizations are in need of money, they can go to private

ii.

commercial or industrial bank to take loan. Cost of bank loan is the interest that the
organization has to pay to the banks.
Issuing public share: Organizations can collect fund by issuing shares of the

iii.

company to the public. The shareholders liability is limited to the face value of the
share price. There are two types of shares: equity shares and preference shares. Cost
iv.

of issuing public share is the dividend that the company has to pay.
Issuing debentures: Organizations can borrow and raise loans by issuing debentures.
Interest given on the debenture is fixed and cannot be adjusted later. The company is

v.

bounded by law to pay interest even when there are no profits.

Investors: Organizations can offer investors to invest money on them. But this is
method of borrowing money only works when the organization is highly effective and
already has an established reputation of profitable firm.
Government funding: Many organizations that works in specialized field can offer

vi.

government to grant donations. There is no need to pay interest if it is granted as

donation or the interest rate is very low if it is borrowed from government.

Task 3- Elaborate the budgetary process of an organization

3.1 A budget is a quantitative plan for acquiring and using resources over a specified time
period. Budgets are used for two purposes-planning and control. In practice, most companies
set their budget targets at a highly achievable level.
Apple Inc. should consider the following factors while setting up the budgetary targets:
a)
b)
c)
d)
e)
f)

cost
profit
advertising expense
quality control
competitors price
Government taxes and policies.

Budgetary process refers to the creation, control and managing of financial plan of an
organization or individual.
A budgetary process is complex and time consuming. In Apple Incorporation, A standing
budget committee controls and directs the budgetary system of an organization and prepares
the budget itself based on previous budgets or achievable estimations.

This budget

committee may include supervisors or managers of various departments of the organization

such as sales, production, quality control, purchasing, packaging etc. The president calls
meeting with all the members of budget committee where they discuss the following years
expected activities, and propose new activities. After that, each department may propose their
individual budget to the standing committee, but only after getting the approval from its
distinct executive officer. The budget committee reviews, inspects and audits the proposed
budget of the departments, and make a final master budget in accordance with the expected
outcomes.

3.2 The master budget consists of a number of separate but interdependent budgets that
formally lay out the companys sales production and financial goals. It is generally consisted
of a cash budget, a budgeted income statement and a budgeted balance sheet.

[Figure collected from- Ray H. Garrison, Eric W. Noreen, Peter C. Brewer. Managerial
Accounting. 13th Edition (International). New York.McGraw-Hill/Irwin.Page-575.]
The first step in the creation of master budget is to prepare a sales budget. a sales budget
shows the expected sales for the budget period, based on the Apples sales forecast, which
may require mathematical calculations and statistical assumptions.
Production budget is prepared after sales budget, which is used to determine the budgets for
manufacturing costs, including direct materials budget, direct labor budget, and the
manufacturing overhead budget. These budget combined with sales budget and selling &
administrative budget expense budget prepare the cash budget. A cash budget shows in details
how the cash will be collected and used. After cash budget, the budgeted income statement
and budgeted balance sheet can be prepared.
Cash Budget: cash budget is composed of four parts:
i.
ii.
iii.
iv.

the receipts part

the disbursements part
the cash excess or deficiency part
the financing part

Budgeted income statement: A budgeted income statement refers to a financial plan that
shows the estimated net income, by adjusting gross margin against selling & administrative
expense along with other expenses.

A sample Budgeted Income Statement of Apple Incorporation:

(Values used are not real)
Description
sales
Cost of goods sold
Gross margin
Selling & administrative

2012
Actual (in )
18000000
12000000
600000
450000

2013
Actual (in )
2000000
1300000
700000
576000

2014
Budgeted (in )
2250000
1400000
850000
585000

expense
Net operating income
interest expense
Net income

150000
20000
130000

124000
21900
102100

265000
25000
240000

The budgeted balance sheet: The budgeted balance sheet refers to a financial statement that
shows estimated levels of assets and liabilities of the organization in budget period.

3. 3 Comparison of actual expenditure and income to the master budget of an organization

(Values used are not real)
2012
Actual

2013
Actual

2014
Budgeted

2014
Actual

Variance
(in pounds)

sales

(in )
18000000

(in )
2000000

(in )
2250000

(in )
2300000

50000

Cost of goods sold

12000000

1300000

1400000

1420000

20000

Gross margin

600000

700000

850000

880000

30000

Selling &

450000

576000

585000

586750

1750

expense
Net operating income

150000

124000

265000

293250

28250

interest expense

20000

21900

25000

23365

(1635)

Net income

130000

102100

240000

269885

29885

administrative

Sales: the actual sales amount is 2300000 which is 50000 more than the estimated
budget. This increasing amount of sales shows that the company is running smoothly

and the sales of products are likely to be higher in next year.

Cost of goods sold: As the volume of sales increases, naturally the cost of goods sold
will also increase. Another reason of increasing cost of goods sold may be increase in

direct manufacturing cost such as electricity and overhead cost, which is very

common.
Selling and administrative expense: Expense in this area has increased by 1750 than
the estimated amount. This is mainly due to the increase in sales volume which has

resulted in slight increase in distribution expenses.

Interest expense: Interest expense has decreased by 1635 which is a good symptom
because organization has found a cheap way of collecting fund than the estimated

budget.
net income: Increased amount of sales and decreased amount of cost of borrowing
fund has resulted in an increase of net income by 29885 than the budgeted amount.

3. 4 Budget monitoring is a systematic approach by which an organization continuously

monitors the performance of the organization compared with estimated activity in the budget
to understand whether the organization is going towards predetermined objectives.
The purposes of the budget control system are:
i.

Prime purpose: is to evaluate actual result against the estimated value to facilitate the

ii.

future decision making process of the managers.

Providing necessary information upon which managers are more motivated to achieve

iii.
iv.

organizational goals.
Ensuring that all resources within the organization are effectively and efficiently used.
Minimizing the gap between the actual result and estimated result by controlling the

v.

internal and external organizational operations

Comparing data against the previous years to know about the current condition of the

vi.

organization
Identifying necessary trends that are influencing the business operations.

Budgetary monitoring process is highly essential in every organization and it the

responsibility of the all the managers to monitor activities associated with the budget. An
effective budgetary monitoring system will show manager where remedial actions are
required.

Task 4: Review of cost reduction and Management process for an organization

4. 1 Cost reduction is a process by which organization redefines its business process to

minimize avoidable cost and yield more profit. Successful reduction of cost can put an
organization in a more favorable condition among the competitors.
There are many cost reduction strategies, and they all talk about redesigning the business
process that generates more cost. Essential factors for a successful cost reduction strategy are:

Focusing on the operating cost of the organization and minimize it if necessary

improving the management process where necessary
introducing an effective waste management program in the organization

Different approaches that may manage and improve business activities are:
I.

Lean thinking model: The lean thinking model tells us how to put resources around
the business processes that may response quickly by customers orders. The result is
minimized inventory cost, fewer number of product defects, less waste, quicker
customer response and reduction of overall cost.

[Figure collected from- Ray H. Garrison, Eric W. Noreen, Peter C. Brewer. Managerial
Accounting. 13th Edition (International). New York.McGraw-Hill/Irwin.Page-9.]
II.

Theory of constraints: Theory of constraints is a system that identifies the

organizational constraints and suggests effective way of getting rid of those
constraints to make improvements.

4.2 Activity-based costing is a costing method that is designed to provide managers with cost
information for strategic and other decisions that potentially affect capacity and therefore
fixed as well as variable cost.
How ABC helps in an organization?

In traditional cost accounting system, all manufacturing costs are assigned to

products-even manufacturing costs that are not caused by production. But in ABC, the

overhead costs assigned to the products based on activities.

Helps to identify excessive costs and unnecessary products that are consuming

resources of the organization.

Determines cost per unit of production more accurately
Identifies non-value added business activities and thus allocates resources to the
value-added activities to improve overall business process

ABC method relies on five levels of activity:

a)
a)
b)
c)
d)

unit-level activities
batch-level activities
product-level activities
customer-level activities
organization-sustaining activities

Activity based costing is not a replacement for usual costing system, but rather used as a
supplement. Nowadays, most organizations use two costing systems, the official systems to
prepare external reports and ABC system to prepare internal reports.

Task 5- Demonstrate the use of financial appraisal techniques to make strategic

investment decisions for the organization.

5.1 Organizations use financial appraisal techniques to make strategic investment decisions.
These techniques help them to determine the potential value of an investment done by the
organization. There are 3 methods of investment appraisal which can determine the return on
investments. They are:
a) Payback method
b) Net Present Value
c) Internal rate of return
Now lets assume we have two different investment projects. Project ABC and Project XYZ,
each project has a cost of 10000 and the cost of capital for each project is 12%. The
expected net cash flows are as follows:
Year

Expected net cash flows

10

Investment Project

Investment Project

ABC (in )
(10000)
6500
3000
3000
1000

XYZ (in )
(10000)
3500
3500
3500
3500

0
1
2
3
4
Calculation of Payback Period:
Payback Period= P+ (Q/R)
Where,
P is

the

last

period

with

negative

cumulative

cash

flow;

Q is the absolute value of cumulative cash flow at the end of the period P;
R is the total cash flow during the period after A

Calculation of cumulative cash flow:

Year

0
1
2
3
4

Investment Project ABC

CF
(10000)
6500
3000
3000
1000

(in )
Cumulative CF
(10000)
(3500)
(500)
2500
3500

Investment Project XYZ

(in )
CF
(10000)
3500
3500
3500
3500

Cumulative CF
(10000)
(6500)
(3000)
500
4000

Project ABC
10000 is covered in 3rd year, so

Project XYZ
10000 is covered in 3rd year, so

Payback period=

Payback period=

2 years + (12 months/3000) x 500

= 2 years + (12 months x 3500) x 3000

= 2 year and 2 months

= 2 year and 10.28 months

11

Calculation of Net Present Value:

Year

0
1
2
3
4
Net Present Value

Amount
Project
Project
ABC
XYZ
(in )
(in )
(10000)
(10000)
6500
3500
3000
3500
3000
3500
1000
3500

Discounting Factor

1
.893
.797
.712
.636

Present Value
Project
Project
ABC
XYZ
(in )
(in )
(10000)
(10000)
5804.5
3125.5
2391
2789.5
2136
2492
636
2226
967.5
633

Calculation of internal rate of return:

Calculation of net present value at discounting factor 8 %
Year

Amount

Project
ABC
(in )
(10000)

Project
XYZ
(in )
(10000)

6500

Discounting Factor

Present Value

Project
ABC
(in )
-10000

Project
XYZ
(in )
-10000

3500

.926

6019

3241

3000

3500

.857

2571

2999.5

3000

3500

.794

2382

2779

1000

3500

.735

735

2572.5

1707

1592

Net Present Value

Calculation of net present value at discounting factor 14 %

Year

Amount

Discounting Factor

Present Value
12

Project
ABC
(in )
(10000)

Project
XYZ
(in )
(10000)

Project
ABC
(in )
-10000

Project
XYZ
(in )
-10000

6500

3500

0.877

5700.5

3069.5

3000

3500

0.769

2307

2691.5

3000

3500

0.675

2025

2362.5

1000

3500

0.592

592

2072

624.5

195.5

Net Present Value

Internal Rate of Return

Investment Project ABC

Investment Project XYZ

8% + 6% x (1707 / 1082.5)

8% + 6% x (1592 / 1396.5)

= 8% + 9.46%

= 8% + 6.84%

= 17.46%

= 14.84%

5.2 & 5.3 If a projects NPV is positive, the project can be taken, but if it is negative, the
project should be rejected. In case of two projects, Project having the higher NPV should be
taken. We should choose Project ABC because it has higher NPV and also less day of
payback period. The NPV method is more accurate because it considers risk, inflation and
cost of capital while PB method does not consider the time value of money and cost of
capital. PB method also fails to consider the cash flows earned after the time boundary. The
best way would be, using PB method first to narrow down the options and then apply NPV
method to see which project is the best.
To take the best decision, some other factors should be taken account:

risk of taking the project

expected result of the project due to financial imbalance in the market
availability of other projects in the market
local economic condition
13

government laws, policies, regulations

Rate of inflation or deflation etc.

Task 6: Interpret the financial statements for planning and decision making

6.1 There are many methods to find out about the financial viability of the organization, but
Ratio Analysis is the widely used method. Ratio analysis is used to interpret the financial
statements of the organizations to find out strength and weakness of it. It is also used:

to determine liquidity position

to determine long term solvency ability
to find out operating efficiency of the firm
to control cost and expenditure
to forecast and plan about budgets etc.

Lets assume Harold Peter & Michael Clark, two friends who are in the same Fast-food
business. We will use ratio analysis techniques to find out whose business is more profitable.

Profit and Loss statement

(For the end of June, 2014)
Description
Sales
less: Cost of goods sold
Gross profit
less: Selling and administrative expense
Net income
***average inventory during that period
Calculation of gross profit margin:

Harold Peter
(in pounds)
384000
288000
96000
38400
57600
14400

Michael Clark
(in pounds)
351000
280800
70200
28080
42120
15600

Harold Peter

Michael Clark

Gross Profit margin

=( 96000/384000)x 100

=(70200/351000)x 100

= (gross profit/net sales) x 100

= 25%

= 20%

14

Calculation of net profit margin:

Harold Peter

Michael Clark

Net Profit margin

=( 57600/384000)x 100

=(42120/351000)x 100

=(Net profit / Net sales) x 100

= 15%

= 12%

Calculation of Inventory turnover ratio:

Harold Peter

Michael Clark

Inventory turnover ratio

=(cost

of

goods

sold/

average =(288000/14400)

inventory)

= 20 times

=(280800/15600)
= 18 times

6.2 Interpretation:
The gross profit ratio shows the proportion of profits that the organization produces, before
adjusting selling and administrative expenses.Net profit margin determines how much out of
every pound of sales a company actually earns profit. For example, if a companys net profit
margin is 25%, it means the company has a net income of 0.25 for each pound of sales.
From our analysis, Harold Peter is doing better in the business than Michael Clark, as both of
profit ratios yield higher percentage.
Inventory turnover ratio tells about the number of times an organization's inventory is sold
during an accounting period. Here, Inventory turnover ratio shows 20 times for Harold Peter
which is more than Michal Clark. So, inventory of Harold Peter is more used than the
Michael Clark, which is a good signal of doing better business.

6.3 Recommendations for the business:

15

The total amount of sales of Michael Clark is less by 33000 than the Harold Peter.
Michael Clark may increase the volume of sales by recruiting more sales agent and/or
increasing the amount of commission. But doing so will result in more sales and
administrative expense. So Michael Clark needs to operate his business more

efficiently and effectively by properly utilizing all the resources.

Michael Clark may improve his business process by implementing Activity Based
Costing system. By doing so, he will get accurate results of overhead costs and

indentify where unnecessary costs are being made.

Inventory of Michael Clark is less used than the inventory of Harold Peter. This
means, Michael Clark is not using an effective inventory control system. He may use
latest technology such as bar codes, scanners etc. to track the inventory to avoid extra
cost.

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Edition (International). New York. McGraw-Hill/Irwin. Chapter-1,3,8,9
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Hall/Financial Times. Chapter 45-An introduction to the analysis and interpretation
of accounting statements.

16

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Developed
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18