Accounting Theory

ACCOUNTING THEORY

DEPRECIATION ● ● ● ●

-Why depreciate? All fixed assets have a limited useful life These assets lose value over a number of years Loss in value is an expense charged to the P+L If depreciation is not charged, profits will be overstated and the balance sheet will not show the true value of the assets

-Why does an asset depreciate? ● Use/wear and tear ● Passage of time ● Obsolescence ● ● ● ●

-Estimating Depreciation (4 factors) Cost of the asset Estimated life of the asset Estimated residual/scrap value of the asset Selection of an appropriate method

-Calculating Depreciation STRAIGHT LINE METHOD ● Reduces value of the asset by same amount each year ● Means depreciation in P+L is the same each ear ● Normally calculated by using percentage of cost of asset, or by dividing the cost by the number of years of its expected life REDUCING BALANCING METHOD (BOOK VALUE) ● This reduces the value of an asset by a smaller amount each year ● Calculated by applying a fixed percentage to the cost of the asset in year 1, and thereafter to the NBV

Depreciation- EXAM QUESTIONS 2013 Q2 (d) (i) Q- Why does a company charge depreciation when calculating profit? A- Depreciation is an expense. Failure to include depreciation in final accounts will result in profits being overstated and the net assets on the balance sheet will not show true value 2013 Q 2 (d) (ii) Q- Why would a company choose one method of depreciation for another? A- This is due to its policy on depreciation and ensuring the consistency concept is applied when preparing accounts Straight line method - Same amount each year, appropriate for assets that lose value slowly e.g buildings Reducing balancing method- Reduces value by smaller amount per year, appropriate for assets that lose value fast e.g vehicles 2010 Q3 (d) Q- Explain what is meant by depreciation A- Depreciation is the measure of the wearing away or loss in value of a fixed asset, as a result of wear and tear, passage of time or obsolescence 2005 Q5 (d) Q- What factors are taken into account when arriving at the annual depreciation charge? A- Cost of asset Estimated life of asset Scrap value of asset Method of depreciation DEPRECAITION THEORY CAN COME UP IN A REVALUATION QUESTION

CONTROL ACCOUNTS -Purpose of control accounts ● Check the accuracy of double entry book-keeping ● Helps locate errors quickly ● Ensure accuracy with creditors and debtors ledger ● Find out quickly amounts owed by debtors and amounts owing to creditors -Preparation of control accounts -Debtors ● The figures used in Debtors ledger control A/C are taken from the totals of the books of first entry i.e Sales, Sales returns, Journal Entries, analyzed receipts + lodgments books, which are all entered in the general ledger ● The list of debtors is taken from individual balances in the debtors ledger ● The balance from the control A/C and the balance when all the individual debtors are added up should be equal -Creditors ● Figures used in creditor’s control A/C are taken from the total of the books of first entry i.e Purchases, Purchases returns, Journal entries and analyzed receipts cash payments book ● The list of Creditors is taken from the individual personal balances in the creditor’s ledger -The advantages/importance of Control accounts ● The act as a check on the accuracy of the postings and totals of the individual ledger accounts ● They allow amounts owed by debtors/owed to creditors to be ascertained quickly by simply balancing the control accounts ● They enable errors to be localized and found more speedily ● The are useful when preparing accounts from incomplete records -Some elements of control accounts Opening small balance – how does it arise? (in a debtors control account) ● When a debtor pays for sales, but sometimes later returns some of the goods ● An overpayment of a debt ● Full payment was made, and then a discount was granted (in a creditors control account) ● When a payment has been made to a creditor and later goods have been returned ● An overpayment of a debt ● Full payment has been made, and then a discount was granted -Contra Entries ● A contra entry occurs when a firm is both the supplier (creditor) and a customer (Debtor)

● For example, a firm may both sell and purchase from the same firm ● A contra entry has the effect of reducing the amount owed by debtors while also reducing the amount owed to creditors

-Bills Payable ● These reduce creditors ● They will appear in the debit side of the personal account and the debit of the control account -Bills Receivable ● These reduce debtors ● They will be shown in the credit of the debtors personal account and the credit of the control account

Control accounts- EXAM QUESTIONS 2013 Q2 C Q- Which books of first entry are used in the production of Debtors Control Accounts? A- Sales, Sales returns, Journal Entries, Analyzed receipts lodgements Q- Explain the importance of Control accounts Ao They act as a check on the accuracy of the postings and totals of the They individual ledger accounts o They allow amounts owed by debtors/owed to creditors to be ascertained quickly by simply balancing the control accounts o They enable errors to be localized and found more speedily o The are useful when preparing accounts from incomplete records 2010 Q4 C Q- Give reasons why the balance in the creditors control accounts may not agree with the balance in the schedule of creditors A- Errors in either the control account or in the schedule but not in the other Failure to complete the double entry/error in the ledgers Incorrect totaling of subsidiary books sent to Control A/C 2007 Q2 C Q- Explain Contra Item A- See Notes Q- Explain how opening balance of €530 could arise

A- See notes (in debtor’s account) 2005 Q2 C Q- Explain why Creditor’s control accounts are prepared A- Check the accuracy of double entry book-keeping Helps locate errors quickly Ensure accuracy with creditors and debtor’s ledger

CORRECTION OF ERRORS IN SUSPENSE ACCOUNTS -Errors revealed by Trial Balance ● Mathematical errors- Errors in addition or subtraction ● Double Entry errors- An entry on the debit without a corresponding entry on the credit ● Misplaced Entries- an entry entered on the incorrect side (all of these errors will cause a suspense to arise) -Errors not revealed by trial balance 1. Errors of original entry 2. Errors of omission 3. Errors of commission 4. Errors of principle 5. Compensating errors 6. Complete reversal of entries 1-Errors of original entry These are errors that were made in the books of original entry, which were then posted to the appropriate ledgers e.g cash sales €207 entered as 702 in both Cash and Sales accounts 2- Errors of omission This is where the entries have been completely left out, hence nothing has been entered on the debit side or credit side of the relevant accounts 3- Errors of commission These arise when the correct amount is posted to the correct side of the incorrect account 4- Errors of principle These are entries that are on the correct sides but in the wrong type of accounts i.e repairs debited to the delivery vans account 5- Compensating errors This is where one error cancels another error e.g payment of €600 for cleaning entered as €60 in debit of cleaning account and on the credit side of the cash account 6- Complete reversal of entries This is where the correct accounts are used but both entries are on the incorrect sides of the accounts.

-Suspense accounts -When a trial balance fails to balance, the difference of both sides is placed temporarily in an account called the Suspense Account, therefore the suspense account is included as an account in the trial balance and draft final accounts can now be prepared -When all of the errors have been found + corrected, the balance in the suspense account will be eliminated and all of the ledger accounts will be correct

Correction of errors in suspense accounts- EXAM QUESTIONS

2012 Q2 C Q- What is the purpose of preparing a trial balance? A- A trial balance is prepared in order to test the accuracy of the double entry bookkeeping before preparing Final Accounts. A trial balance should have the same total of debits and credits and have the same accounts because under double entry bookkeeping every debit entry should have a corresponding credit entry Q- State and explain any two types of errors not revealed by the trial balance A- See notes 2010 Q7 E Q- Identify three different types of errors that affect the balancing of a trial balance A- Entering one amount on the debit side of one ledger account and entering a different amount on the credit side of another ledger account Mathematical errors= figures and additions Posting only one side of the double entry

CLUB ACCOUNTS - Clubs, societies and non-profit making organizations are set up for the benefit of the members rather than making of a profit - Income comes from fundraising and subscriptions -Club treasurer duties ● Ensures subscriptions and other funds are collected ● Makes payments of the day to day recurring costs of the club ● Makes regular lodgments to the bank ● Maintains proper records i.e. analysis receipts and payments account, receipts and payments summary accounts and final accounts ● Produces treasurers report and analysis at AGM ● Produces cash flow projections ● Advices members on implications of future planned expenditure like building a new clubhouse The accounts of a club 1- Analysis Receipts and Payments book This book is used to record the day to day receipts and payments of the organization 2- Summary of Receipts and Payments Account This is a summary of the organization’s daily receipts and payments of cash for the period covered by the account The entries from this account come from the totals of the analysis columns in the analyzed receipts and payments book Disadvantages of Receipts and Payments account-

● It doesn’t give a true financial position of the club as amounts due and prepaid are not included ● It doesn’t distinguish between capital and revenue expenditure ● It does not show whether there is enough income to cover expenditure (doesn’t show profit or loss) 3- Income and expenditure account ● The I+E account shows the difference between all income and all expenditure for the financial period ● It is similar to a P+L account as it must only take into account the actual income and expenditure for the year ● It must be adjusted for accruals and prepayments

Advantages● It reveals the true financial position of the club showing a surplus or deficit ● It adjusts for accruals and repayments ● It reveals whether or not the club has enough income to pay for its activities 4- Accumulated Fund ● This is a statement showing the list of assets less liabilities at the beginning of a financial period. ● It allows us to calculate the capital at the start of the period for the club

5-Special Purpose Profit + Loss account ● Sometimes non-profit making organizations such as a club prepare a p+l account for activities that are carried out to make a profit like running a lotto, bingo or disco, or restaurant ● All expenses and revenue relating to that particular activity are entered into a special profit and loss account and the profit is transferred to the I+E account 6- Balance sheet This shows the Assets and Liabilities of a club for a financial period

Special Club receipts 1- Life Membership -This entitles a member to use the facilities of a club for the remainder of their life -The money received is credited to a membership account (shown as a long term liability in balance sheet and transferred in installments into the I+E account) 2- Levies -A levy is a payment made to a club by its members to fund a special project such as an extension -It is treated as a long term liability in the balance sheet as it is due to the members until it is used

SERVICE FIRMS -People who provide services to the community must keep accounts e.g. doctorsm solicitors, dentists, accountants -They should keep records for the following reasons ● To find the profit or loss of the business ● To keep records of the amounts owed to them and by them ● To find the value of assets and net worth of the business ● To present to financial institutions/revenue commissioners ● To make comparisons with previous years ● To facilitate budgeting + planning -Characteristics of Service Firms ● They have few fixed assets ● Main sources of income is the fees they charge ● They maintain a small stock of products which they use for their profession, e.g. shampoo in a hair salon ● Not likely to prepare a trading account, as they are not involved in buying and selling

Service Firms- EXAM QUESTIONS 2012 Q6 (e) Q- The Company wishes to purchase equipment for the new extension. Advise the company on how to fund the expected cost of €150,000. A- My advice would beSell investments 40,000 Sell remaining shares 50,000 Borrow 60,000

Total

150,000

The company would be able to pay back the loan quickly as they had a surplus of €151760 in 2011 and the company is generating through cash. Even though it owes the bank 108,600, it has paid out amounts up to €310,000 in non recurring and non trading items 2010 Q6 (e) Q- The management of the nursing home is considering a increase of 10% in the client’s fees. What advice would you give? Explain why. A-Raising the client’s fees by 10% would increase income by €33,950.Tehre is no need to increase fees for viability or profitability purposes. The company is profitable at 18.4% return on capital employed in the current climate. The company is generating enough cash. It has repaid a loan of €40,000, purchased equipment €15,000 and contributed €35,000 to a new mini bus. In the current climate there is increased competition and as such, charges should not be increased.

FARM ACCOUNTS -Reasons why they are prepared To calculate the profit or loss of the farm Calculate net worth of the farm Establish amounts owed to/by the farm Establish performance of each section of the farm e.g sheep, cattle To apply for grants To apply for loans Facilitate planning and budgeting -The Accounts Receipts and payments account Statement of capital Enterprise analyze account  This is a trading/Profit and loss account for particular enterprise  The balance/gross profit is transferred to the General P+L of the farm  Examples of enterprises are Cattle and milk, Sheep, Pigs, Crops, orses, Poultry, Deer  General P+L account (to ascertain profit or loss of the farm)  Balance sheet (statement of assets and liabilities)

-Terms associated with farm accounts Conacre – this is a payment of rent made by a farmer to a land owner for use of land. Can be revenue or income Single Payment – payment to farmers made by EU under Cultural Agricultural Policy 2005. It is a system of direct payments Rural environment protection scheme (REPS) – These payments are made to farmers to protect the environment within their own farms Drawings – This is the farmer’s consumption of farm produce for private uyse e.g. beef, milk, vegetables, L+H. it is treated as drawings and also as a sale of that particular item.

INCOMPLETE RECORDS 2013 q7 (C) Q- What additional information would be available to Kelly if he used the “double entry” system to record financial transactions       

AGeneral nominal ledger accounts Trial Balance Total sales figure Bank balance Capital and Drawings Bad debts, expenses due/prepaid Discounts allowed/received

2011 Q4 (b) Q- What advice would you give to O’Hagan in relation to record keeping?

A- O’Hagan should keep a detailed cash book and general ledger supported by subsidiary day books. This would enable O Hagan to prepare an accurate trading, and profit and loss account + balance sheet, and therefore avoid reliance on estimates 2007 Q 7(c) Q-(i) explain the term accounting concept (ii) name two fundamental accounting concepts (iii) Illustrate an accounting concept applying to the accounts of P. Lynch A- Accounting concepts are accounting practices or rules that are applied in the preparation of financial accounts Accruals, Going Concern, Consistency and Prudence are accounting concepts Accruals concept- all expenses incurred in a particular period must be included in the accounts of that period regardless of whether they are paid or not. Similarly, all revenue income must be included in the accounts of that period whether received or not. E.g. electricity due for the current year must be included in the accounts, although the bill may not be paid until the following year as the expense refers to the current year. Insurance prepaid should not be included in the current year’s accounts as the payment refers to the following year.

PUBLISHED ACCOUNTS All companies, irrespective of size, must by law produce company accounts and reports annually. A company’s annual report will include ● A director’s report ● An auditor’s report ● Financial statements, which include the published profit and loss a/c, balance sheet (with notes) and a cash flow statement The Directors Responsibility of directors 1. Keep a proper set of records which enable a P+L account and balance sheet to be prepared in accordance with the company’s acts

2. 3. 4. 5. 6. 7.

Safeguard the assets of the company Prepare annual financial statements Select suitable accounting policies State whether applicable accounting standards have been followed Make sure all financial statements are signed by two directors Convene AGM’s

Director’s report must contain 1. Dividends recommended for payment 2. Amount to be transferred to the reserves 3. A report of any changes to the nature of the company’s business during the year 4. A fair review of how the business developed during the year, and of the position at the end of the year 5. Any likely future developments of the business 6. Any activities in the field of research and development 7. Significant changes in the fixed assets The Auditor The role of the auditor is to express an opinion on the financial statement. The auditor will decide and report on whether the statements give a true and fair view of the state of affairs of the company and whether they comply with the company’s acts An audit This is an independent examination of a company’s financial statements and the espress of an opinion on the preparation of accounts The purpose of an audit is to enable the auditor, in keeping with the requirements of the companies act, to show that the truth and fairness shown by the P&L and balance sheet, and any other information required to be disclosed in the balance sheet.

True and fair view The accounts of a business will give a true and fair view if the auditor is satisfied that 1- All info necessary to complete the audit and required by the companies act is available and included 2- The fundamental accounting concepts have been adhered to when preparing the accounts 3- The accounts have been prepared in a way that is consistent with the previous accounting period Note: Companies acts do not require the auditor to certify that the accounts are correct, but that they give a true and fair view of the financial position of the business. It is not the function of the auditor to

correct errors or fraud. However if fraud is detected, it is the duty of the auditor to report it

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Auditor’s report 1- Auditor’s report must show The financial statements give a true and fair view of the state of affairs of the company at the end of the year The financial statements are prepared in accordance with the company’s acts All the information necessary for the audit was available the info given by the directors (director’s report) is consistent with the financial statements The Net Assets are more than 50% of the called up capital

2-Unqualified report VS qualified report ● An unqualified report, often referred to as a clean report is when the auditor can report that in his opinion, the above conditions have been met ● An unqualified report is when an auditor states that in his/her opinion the accounts of the company do not comply with all of these conditions above i.e the financial statements do not give a true and fair view of the company’s state of affairs

PUBLISHED ACCOUNTS- EXAM QUESTIONS 2013 Q6 (b) (i) Q- Name the bodies/institutions that regulate the productions.content and presentation of company financial statements A- The government- legislation

The European Union- directives Accounting standards bodies- FRS’s and SSAP’s The Stock Exchange (ii) Q- What is an audit? explain a qualified auditor’s report A- An audit is an examination of the financial statements of an enterprise by an appointed auditor -The audit is conducted by an auditor who is independent -The auditor expresses an opinion and certifies whether the accounts give a true and fair view of the financial position of the business -The companies acts require the auditor to certify that the accounts give a true and fair of the financial position of the business

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A Qualified Auditor’s Report is when an auditor is not satisfied or is able to conclude that The financial statements are prepared in accordance with the Companies Act The financial statements give a true and fair view of the state of affairs of the company at the end of the year All the info necessary for the audit was available The information given by the directors is consistent with the financial statements The net assets are more than 50% of the called up capital The report will state the elements of the accounts that are unsatisfactory 2011 Q3 (b) (i) Q- State how a company should deal with a contingent liability which is probable? A-When a contingent liability is probable, the estimated amount should be provided for in the accounts and a note should show the nature of the loss (ii) Q- Explain the difference between an auditor’s qualified and unqualified report A- An unqualified report is often referred to as a clean report. A report is unqualified if the auditor is satisfied that the following apply- see list in 2013(5 points)

2008 Q4 (b) (ii) Q- What regulations must accountants observe when preparing financial statements for publications? A- Accountants must observe regulations laid down by; ● The Companies Acts ● The Financial Reporting council/ Accounting Standards Board ● The Stock Exchange

2009 Q4 (b) (ii) Q-Explain the term “exceptional item” and give an example A- This is a material item of significant size. It is a profit or loss that must be shown separately in the profit and loss account because of size. Example: Profit or Loss on the sale of a fixed asset or large bad debt 1999 Q6 (b) Q- State the criteria that determine the size of a public or large private company. A- To be classified as a public or large private company, 2 of the 3 of the following must apply● Balance sheet total must be greater than 7.62 million euro ● Annual income must be greater than 15.42 million euro ● Average number of employees must be greater than 250

CASH FLOW STATEMENTS -Cash Flow Statements are concerned with describing and evaluation the true inflows and outflows of cash that lead to the change in cash figures from theone balance sheet to the next

Purpose To assertain cash inflows and outflows during the period  To assist in predicting future cash inflows  To aid financial planning  To provide information for assessing liquidity  To highlight profit isn’t always equal to cash  To comply with legal requirements Cash inflows Profits  Decrease in stock  Decrease in Debtors  Increase in Creditors  Interest paument  Dividemnts/ investment income recieved  Sale of fixed assets  Capital introduced/the issue of shares  Loans recieved/ Debentures issued  Tax refunds Cash Outflows Losses  Increase in stock  Increase in debtors  Decrese in creditors  Interest paid  Dividents paid  Purchase of fixed asset  Drawings  Repayment of loans  Tax paid

Non cash items- No cash items in the profit and loss account affect profit but don’t change the cash figure  Dereciation  Profit or loss on sale of fixed asset  Increase/decrese in provision for bad debts

Cash doesn’t always equal profit It is important to realise that profit ≠ cash i.e some transactions will affect cash but not profit such as the purchase or sale of fixed asset or capital introduction/withdrawl Financial Reporting Standard 1- (FRS1) -The FRS1 revised in 1996 rquires large companies to prepare cash flow statements for each accounting period

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-It also requires that cash flow statements should be entered under certain standard headings according to the activity that gave rise to them – Operating activities Return on investment and servicing of finance Taxation Capital expenditure and financial investment Equity Dividends paid Management of liquid resourses Financing CASH FLOW EXAM QUESTIONS

2012 Q7 (b) i Q- Explain why earning profit doesnt always result in an increase in cash balances. Use figures to support answer A- The accounts and cash flow statement show an operating profit of 337,000, but the incrse in cash was 53,000. B- Reasons Credit sales don’t affect cash but increase profit  Non cash gains/losses affect profit but not cash (profit on sale of fixed asset/depreciation)  Sale/Purchase of fixed assets affects cash but not profit (receipts 100000, payments 160,000 + 119,000)

 Introduction/withdrawl of capital increases cash but not profit (receipts 220,000 payments 50,000) (b) ii Responsibility of directors To comply with copmanies act  To keep proper accounting records for stetements to be prepared  Prepare annual financial statements  Sign Financial statements  Select suitable accounting policies  Safeguard assets of company 2010 Q2 (b) i Q- Outline benefits of preparing a cash flow statement  Shows cash inflow/outflow over the year  Shows profit doesnt always equal cash  Used to predict future cash flows  Provides info to assess current liquidity (b)ii Q- Distinguish between a Cash Expense and a non-cash expence A- Cash expense reduces profit and cash- wages Non-Cash expense reduces profit but not cashdepreciation 2008 Q6 (b)ii Q- Prepare a note on the Accounting Standards Board A- -The accounting standards board issues new accounting standards called FRPs. It also ammends and withdraws old ones -FRS1 which was issued in 1991 and emmended in 1996 requires large companies to prepare cash flow stements for each activity period. -It requires that individual cash flows should be entered under standard headings according to the activity that gives rise to them

PRODUCT/JOB ABSORPTION COSTING 2012 Q8 (iv) Q- explain why it is necessary to transfer Service Department costs to Production Departments 1 and 2 A- service departments can’t recover costs. Service departments are secondary to production departments and as a result, service dpsrtments costs must be transfered to production departments on an equitable basis e.g machine hours. Overheads can only be recovered through production i.e they are included as a cost of production. 2012 Q8 (b)iii Q-Explain with examples “controllable” and “uncontrollable” costs. A- Controllable costs are costs that can be controlled by the manager at a cost centre. He will make the decision about theamount of the cost or if the cost should be incurred, and can be held responsible for cariances in the costs e.g all variable costs are controllable. Commission to sales personel can be controlled by the sales manager. Uncontrollable costs are costs over which the manager of a cost centre has no control, and therefore cannot have responsibility for variances in these costs. E.G rates to the local authority are uncontrollable. 2011 Q8(f) ii Q- List and explain two limiatations/assumptions of marginal costing. Explain what is meant by a step fixed cost. Roughly sketch a graph of step fized costs using the following rental payments A Variable costs are assumed to be completely variable at all levels of output. However variable costs may decrease due to economies of scale or may increase because of increased costs.  It is assumed that in marginal costing fixed costs remain the same although most fixed costsare step-fixed and are only fixed within a relevant range.  It is assumed that all mixed costs are easily separated into fixed or variable. The High Low method can be used for this purpose but it is not always possible to do this.  It is assumed that the selling price per unit is constant and does not allow for discounts.  Production in a period usually equals sales. Fixed costs are charged in total to a period and are not carried forward to next period.

Step fixed costs are costs that are fixed within a certain range of activity but change outside of that range. E.g. Rent could be fixed up to a certain level of production. However, if production increases and results in the rental of more factory space, then the rent would increase to a new level. Thus the fixed costs would increase in steps.

2009 Q8 (d) (ii) Q- Outline two differences between Management and Financial accounting A-

Management Accounting Concerned with planning for the future and provides information for planning and budgeting Has an internal focus and furnishes information to aid decision making Is not governed or restricted by legistlation or legal requirements Reports prepared as often as the manager requires them Reports are prepared or costs centres and departments

Financial Accounting Concerned with recording past events. Information is provided in the form of a P+L account, balance sheet and Cash Flow statement Has both an internal and external focus and furniches information to stakeeholders such as managers, shareholders and creditors Is governed and regulated by both legislation and accounting standards such as FRS’s Reports are made usually once a year Reports are prepared about the whole business

2007 Q8 (a) iv Q- Explain what is meant by re-apportionment of overheads A- reapportionment of overheads i the term used where service department costs are re-appointed between production departments because overheads can only be recovered by being included as part of the cost of production

(a )v Q- Illustrate and explain “over absorption” of overheads A- Overabsorption of overheads is when costs are recovered, budgeted costs are greater than actual costs e.g the cost of fuel was reduced and was lower than planned. 2005 Q8 (d) Q- Name 3 overhead absoroption rates and state why they are based on budgeted rather than actual figures A-Absoroption rates Per Labour hour  Per Machine hour  Per Unit  Per perventage of price cost Overhead absorption rates are based on budgeted rather than actual costs because actual costs may not bek nown util the end of the year and the business may not wait until then to decied the cost of the product as they need a dfinite selling price to charge 2003 Q8 (b)ii Q- State 2 reasons why product costing is carried out and explain each one  to control costs- budgeted vs. Annual  To help planning and decision making

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To ascertain the value of closing stock in order to prepare final accounts

MARGINAL COSTING Cost Volume Profit Analysis  This is the study of the relationship between costs and volume (level of output) and the effect on profit and various levels of activity  Used for decision making by managers  Marginal costing is an alrternative method of costing to absorption costing. Both are used in CVP analysis Principles of marginal costing  Total cost of a product can be divided into fixed costs and variable costs  Fixed costs or period costs are not affected by volume of output  If production is increased by one unit, costs will increase only by the variable costs of that one unit  When one extra unit of a product is sold, income will increase by the amount of sales value of the unit sold  Costs will increase by the variable costs of producing and selling that extra unit

Contribution is the amount each unit of sales contributes towards covering the fixed costs and profit, in other words, the contribution earned goes initially to cover fixed costs, and when fixefd costs have been recoveredm all further contributions are profit. Contribution to sales ratio  This is another formula used to calculate the break-even point.  It is used to find B.E.P in sales revenue  It is a emasure of the rate at which profit is being earned; it is used in marginal costing where the variable cost per unit and sales revenue are not available  It is used in calculating: Break even point Level of sales required to reach target profit Margin of Safety This is the amount by which sales can fall before break even point is reached Break Even Charts The relationship between revenuse, variable costs, fixed costs and profit/loss can be represented in graph form with a break-even chart. The break-even point is the point at which the total cost line interescts the revenue line. From graph, you can see the break-even point in units and in € Sensitivity Analisys This is a technique that can be used by a management accountant to examine the effect on profit brought about by a change in any of the following 1. Selling price 2. Direct Material costs 3. Labour costs 4. Variable overheads

Limitations and assumptions of Marginal Costing Variable costs: It is assumed that variable costs are completely variable at all levels of output. However, variable costs may decrease due to eceonomy of scale or may increase because of increased costs. Fixed Costs: It is assumed that in marginal costing fixed costs remain the same, although most fixed costs are step-fixed and are only fixed within a relevant range.

Mixed costs: It is assumed that all mixed costs are easily separated into fixed or variable. The high/low method can be used for this purpose but it is not always possible to do so. Selling Price: It is assumed that the selling price per unit is constant. It does not allow for sales price variations due to discounts given for bulk sales. Sales Volume: It assumes that production in a period usually equals sales and that there is no closing stock. Fixed costs are charged in total to a period and are not carried forward to the next period when valuing closing stock. Product mix: CVP can only be applied to a single product or to a constant mix of products. Comparing marginal costing and absorption costing 1. In marginal costing, fixed costs are charged in full to the period in which they have arisen, whereas in absorption costing, a share of fixed costs is carried forward into the next accounting period (i.e closing stock) 2. Clsoing stocks are valued higher under absorption costing because of the element of fixed costs and so accounts show higher profits 3. Absorption costing must be used for financial accounting to comply with regulation 4. Marginal costing is a very useful technique for decision making purposes. This is because the contribution concept is a great aid to profit planning

BUDGETING Capital budget This budget deals with any planned capital expenditure, e.g purchase of fixed assets, and planned capital receipts, such as

the sale of fixed assets, share issues, and borrowing. Decisions relating to these matters are the responsibility of the board of directors. Preparation of Capital Budget is the responsibility of the financial controller. Cash Budget  This budget is a plan that summarises the expected inflows and outflows of cash, usually on a monthly basis.  Highlights monthly surplises and deficits  Helps management to plan in advance for investing short term surpluses, or arrange a source of finance to cover short term deficits. Aims/advantages:  Ensures always sufficient cash is available to meet the levels of operations of the company  To anticipate periods of cash surpluses for short-term investment  To anticipate periods of cash deficits so alternative sources of finance can be arranged, e.g. bank overdraft Master Budget Once all the budgest have been prepared, a master budget is then prepared to provide an overview of the planned operations of the company for the budgeted period. It consists of a budgeted profit+loss account and a budgeted balance sheet. In the case of a manufacturing company, a master budget will comprise of a budgeted manufacturing account, a budgeted trading account, a budgeted p+l account and a budgeted balance sheet.