12 Disember 2025
10 Disember 2025
Non-manufacturing costs
Meaning
Costs outside the factory, i.e. selling, distribution, and administration. These are period costs and are not included in the cost of inventory.
Typical examples:
Selling and distribution costs
- Sales commission for sales staff.
- Advertising and promotion expenses.
- Delivery/transportation of finished goods to customers.
Administrative costs
- Office staff salaries (e.g. HR, accounts, admin).
- Office rent, office utilities, telephone, stationery at head office.
Manufacturing overhead costs
Meaning
All indirect costs related to the factory/production that are not direct materials or direct labour. Still part of product cost, but cannot be traced easily per unit.
Typical examples:
Indirect factory costs
- Factory rent or factory building depreciation.
- Factory electricity, water, and utilities.
Indirect labour and materials in the factory
- Salary of factory supervisor or maintenance staff.
- Indirect materials like lubricants, cleaning supplies, screws, glue, etc. used in production but not worth tracing per unit.
Prime costs
Meaning
Prime cost = Direct Materials + Direct Labour
These are costs that can be directly traced to each unit of product.
Typical examples for a manufacturer:
Direct materials – e.g. main raw materials used in production
Example: Wood, steel, fabric, or main components used to make the product.
Direct labour – wages of workers who physically convert materials into finished goods
Example: Wages of machine operators, assembly line workers who work directly on the product.
Differences between management accounting and financial accounting
|
Aspect |
Management
Accounting |
Financial
Accounting |
|
Report
frequency / timing |
Prepared
as often as needed (daily, weekly, monthly, by project, ad hoc). Often
uses future-oriented and real-time information for planning and
control. |
Prepared
periodically according to reporting cycles (usually quarterly and
annually). Mainly historical information based on past
transactions. |
|
User
orientation |
Aimed
at internal users: managers at all levels, department heads, project
leaders, budget committees, etc. Focus is on helping decision making,
planning, controlling, and performance evaluation inside the
organisation. |
Aimed
at external users: shareholders, investors, lenders, regulators, tax
authorities, and sometimes the public. Focus is on providing a true and
fair view of financial position and performance of the whole entity. |
28 November 2025
27 November 2025
22 November 2025
21 November 2025
Comparing traditional vs ABC
Product costs from a traditional absorption system (using only one volume base like machine hours or labour hours) can be less accurate than ABC for several reasons:
1. Not all overheads are driven by volume
- Traditional costing assumes most overheads change with units, labour hours or machine hours.
- In reality, many overheads are driven by activities (set-ups, inspections, order processing, material handling), not just volume. ABC captures this; traditional costing does not.
2. Complex / low-volume products get mis-costed
- A low-volume product that needs many set-ups, design changes, or special handling may use more support resources but not many machine hours.
- Traditional costing will under-cost this product because it looks “cheap” on machine hours. ABC will load more overhead onto it based on its high activity usage.
3. Simple / high-volume products may be over-costed
- A high-volume, standard product may use many machine hours but very few support activities.
- Traditional costing over-costs it by dumping a big share of overhead on it, while ABC charges it less because it consumes fewer activities.
4. Poor decision-making
Because costs are distorted, managers may:
- Set wrong selling prices,
- Drop profitable products (that appear loss-making under traditional costing), or
- Keep unprofitable products (that appear profitable).
ABC gives a clearer link between the cause (activity) and the effect (overhead cost), so product costs are usually more reliable for decisions.
How creative accounting affects ratio analysis
How creative accounting affects ratio analysis
Ratio analysis assumes that the numbers are fairly presented. If accounting has been “creatively” managed, then the ratios that depend on those numbers are also distorted.
Here’s how it can impact key categories of ratios:
(a) Profitability ratios
Examples: gross profit margin, net profit margin, ROA, ROE, EPS.
If revenue is accelerated or expenses are deferred:
- Profits are overstated → margins, ROA, ROE look stronger than they really are.
If provisions/depreciation are understated:
- Current profit is inflated, future periods may suffer (profit volatility).
Effect: Investors may believe the firm is performing well and growing, when it is actually just manipulating timing of income and expenses.
(b) Liquidity ratios
Examples: current ratio, quick ratio.
If the firm:
- Classifies short-term liabilities as long-term,
- Inflates current assets (e.g. overdue receivables not written down),
Then:
Current ratio and quick ratio can look healthy, even though the firm may struggle to pay its short-term debts.
Effect: Banks and creditors may underestimate short-term cash flow problems.
(c) Gearing / solvency ratios
Examples: debt–equity ratio, debt ratio, interest coverage.
Using off-balance sheet financing or misclassifying liabilities can:
- Understate total debt,
- Overstate equity (if assets are inflated and not impaired).
Interest coverage may look comfortable if profit is overstated.
Effect: Users may think the company has low risk and plenty of borrowing capacity, when in reality it is highly leveraged.
(d) Efficiency (activity) ratios
Examples: inventory turnover, receivables turnover, asset turnover.
If inventories or receivables are not properly written down:
- Inventory turnover may appear reasonable because obsolete stock is not recognised.
- Receivable turnover may look good while many debts are actually uncollectable.
Effect: Management may appear efficient while assets are not being used effectively.
(e) Trend and comparison analysis
Ratio analysis is often used to:
- Compare performance over time (trend analysis), and
- Compare with other firms (cross-sectional analysis).
Creative accounting breaks both:
Trend analysis
- If the company “manages” profit differently each year (e.g. big bath one year, then smooth profits), trends become meaningless.
- Growth in profit or improvement in ratios may reflect changes in accounting methods, not real improvement.
Cross-company comparison
- Different firms use different levels of aggressiveness in estimates and policies.
- A more conservative company may look weaker in ratios than an aggressive company, even though it is ctually healthier.
- This reduces comparability, which is one main objective of accounting standards.
Overall impact on users of ratio analysis
Because ratio analysis is only as good as the underlying data, creative accounting leads to:
- Misleading conclusions about profitability, risk, and performance.
Wrong decisions by:
- Investors (buying/selling shares based on inflated EPS, ROE).
- Lenders (granting loans based on manipulated gearing and liquidity ratios).
- Management (believing targets are met when performance is artificially boosted).
Loss of trust in financial reporting once manipulation is revealed.
So, when using ratio analysis, analysts should always remember:
Ratios are useful tools, but they are not foolproof.
If accounting numbers are distorted by creative accounting, the ratios will also be distorted.
In short
“Therefore, the usefulness of ratio analysis depends heavily on the reliability and integrity of the underlying financial statements. Creative accounting reduces that reliability, making ratio analysis less accurate and potentially misleading.”
Creative accounting
What is creative accounting?
Creative accounting is an act of using accounting choices, estimates and timing to manipulate reported results and financial position without telling users the full, honest economic story.
Common ways it is done:
1. Revenue recognition tricks
- Recognising revenue earlier than appropriate (e.g. before goods/services are really delivered).
- Using aggressive assumptions for long-term contracts so current year profit looks high.
2. Expense manipulation
- Capitalising costs that should be expensed (e.g. treating ordinary repairs as “assets”) to boost current profit.
- Deferring expenses to future periods (“parking” them under prepayments or intangible assets).
- Understating provisions (e.g. warranty, doubtful debts) so current expenses look lower.
3. Changing estimates and policies
- Extending useful lives of assets → lower depreciation now, higher profit.
- Changing inventory valuation method to improve gross profit.
- Adjusting bad debt percentages to “manage” profit.
4. Off–balance sheet and classification games
- Keeping liabilities off the balance sheet (e.g. certain leases, special purpose entities).
- Classifying liabilities as non-current instead of current to improve liquidity ratios.
- Reclassifying items in the cash flow statement to make “operating cash flow” look stronger.
5. “Big bath” behaviour
Taking huge write-offs in one bad year so future years look very good (cleaning the slate).
All of these may technically comply with standards if disclosed, but they distort the picture that users see.
The limitations of using ratio analysis to evaluate a firm’s performance and financial health
1. Ratios are only as good as the financial statements
- If the financial statements contain errors, are manipulated (“window dressing”), or use aggressive accounting estimates, the ratios will give a misleading picture.
- Example: Delaying expenses or recognising revenue early can make profitability and liquidity ratios look better than they really are.
2. Differences in accounting policies
- Firms may use different accounting methods (e.g. FIFO vs. weighted average, different depreciation methods, different impairment policies).
- These policy choices affect profits, assets and liabilities, making ratios across firms not perfectly comparable.
- International comparisons (IFRS vs local GAAP) make this even more problematic.
3. Historical cost and inflation
Financial statements are usually prepared on a historical cost basis. In periods of high inflation, asset values and expenses may be understated.
This can distort:
- Return on assets (ROA) – assets may be undervalued.
- Profit margins – revenues are at current prices, but expenses may be based on older, lower costs.
4. Lack of qualitative information
Ratios focus on numbers and ignore important qualitative factors, such as:
- Quality and competence of management
- Brand strength and customer loyalty
- Employee skills and morale
- Technological advantage, innovation, and R&D
- Regulatory or political risks
A company may look weak on ratios but have strong strategic prospects (or vice versa).
5. No universal “right” benchmark
A ratio on its own says very little. It must be compared with:
- Past performance (trend analysis)
- Industry averages
- Competitors
Even then, there is no clear “correct” level; judgement is needed. For example, a current ratio of 1.2 might be acceptable in a fast-moving retail business but risky in a capital-intensive industry.
6. Industry and firm differences
- Different industries have very different “normal” ratios (e.g. supermarkets vs. heavy manufacturing vs. banks).
- Even within an industry, firms may have different business models (online vs physical stores) that make direct comparison difficult.
- Using industry averages blindly may lead to wrong conclusions.
7. Short-term, static view
- Ratios are usually based on year-end figures; they provide a snapshot at one point in time.
- They may not reflect seasonal variations or intra-year fluctuations in sales, inventory and cash.
- A firm may look liquid at year-end because it reduced payables just before the reporting date.
8. Past performance may not predict the future
Ratios are backward-looking, based on historical data.
They may not capture:
- Upcoming new products or contracts
- Changes in technology or consumer preferences
- Future economic downturns or interest rate changes
A company with strong past ratios could still face serious future problems.
9. Difficulty in interpreting composite effects
One ratio can improve while another worsens. For example:
Profit margin falls but asset turnover rises → what happens to ROA overall?
Ratios are inter-related; focusing on a single ratio without understanding its relationship to others can be misleading.
Different analysts may interpret the same set of ratios differently.
10. Impact of one-off or exceptional items
- Non-recurring items (e.g. gain on disposal of a building, restructuring expenses, impairment losses) can significantly affect profitability ratios.
- If these are not adjusted out, the ratios may not reflect the firm’s underlying, sustainable performance.
11. Ignoring cash flow reality
- Many commonly used ratios are based on accrual accounting, not actual cash flow (e.g. profit margin, ROA, ROE).
- A company may show profit but have poor cash flow, which is more critical for survival.
- Without analysing cash flow ratios (operating cash flow to debt, interest coverage using cash, etc.), the picture is incomplete.
12. Different definitions and calculations
- There is no single standard formula for some ratios (e.g. some use average total assets, others use closing balance; some use EBIT, some use net profit).
- If the definition is not consistent, comparison across firms or across time may be invalid.
13. Conglomerates / diversified companies
- For companies operating in very different industries (conglomerates), industry averages become less meaningful.
- Group-level ratios may hide serious problems in a particular division or segment.
14. Possibility of ratio “management”
Management may take decisions mainly to improve ratios rather than to create real economic value, such as:
- Cutting R&D or marketing to boost short-term profit margins
- Selling assets to improve ROA
- Delaying necessary maintenance to reduce expenses
This can harm long-term performance even if the ratios look better in the short run.
In short
While ratio analysis is a useful starting point for evaluating performance and financial health, it has significant limitations.
- Ratios depend on the quality and comparability of the underlying financial statements, are affected by accounting policies, inflation and one-off items, and provide only a historical and quantitative view.
- They must therefore be interpreted with caution, in conjunction with other information such as cash flow analysis, qualitative assessments of management and strategy, and the broader economic and industry context.
Common Exam Tips for Students
1. Always find cost per unit for variable costs.
2. Never multiply fixed costs by units. Fixed costs stay the same.
3. Read the question carefully:
“Prepare a flexible budget for 6,000 and 8,000 units” → do two columns.
4. Show workings clearly:
- Variable cost per unit
- Fixed and variable split for mixed costs.
5. In discussion questions, mention:
- Fair comparison
- Better control
- Helps in decision making and performance evaluation.
How Flexible Budget Helps in Performance Evaluation
When actual output is different from budgeted output:
- Prepare flexible budget at the actual units.
- Compare Actual vs Flexible Budget, not Actual vs Original Budget.
This allows us to see:
- Are costs over or under control?
- Is the problem due to inefficiency or just different volume?
Simple Example (Numbers Made Easy)
Original budget at 5,000 units:
- Selling price per unit: RM10
- Direct material: RM10,000
- Direct labour: RM7,500
- Fixed overheads: RM8,000
Step 1: Calculate per unit for variable costs
- Sales per unit = RM10
- Direct material per unit = 10,000 ÷ 5,000 = RM2
- Direct labour per unit = 7,500 ÷ 5,000 = RM1.50
Fixed overhead remains RM8,000
Required: Flexible budget at 7,000 units
Sales:
= 7,000 × RM10 = RM70,000
Variable costs:
- Direct material = 7,000 × RM2.00 = RM14,000
- Direct labour = 7,000 × RM1.50 = RM10,500
Fixed costs:
Fixed overheads = RM8,000 (no change)
Flexible Budget at 7,000 units
| RM | |
|---|---|
| Sales | 70,000 |
| Less: Costs | |
| Direct material | 14,000 |
| Direct labour | 10,500 |
| Fixed overheads | 8,000 |
| Total cost | 32,500 |
| Profit | 37,500 |
Students can see:
- At higher units, sales and variable costs increase,
- But fixed cost stays the same, so profit increases.
Steps to Prepare a Flexible Budget
Step 1: Identify each cost as:
- Variable
- Fixed
- Semi-variable (then split into fixed + variable)
Step 2: Find variable cost per unit
For each variable item:
Example:
Direct material cost = RM15,000 for 5,000 units
RM15,000÷5,000=RM3 per unit
Step 3: Identify total fixed cost
Fixed costs stay the same at all activity levels (within relevant range).
Example:
Rent = RM4,000 per month (fixed)
Depreciation = RM5,000 (fixed)
Total fixed cost = RM4,000 + RM5,000 = RM9,000
Step 4: Prepare the flexible budget for the required activity level
For example, flexible budget at 7,000 units:
1. Sales
Selling price per unit × 7,000
2. Variable costs
Variable cost per unit × 7,000 (for each item)
3. Fixed costs
Same total as original (do not multiply by units)
Calculate:
- Total cost
- Profit = Sales – Total cost
Cost Behaviour in Flexible Budget
To prepare a flexible budget, students must understand cost behaviour:
1. Variable Cost
- Changes in total with activity level.
- Cost per unit is constant.
Example: direct material, direct labour, sales commission.
Total variable cost=Cost per unit×Number of units
2. Fixed Cost
- Total cost is constant (within relevant range), even if activity changes.
- Cost per unit will change.
Example: factory rent, supervisor salary, depreciation.
3. Semi-variable / Mixed Cost
- Has fixed part + variable part.
- Example: electricity, maintenance.
- Need to separate into fixed and variable elements before preparing flexible budget.
Why Do We Need a Flexible Budget?
Because actual activity is usually different from the planned activity.
If we compare:
Actual result at 7,000 units
vs
Original budget at 5,000 units
→ This comparison is not fair.
The flexible budget fixes this problem by adjusting the budget to the same activity level as actual.
Main purposes:
- To make a fair comparison between actual and budget.
- To help managers control costs.
- To show whether differences are due to:
- Change in activity level, or- Inefficiency / overspending.
What is a Flexible Budget?
A flexible budget is a budget that changes (flexes) according to the actual level of activity (e.g. units produced, units sold, machine hours, labour hours).
Static budget
= based on one activity level
Flexible budget
= can be prepared for many activity levels
(e.g. 5,000 units, 6,000 units, 7,000 units)
17 November 2025
The high–low method
The high–low method is a simple way to split a mixed cost into:
- a fixed cost part, and
- a variable cost per unit part
using only two data points: the highest and lowest activity levels.
1. When do we use it?
In cost accounting, some costs are mixed (semi-variable), e.g.:
- Electricity
- Maintenance
- Factory supervisor overtime, etc.
These costs change with activity, but not in a simple straight way.
We want a cost formula:
Total cost=Fixed cost+(Variable cost per unit×Units)
The high–low method helps us find the fixed and variable portions.
2. Steps of the High–Low Method
Step 1: Choose the highest and lowest activity levels
From your data (several months/periods), identify:
- The period with the highest units (or machine hours, etc.)
- The period with the lowest units
Important: We choose based on activity level, not highest/lowest cost.
Example data:
|
Month |
Units |
Total
Cost (RM) |
|
Jan |
6,000 |
12,500 |
|
Feb |
8,000 |
15,500 |
|
Mar |
10,000 |
18,500 |
|
Apr |
14,000 |
24,500 |
High activity: 14,000 units, cost RM24,500
Low activity: 6,000 units, cost RM12,500
Step 2: Calculate variable cost per unit
Using the example:
Step 3: Find the fixed cost
Use either high or low point in:
Total cost=Fixed cost+(Variable cost per unit×Units)
Using the high point (14,000 units, RM24,500):
Step 4: Use the formula
Now we can estimate the cost at any activity level, say 12,000 units:
Total cost = 3,500 + 1.50 (12,000)
=3,500+18,000
= RM21,500
3. Advantages & Limitations
Advantages
- Very simple and quick.
- Only need two data points.
- Good for a rough estimate (e.g., for exam/teaching, budgeting, quick planning).
Limitations
- Uses only highest and lowest points, ignores all other data.
- If high or low points are abnormal (e.g., one-off event), result may be misleading.
- Assumes a linear (straight-line) relationship between cost and activity.
4. Short definition (for exam)
High–low method is a technique to separate mixed costs into fixed and variable components by using the highest and lowest activity levels, calculating the variable cost per unit from the change in cost over the change in activity, and then determining the fixed cost from the total cost at either activity level.
15 November 2025
14 November 2025
13 November 2025
Langgan:
Ulasan (Atom)